Europe’s Empty Fiscal Compact

CAMBRIDGE – The driving force of Europe’s economic policy is the “European project” of political integration. That goal is reflected in the European Union’s current focus on creating a “fiscal compact,” which would constitutionalize member states’ commitment to supposedly inviolable deficit ceilings. Unfortunately, the compact is likely to be another example of Europe’s subordination of economic reality to politicians’ desire for bragging rights about progress toward “ever closer union.”

The plans for a fiscal compact have evolved rapidly in recent months, shifting from a politically unpopular “transfer union” to a dangerous plan for fiscal austerity and, finally, to a modified version of the defunct Stability and Growth Pact of 1997. In the end, the agreement that will emerge later this year will do little, if anything, to change economic conditions in Europe.

German Chancellor Angela Merkel initially proposed the “transfer union,” in which Germany and other strong eurozone economies would transfer funds year after year to Greece and other needy countries, in exchange for the authority to regulate and supervise the recipient countries’ budgets and tax collections. The German public rejected the idea of permanent transfers from German taxpayers to Greece, while Greek officials and the Greek public rejected the idea of German control over their country’s fiscal policy.

The next step was the fiscal plan that was agreed in Brussels at the end of last year, which completely abandoned the idea of a transfer union in favor of an agreement that each eurozone country would balance its budget. Under this scheme, a financial penalty would “automatically” be imposed on any country that violated that obligation. With balanced budgets everywhere, there would be no need for fiscal transfers.