Thursday, February 19, 2009

Ridiculous Euro Stability Pact

The Stability & Growth Pact (SGP) is an agreement by EU member states related to their conduct of fiscal policy. Under SGP, country members are not allowed to incur budget deficit of greater than 3% of their GDP

However due to the tough restrictions imposed, many economists & politicians from EU has criticised & called it as ‘stupidity pact’. Among the earliest that stirred controversies is non other than Romano Prodi, the President of the European Commission from 1999-2004. On 21st October 2002 he mentioned:

“Enforcing the Pact inflexibly and dogmatically, regardless of changing circumstances... is what I called - and still call – stupid”

Well, I do agree with him on several issues:

(1) Narrowly defined. First, the clause of not having a deficit between public spending & tax revenues over than 3% is somewhat vague. There is no detailed explanation regarding the composition of spending. In other word, it does not distinguish between incurrence of current spending like paying unemployment benefits, pensions, servicing debts etc which ‘does not add much value’ to the economy compared to investments on schools, hospitals, upgrade infrastructures etc which influence the AD in short run & AS in long run. In UK, all these are well addressed since Gordon Brown introduced himself a restriction called Golden Rule & Sustainable Investment Rule

Source: BBC

(2) Absurd restriction in period of recession. Many argued that the restriction should be increased e.g. 5% deficit of GDP. It makes much sense especially in the period like now where all those largest economies of Euro-land such as Germany, France, Italy etc has fallen into deep recession. In such period, the deficit will be magnified as government spending will automatically increase & yet there is shortfall in tax receipts. Also since unemployment picks up, real economy will shrink. France & Italy are among those which have already incurred large deficit. Forcing these economies to run balanced budget now will condemn any recovery efforts. Also it is one of the most solid reasons to explain for slow economic growth in major EU economies even before the mortgage crisis as government can’t spend

(3) Biasness towards larger government. Earlier in 2001, Portugal, France, Germany & Italy admitted that the deficit had breached the ceiling of 3% & ask for leniency e.g. longer duration to balance the deficit This infuriated Spain, Netherlands & other smaller member states which are close to balance. They argued that it is unfair for member countries that have to be frugal in spending

(4) Force some countries to under report the figure.
Tight restrictions had forced some countries to under report the deficit. Italy, Portugal & Spain are accused of doing so