Europe Struggles With Painful Deficit Cures

WSJ: BRUSSELS—A pledge by European Union governments to bring their swollen budget deficits back in line with EU rules by the end of 2013 is causing economic pain and political discontent across Europe, prompting officials to begin a politically sensitive discussion on how the goal could be changed to avoid driving the Continent further into turmoil.

 

The target, set in 2009, is still seen as an important signal that the budget rules won't be flouted as they were in the past. But meeting the 2013 goal, which for most countries was a deficit of 3% of gross domestic product, will entail more spending cuts or tax increases by governments across the EU.

These further measures will come with the European economy already reeling from earlier rounds of austerity and the fallout from the sovereign-debt crisis. The euro zone is teetering on the brink of recession, and unemployment in the currency area is at a record high.

 

The political consequences of austerity are becoming apparent. The Dutch government, one of the EU's main enforcers of fiscal orthodoxy, collapsed this week over disagreements about spending cuts and taxes that will be needed to bring the deficit under 3% of GDP next year. François Hollande, the French Socialist candidate who is favored to defeat incumbent President Nicolas Sarkozy in next month's election, has made a pledge to soften Europe's austerity policies a central plank of his campaign.

 

Even the relatively new center-right government of Spanish Prime Minister Mariano Rajoy, which already got into a fight with EU bureaucrats in Brussels over its plans to soften scheduled budget cuts, faced unexpected weakness in regional elections last month, a sign the Spanish public is becoming increasingly weary of recession.

 

The hope in 2009 was that Europe would have firmly emerged from the crisis by at least 2011, the deadline the bloc set for all EU nations to start cutting their deficits. But the sovereign-debt crisis, weighty private-sector debts and the surprisingly large impact of austerity have combined to drag Europe back toward recession.

"Achieving deficits of no more than 3% of GDP by next year is not achievable for a large number of euro-zone countries," said Marie Diron, director of macroeconomic forecasting at the consulting firm Oxford Economics. "In many cases, this crisis is the opportunity to implement structural changes to public finances that would have not been possible otherwise. But pursuing fiscal objectives at all costs is extremely damaging to growth."

 

Some of the EU's policy makers acknowledge the problem, yet they fear that changing the 2013 target will shake the confidence of financial markets in their dedication to deficit-cutting. Some governments, led by Germany, are likely to oppose any adjustment.

 

"The debate is not to be excluded," said one EU official, "but it could give a signal that we are easing up at a time when we are struggling to show that we can keep the system."

 

An official from a euro-zone national government said that "We will have to, one way or another, adjust the trajectory of the budget-cutting path."

 

Officials say the discussion, in its early stages, is likely to heat up in coming weeks, when governments are supposed to submit their budget plans to the European Commission, the EU's executive arm, and other governments for review.

 

The gravity of the situation confronting a number of governments is starting to change the debate. Spain will be forced to cut its deficit by 5.5 percentage points over the next two years, a Herculean task given that the unemployment rate is around 23% and the economy is likely in recession.

 

The Netherlands is facing a deficit of 4.6% of GDP next year without further cuts, the government's economic analysis agency said last month. These cuts will be coming in the face of strong headwinds: The economy is expected to contract this year. Consumer confidence is weak, weighed down by falling real-estate prices and the large mortgage debts of Dutch households.

 

France, too, will have to cut its deficit to 3% of GDP from around 5.2% by the end of 2013 with its economy barely growing. The IMF last week projected that the French deficit would be 3.9% without further cuts. The rules apply even to countries outside the euro zone. The U.K., with one of the EU's highest deficits at the start of the crisis, was given an extra year to cut its deficit to 3%, but it too is in danger of missing the target.

 

One option floated by some officials involved in the debate would place the actual budget deficit on an "equal footing" with the "structural" deficit, which is what the deficit would be if the economy were operating at full capacity. That isn't an easy figure to calculate, but it is meant to account for the fact that a recession depresses government tax revenue and increases spending on things like unemployment benefits. Once the economy recovers, a country with a small structural deficit should see its actual deficit contract sharply.

 

Write to Matthew Dalton