Much of European politics and economic policy can get lost in clumsy jargon and arcane decision-making processes. However, that does not make it any less important. For liberal democracies, free market economies and indeed the global order, Europe matters. Faced with a bellicose aggressor on its borders and the systemic rival that is China, the world has never needed a strong, prosperous and unified Europe more.

The latest debate, however, on what sounds like an esoteric piece of random European economic vernacular — the reform of the universally maligned Stability and Growth Pact — threatens to hobble the process of integration and progress just when it is needed most.

The origins of the dysfunctional Stability and Growth Pact, like many of the problems of Europe, can be traced back to the deeply flawed if spectacularly ambitious path towards the introduction of the single currency in 2002. It was meant to be the monetary assurance underpinning the common market and European project, but sadly, such have been the inadequacies of the half-formed creature which is the euro that it has all too often threatened to blow up the entire edifice. 

The Eurozone has a single European Central Bank, which inherited a hawkish bent from the Bundesbank. There are fiscal rules limiting deficits and setting debt ceilings (the Stability and Growth Pact). But there is no unified economic policy, no unified regulatory structure for banking, no common fiscal policy or treasury, and — perhaps most importantly — there is limited appetite for further integration.

For the first years it performed tolerably well, but it was clear that if faced with an exogenous shock the bloc did not have the tools required to survive. This crucial moment arrived in 2008 with the financial crisis and subsequent Eurozone meltdown.

As Alberto Alesina, Carlo Favero and Francesco Giavazzi have argued in the masterful book Austerity, Stability and Growth Pact fundamentalism and austerity were counterproductive on their own terms. EU countries that were forced into cuts to public expenditure alongside tax rises ended up with higher debt levels because cuts led to lower GDP growth and lower tax revenues. Even the International Monetary Fund has admitted that “because fiscal consolidation tends to slow GDP growth, it tends to have a negligible effect on debt ratios”.

Fiscal and monetary policy must be coordinated if any economy is to consistently grow, increase productivity and reduce its debt burden. The Stability and Growth Pact meant that not only were eurozone member states precluded from having any freedom over their monetary policy, they were also stuck in the straitjacket of an ordoliberal rule-based fiscal policy, incapable of responding to any exogenous demand shocks. Any downward lurch in economic activity would be met with procyclical and not countercyclical responses, greatly exacerbating the economic, political and societal ill effects of a recession.

Thankfully, by the time of the Covid crisis it had become generally accepted that these rules were not fit for purpose and were suspended — with the common understanding that before being reimposed they would be comprehensively reworked.

The first draft of reforms to the Stability and Growth Pact was put forward last week by EU economics commissioner Paolo Gentiloni. Like so many proposals in Europe, it managed to disappoint everyone equally.

Christian Lindner, Germany’s hawkish finance minister of the Free Democrats, said the proposed reforms did not go far enough to tackle high debt levels. In a recent letter to the Financial Times, he said that the Stability and Growth Pact should be strengthened, a tirade in the mould of the former Dutch finance minister Jeroen Dijsselbloem, who at the peak of the eurozone crisis said that southern Europeans wasted money on “drinks and women”.

France took an opposing view, saying that aspects of the budget regime were too rigid, while Italy complained that it gave too little scope for essential investment spending in areas like the green transition. Giancarlo Giorgetti, the Italian finance minister, said “Germany demands geometrical, numerical rules” which are “absurd”.

It is unclear where it will come out, other than in all likelihood ensuring that no one will get the outcome that anyone wanted and instead everyone will be stuck with a universally suboptimal result. 

What is clear, however, is that leadership is sorely lacking. Following his recent travails at home, French President Emmanuel Macron has lost whatever credibility he once had at a European level. By continuing to pander to the meddlesome Free Democrats to ensure his rickety coalition does not fall apart, German Chancellor Olaf Scholz has proven that he is no leader on a European stage, but rather a stooge to minority domestic interests. And Giorgia Meloni, while admittedly far more progressive on Europe than had been feared, is light years away from the heavyweight that was former Italian PM Mario Draghi.

The days of the likes of Macron, Merkel and Draghi driving European reforms and integration forward are over. It is unclear who will take over. Right now, the engine is sputtering. Faced with more existential threats than ever, it is critical that someone cranks it into gear before it risks going into reverse. DM/BM