Europe’s fiscal Constrains Preventing it from Progressing?

Everyone knows the European Union seeks “strategic autonomy.” The coming months will demonstrate to the rest of the world if it is serious. 

Strategic autonomy refers to Europe’s ability to make decisions based on its own interests and ideals, regardless of what others do. It’s a sensible reaction to a world that has become less hospitable to Europeans, in which Russia has troops on the Ukrainian border, China is exerting pressure on Lithuania, and the US has pulled out of Afghanistan, leaving thousands of Europeans and their Afghan allies stranded. Is Europe, on the other hand, prepared to go to any length to increase its maneuverability? That isn’t the case. 

Defense spending is one obvious example. In the EU, they totaled to 1.2 percent of GDP in 2019, with only Estonia and Greece approaching NATO’s 2 percent of GDP spending target. These spending levels appear to show that Europe is content to continue to rely on the US security umbrella. 

However, there is one area where the EU relies on others’ decisions rather than its own: the economy. 

Since the financial crisis of 2008, the EU has been increasingly reliant on the rest of the world for economic support. The eurozone’s account balance with the rest of the world was neutral before the crisis. Despite significant internal imbalances, its net exports were roughly equal to the value of its imports. 

However, the eurozone periphery’s reaction to the crisis, which primarily consisted of austerity measures, stifled consumption and investment. Spain, Italy, and Ireland all went from having trade deficits to having trade surpluses. Although the euro has been saved, Europe now relies on external demand to fuel development and job creation. The EU’s account surplus was 3.4 percent of GDP in the first quarter of 2021. Europe’s ability to act independently is harmed by this dependence. As the unprecedented pandemic spending expires, a hasty return to austerity will further exacerbate the problem. The ongoing review of EU fiscal regulations will serve as a critical key test for whether the EU is ready for change. There are essentially two factions here: 

This camp wants the Stability and Growth Pact to be reinstated in 2023, with fiscal deficits limited to 3 percent of GDP and debt-to-GDP ratios of less than 60 percent quickly reduced, or facing fiscal tightening through the European Commission’s excessive deficit procedure. 

The second contends that the pandemic just highlighted existing flaws and that the EU’s economic framework should be evaluated and altered to encourage investments in decarbonization, technology, infrastructure, and defense. It intends to build on the EU’s pandemic experience with fiscal solidarity and mutual borrowing, as well as move closer to a healthy union with shared vaccine purchasing and R&D spending. 

This side does not necessarily demand a complete renegotiation of the Stability and Growth Pact, but it does want investments in green and digital transitions to be exempt from debt and deficit targets for member nations. With EU government debt reaching 93 percent of GDP – over 100 percent in the euro area – a sharp shift from growth to austerity is unlikely, particularly if it comes at the expense of productivity-boosting investments in human and physical capital. 

The unwillingness of Germany and other core eurozone countries to borrow money and mutualize debts has hampered not only investment in digital and green infrastructure, but also the internationalization of the euro, as there are no vast pools of safe euro-denominated assets for foreigners to hold, as there are with US treasury bonds. 

The dollar’s dominance in global payments, and the financial system’s resultant centrality, is one of the main reasons why Brussels was unable to protect European companies facing US sanctions over the Iran nuclear deal. 

At least at home, the new German coalition government appears to be more prepared to invest. And, if Europe can rethink its financial objectives and stick to its reform agenda, it will be able to increase future productivity, sustainability, and security while lowering the continent’s vulnerability to foreign economic shocks. Because of low borrowing rates and higher-than-expected social costs of carbon, these expenditures are likely to be less expensive than policymakers believe. However, they will necessitate the EU deciding what it values and allocating resources accordingly.