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Comment & analysis / Comment Print article | Email
France is right to breach the stability pact
Published: October 9 2002 22:05 | Last Updated: October 9 2002 22:05

France faces a formal reprimand from its eurozone partners over its 2003 budget. It should stand its ground. If France is censured, dogma will have been put before sound economics.

There are two charges against the French government. First, it does not plan to bring its budget close to balance or in surplus by 2006 as required by the stability and growth pact, the European Union's deficit rules. Assuming growth of 2.5 per cent a year, Paris forecasts a budget deficit of 1 per cent of gross domestic product in 2006. Second, there will be no fiscal consolidation before 2004. The government plans to keep the deficit unchanged at 2.6 per cent of GDP in 2003, close to the EU's 3 per cent ceiling.

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France is being held to account because governments, the European Commission and the European Central Bank are worried that changes to the pact will undermine its credibility. But the pact's credibility has already been undermined by governments that have used one-off revenue-raising measures, made over-optimistic growth assumptions or shifted borrowing off the balance sheet. By attempting to stick to the letter of the pact, several governments have broken its spirit.

The pact is designed to ensure fiscal discipline and the sustainability of public finances in each eurozone country. It is also meant to allow fiscal policy to help smooth fluctuations in the business cycle, once a sustainable medium-term budgetary position has been achieved.

These are sound principles. However, the pact has serious shortcomings. It is a one-size-fits-all policy that makes no distinction between countries where there are concerns about debt sustainability and those that have very little debt. For most countries, there is no sensible economic rationale for achieving a balanced budget since this would ultimately reduce the ratio of public debt to GDP to zero. Few politicians would do this in preference to cutting taxes or increasing spending. Furthermore, balancing the budget can be painful.

There is no need for France to run a balanced budget by 2006. Last year, France's debt stood at 57 per cent of GDP. On the government's projection, debt will remain below 60 per cent for the next four years. That is surely consistent with debt sustainability.

It is also sensible for France to delay fiscal consolidation until the economy is stronger. Final domestic demand has stagnated in the eurozone area since spring 2001. The last thing the economy needs now is a tightening of France's fiscal stance.

Rather than inflicting unnecessary pain on France, the Commission and eurozone finance ministers should update the rules. Two modest reforms would remove the bias against growth without compromising the commitment to stability.

First, the pact should focus on what governments need to do to achieve debt sustainability - below 60 per cent of GDP - over the medium term. The appropriate budgetary position will vary from country to country but the eurozone as a whole could easily run a budget deficit of 1.5 per cent of GDP over the next four years while steadily reducing its debt as a share of GDP.

Second, governments should be allowed to run budget deficits above 3 per cent of GDP when these are clearly due to cyclical factors. This would prevent an inappropriate tightening of fiscal policies during downturns. If the eurozone were to aim for a structural budget deficit of 1.5 per cent of GDP, it would become more likely that governments would breach the 3 per cent deficit limit when growth slowed. This is already allowed under the treaty, provided the breach is exceptional and temporary and deficit remains close to 3 per cent.

These two reforms comply fully with the underlying principles of the pact and would resolve all of its main shortcomings. Yet neither requires changes to the treaty or even the formal wording of the pact. All that is required is for the Commission, finance ministers and the European Central Bank to take an economic rather than a legalistic interpretation of the rules.

A pact reformed along these lines could accommodate France's 2003 budget. More importantly, it would focus attention on the real culprits: Italy, Belgium and Greece have public debt ratios in excess of 100 per cent of GDP; Germany and Portugal are running budget deficits close to 3 per cent of GDP but their problems can be attributed only in part to weak growth. It is these countries that deserve closer scrutiny, not France.

The writer is chief European economist at Goldman Sachs

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