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Business News/ Opinion / Europe needs a golden rule for spending
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Europe needs a golden rule for spending

Investment in long-term projects should not be factored into the deficit calculations

Photo: BloombergPremium
Photo: Bloomberg

The dilapidated state of infrastructure in Belgium, home to the European Union’s main institutions, has become emblematic of a lack of investment that blights the whole continent and, according to the EU itself, is creating “lasting bottlenecks that undermine productivity growth". This problem can be fixed, but probably not without reforming the bloc’s destructive restrictions on government deficit and debt levels.

The reason for the infrastructure deterioration is clear. To quote the European Commission: “Public investment has been structurally low for several decades, as a result of policy choices within a context of prolonged fiscal consolidation. It reached 2.4% of GDP between 2008 and 2015, slightly up from a pre-crisis average of 2.1% of GDP. Sustained cutbacks in investment budgets are reflected in net public investment (i.e. the capital stock corrected for use and wear), which has averaged zero since the 1990s, eroding the quality of public infrastructure."

Anyone taking even a short trip to Brussels would see evidence of this. Due to lack of maintenance over the past 20 years, all the city’s major tunnels have been closed on public safety grounds, creating the biggest traffic jams the city has ever experienced. Those travelling from Brussels to Luxembourg, where the European Investment Bank and other European institutions are based, will find there is no fast train; the highway has been similarly neglected, with extensive potholes often leaving a single lane to be shared by trucks and cars. According to Belgium’s leading newspaper Le Soir, one out of four kilometres of rail track, one electric substation out of five and half of all railway crossings need to be replaced.

It is important to understand the perverse impact the EU’s so-called Maastricht budget rules have had. The criteria take a blanket accounting approach to government spending. Budgets, Maastricht says, need to be balanced or at least not unbalanced beyond a certain point (3% of GDP for budget deficits and 60% of GDP for public debt). The principle, aimed at preventing snowballing debt, isn’t a bad one. But it has enhanced the baked-in tendency in politics to cut investment rather than expenses. Bridge repairs do not win the kinds of votes that social security handouts do, even if they are a prerequisite for long-term growth.

The fatal flaw of the Maastricht criteria is that all expenditure is treated equally. As a result, many European governments, like that of Belgium, cut new investment and skimped on maintenance. One exception that proves the rule is France, where the roads are superb, but public debt has climbed to more than 95% of GDP (the European Commission has mainly looked the other way).

This is not a uniquely European phenomenon, of course. According to the IMF, pubic investment in advanced economies has decreased to 3% of GDP in 2012 from 5% of GDP in the 1960s. Not surprisingly, the stock of public investment has steadily decreased, and ultimately growth has largely stalled. What is unique to Europe is that supranational rules implicitly encourage rather than discourage this behaviour.

The Belgian government has begun a programme to shore up the country’s infrastructure, led largely by the finance minister. A new plan for tunnel repairs over the next 15 years has finally been approved. Even the European Commission is starting to recognize the problem, qualifying its demand for spending cuts: “Safeguarding productive public investment from the consolidation effort would avoid a negative impact on future economic growth." These are good first steps, but bolder strides are needed.

The Maastricht Treaty should be revised to incorporate a “golden rule" for investment spending. That is, investment in long-term projects should not be factored into the deficit calculations. The European Investment Bank and the European Commission would need to assume a watchdog role in order to ensure that this fiscal leeway is not abused.

Treaty change would be difficult politically. It would require a qualified majority of states, and may trigger referenda. More fundamentally, it would constitute a paradigm change in the approach to public spending in Europe. That is much-needed, but also a big ask.

As economist John Maynard Keynes once said, “The difficulty lies not so much in developing new ideas as in escaping from old ones." BLOOMBERG

Jean-Michel Paul is founder and chief executive of Acheron Capital.

Comments are welcome at otherviews@livemint.com

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Published: 13 May 2016, 12:56 AM IST
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