The stimulus package: How much is enough - and what for?

At first glance, the economic recovery plan unveiled by the European Commission yesterday (November 26) sounds impressive: €200 billion to kick start Europe’s flagging economies through a “timely, targeted, temporary and coordinated” package of measures.

 

While the package mainly focuses on action at Member State level (for example, recommendations on spending and taxation, including “smart investments” in innovation and labour markets), it also contains significant proposals for EU action, such as front-loading structural and social funding, spending more on energy and broadband infrastructure, and increasing the funding made available by the European Investment Bank by €15 billion in 2009.

 

But a note of caution is necessary. The economic climate remains volatile and it is unclear whether this package will do enough to mitigate the impact of the crisis – particularly as it is highly likely to be watered down when EU leaders meet to discuss the proposals at their December Summit.

 

Even if it remains intact, no one is claiming that Europe can escape the current downturn. It is also clear that public finances will remain under severe pressure and the Stability and Growth Pact’s 3% of GDP ceiling on budget deficits will have to be temporarily relaxed for an ever-wider number of countries.

 

However, the package might help ease the pain: it could make the coming recession shallower and shorter by giving a counter-cyclical impulse, which could prevent a downward spiral of low confidence leading to reduced investments. It should also help to prevent a ‘free-for-all’ by giving Member States more flexibility to act but within clearly-defined EU rules, and is in line with the broad goals of the Lisbon Agenda.

 

Focusing on using EU spending to greater effect can also help, although it must be recognised that the scale of the EU budget - 1% of the Union’s GDP - is only a fraction of national budgets.

 

Here lies the crux of the problem for the Commission. Besides influencing the national decisions, the EU has few competences to act in this area. Taxation and spending remain firmly in the hands of the Member States. The current package reflects this - and it is unlikely to change in the near future.

 

This creates a significant problem: while almost everyone agrees that a decisive and coordinated European response is necessary, Member States will not countenance letting a strong Commission direct spending of national funds or set tax rates. The Commission itself also rightly recognises that one size does not fit all in the current crisis and that the room for manoeuvre is very different in different Member States.

 

But behind it also lurks a basic contradiction of European policy in recent years: while more and more is demanded of the EU across a wide range of areas - be it energy security, climate change, the financial crisis or the impact of globalisation - these demands are not accompanied by a transfer of responsibilities or money from the Member States to the Union.

 

There are, however, some levers the EU can use in the current crisis. It is tasked with upholding the principles which underpin the Single Market, for example through the application of procurement, state aid and competition rules. With the Lisbon Agenda, the EU also received a mandate to monitor and drive forward structural reform. Finally, the excessive debt procedure means that the Commission can ‘name and shame’ Member States when they pursue unsustainable fiscal policies.

 

The Commission can, and should, use these tools to put its stamp on Member States’ actions, ensuring that economic policies follow key principles, including cross-border competition and long-term fiscal consolidation.

 

The EU must safeguard the single market, making sure that spending does not favour national ‘champions’. Instead of using money to prop up already struggling firms, investments should be made in human capital and active labour market policies aimed at getting people back into work as well as encouraging innovation and competitiveness. Tax cuts should stimulate additional labour market participation rather than focusing on just boosting short-term, debt-financed consumption.

 

Structural reform remains a key issue for Europe’s economies. Rather than slowing down the pace of reform, Member States need to use the current crisis to reduce unsustainable spending and to enhance the business environment. Government policies need to support structural reform to improve the delivery of public services and to build solid foundations for the future rather than trying to preserve the economic structures of the past.

 

For example, spending on specific sectors should be conditional on businesses preparing for the future ‘green knowledge’ economy. There should not only be tax cuts but also reform of tax systems, and incurring additional government debt should only be sanctioned if Member States can show they have long-term plans in place to make sure that their fiscal position will be corrected and improved after the current crisis.

 

So how does the package perform in this light? Overall, not bad. It contains many of the right policy recommendations and underlines that countries’ deficits will be assessed against how well they have performed in relation to the Lisbon Agenda reforms. Recommendations on reducing payroll taxes or investing in eco-innovation and energy efficiency are steps in the right direction and might help to safeguard some European jobs in sectors threatened by the crisis as well as creating new areas of competitive advantage.

 

But the key test will be how it is implemented. Will the Commission stand up to Member States to prevent policy decisions which will harm Europe’s long-term competitiveness? Will it have the courage to criticise unsustainable fiscal policies and protectionist tendencies brought in under the guise of fiscal stimulation? Will it limit the use of public funds to bail out uncompetitive firms and sectors?

 

Ensuring sound long-term economic policies while at the same time convincing the Member States to support and implement the package in word and deed is akin to walking a tightrope. This is likely to be the main challenge for the Barroso Commission between now and the end of its mandate - and it is also likely to be an important factor when analysts come to judge the success or failure of its economic policies.

 

The stakes are high, not only in terms of softening the impact of the current crisis but also in setting Europe’s economies on the right track for future growth.