The Proposed E.U. “Competitiveness Pact”

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Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance

The recent public debt crises in Greece and Ireland have put forward the issue of sustainable public debt in many of the developed industrialized countries. This crisis, like the mortgage crisis of 2008 and many other crises, stems from the extensive low cost flow of credit in recent years. Debt growth seemed harmless and innocent enough in an era of optimism, rising assets’ valuations and seemingly robust economic development. Unfortunately, for different inherent reasons, these debt bubbles started to burst for Greece and Ireland and the future looks gleam for many other heavily indebted countries in Europe, North America and Asia. The European Union, acting rather sluggishly, has, finally, put in place the European Financial Stability Facility (EFSF), a mechanism for dealing with bailouts of heavily indebted EU countries that are a threat to the economic stability of the Union and the Euro. As it is common for economic policy in the European Union, member states and the corresponding institutions that are responsible for designing it, act in panic or on undisclosed agendas. The last example is the proposed by France and Germany “competitiveness pact” that includes, among many others, increasing retirement age limits even for the countries that face no pension fund problems, setting minimum corporate tax rates across-the-board within member countries and applying constitutional provisions in all member states for implementing balanced budgets. These arrangements in the “competitiveness pact” may be problematic for two reasons:

First, it is true that the Greek, US, Portuguese and Irish examples with over spending and enormous debt to GDP ratios is clearly unsustainable in the long-run and wrong. But on the other hand debt is not a priori bad (and I do not consider myself a Keynesian economist). Incorporating a balanced budget restriction to member states’ constitutions can create serious fiscal problems in the long-run in the case of adverse business cycles fluctuations as there is no financial flexibility for the government and the country as an extension to smooth out recessions. No nation in history ever achieved significant levels of growth using such a provision. Debt is an instrument of growth when used correctly and wisely within the context of a long-run growth plan or as a short-run policy for economic stimulation. There is no company or government no matter how small or big, developing or developed that has no debt. Debt is used to finance long term growth: building infrastructures and financing development. Moreover, debt can and must be used to alleviate and smooth-out intertemporally possible adverse short-run shocks to the economy stemming from oil, financial and stock market crises, adverse weather conditions etc. Even in personal finances, a balanced budget means that there is no chance to borrow money for any extraordinary situations like an adverse income swing or job-loss, not even being able to borrow money to improve future working and living standards i.e.: a student loan to finance a graduate degree, to start a new business, to buy a nicer car or house, etc.

Second, the proposed “pact for competitiveness” as proposed by Germany and France to be adopted by all EU countries in the next six months, can prove to be exactly the opposite of what its name implies. It is a pact aimed by the two countries to preserve the current status quo in competitiveness, their dominance in Europe with no possibility for other countries to compete and attract international investments. Even in countries that are far more integrated and homogeneous than EU, the local governments, such as the States in the US or the Provinces in Canada, can choose and alter their tax regimes and other macroeconomic policy variables to compete within the country. Such a “competitiveness pact” would impede competition within EU member states and make the convergence of peripheral economies’ growth paths to the core economies simply impossible. How could a small country like Greece, Ireland and Portugal compete and increase its growth rates in the effort to converge with the leading EU economies when borrowing from one hand would be impossible and on the other fiscal policies like lower taxation are constitutionally out of the question?

The implementation of economic policy for any economy is based on two pillars: monetary and fiscal policy. Monetary policy has more than ten years ago been ceded by EU’s member states to the European Central Bank with the creation of the Eurozone and the introduction of the euro. Now, constraining fiscal policy with a constitutional provision for balanced budgets will leave national governments with no instruments to implement economic policy targeted towards greater convergence, economic growth and social policies. The current growth and development gap will become permanent if not growing.

About the Author:
Dr. Periklis Gogas is a faculty member at Democritus University of Thrace and an adjunct lecturer at the Greek Open University teaching Macroeconomics, Banking and Finance. He is also a Financial Consultant for Gerson Lehrman Group, Austin, Texas. He received his from the University of Calgary with supervisor Dr. Apostolos Serletis and worked for several years as the Financial Director of a multinational enterprise. His research interests include Macroeconomics, Financial Economics, International Economics and Complexity and Non-linear Dynamics.

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