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No cost to Sweden to join the EU fiscal pact
02-02-2012 15:22
The EU countries have agreed on a fiscal pact. Only Britain and the Czech Republic have chosen to opt out. Sweden is expected to join the pact as it is already clear there is a parliamentary majority in favour of voting yes now that the Social Democrat terms for this have been met.
However, there are still people in Sweden concerned about Sweden's decision to opt in. There seem to be several reasons for this. Such as the fear that Sweden is entering the Euro zone by the back door, despite the referendum vote in favour of keeping the krona. It is also felt that the Euro countries are misguided in tightening their economies to an extent that reduces demand. The risk is that higher levels of unemployment will take a firm hold. There is also a belief that the Euro crisis is not a result of poor budgetary discipline, with Ireland and Spain in particular held up as illustrations that other causes lay behind the crisis. A belief that would argue the fiscal pact will not help in resolving the crisis.
There is no risk of Sweden joining the Euro as a consequence of being in the fiscal pact. A new referendum would be required to agree to that. The Euro zone needs to resolve the crisis first, and there must be support amongst the Swedish electorate that joining would benefit Sweden politically and economically. Sweden was already a member of the Stability and Growth Pact. We have already accepted the requirements of not having a deficit greater than 3% of GDP and government debt below 60% of GDP. What is new about the fiscal pact, that the structural deficit should be no larger than 0.5% of GDP, is something Sweden is meeting through stricter budget discipline on the domestic front, i.e. a surplus target of 1% of GDP over the business cycle, an expenditure ceiling and a tighter budget process. We have plenty of experience of this standard policy, and when the EU follows suit, it is reasonable to support the idea. It also gives us a slightly better opportunity of being involved and influencing economic policy in the Euro countries.
The Euro countries are facing demands to tighten their fiscal policies regardless of the fiscal pact. The financial markets are not prepared to continue lending to Greece and Portugal without high risk premiums that will either make borrowing more expensive or raising money on the ordinary credit markets impossible for these countries. This means these countries need a rescue package from public lenders – a situation that is not sustainable. The Euro countries ought to be given time to get down to a 0.5% structural deficit – if austerity is far too rushed, this could jeopardize economic, political and social stability. The fiscal pact will deliver greater budgetary discipline in the medium term and should be combined with other measures that boost growth and competitiveness. Sweden implemented structural reform after itsfinancial crisis in the 1990s, which delivered positive effects several years later.
The Euro crisis is not purely a consequence of too lax budget discipline. Private debt has also risen sharply in certain cases, such as in Portugal. Too little has also been done to improve competitiveness in the private sector. However, the margins have not been there in the public sector to withstand crises, as the budget target then was 3% deficit on GDP. This meant several countries had a high deficit even in good times. By agreeing on a structural deficit the incentives are greater to generate surpluses in good times and to live with deficits in bad times.
Will the fiscal pact help resolve the crisis? No, not in the sense of placating the finance markets such that risk premiums fall. On the other hand, greater stability in the longer term will send a signal to other institutions that can help to resolve or ameliorate the crisis. This has probably made it easier for the ECB to be able to provide substantial liquidity support to European banks, which in their turn have bought government bonds from the crisis countries, something that has caused interest rates to fall. Problematical credit restrictions that hamper companies and households can then also be eased. The ECB is buying time for the politicians, although if the fiscal pact had not been negotiated, it would have been difficult for the ECB to continue its lending with the risk of a systemic crisis in the banking sector and a collapse of government debt still following later.
The fiscal pact is by no means a universal solution for the Euro crisis, but it is a small step on the way to strengthening the institutions necessary to create a properly functioning currency union, that is to say, fiscal policy union, financialunion or a common bank regulator, and a central bank that can act as the lender of last resort – for both banks and governments. There is little call for fiscal policy union, but the pact will create greater cooperation.
In the meantime, rescue funds such as the EFSF and ESM will have to continue to transfer resources from the richer countries to the poorer ones – something that is in breach of the EU Treaty but which has had to happen as a consequence of the ongoing crisis. This is hardly a sustainable solution, but until the right institutions are in place – and this can take several years – this is the temporary solution that is available. However, the rescue funds will have to be larger and more flexible. If not, the financial markets will continue to speculate on the breakup of the Euro zone and keep risk premiums for lending to crisis countries at an unsustainably high level – and that was hardly the thinking behind the currency union, was it?
Cecilia Hermansson
