For a Better Life in the Currency Union

Last spring, France voted herself a new president in Emmanuel Macron and a new legislative assembly whose majority is on the left but many of whose members denied being part of any party and who want to help the president in his program of reform and non-party politics.

Very recently, however, something unpleasant has intervened to disturb this train of events and shows us that the treaty of Maastricht is alive and well. The new French government was recently reminded of its legacy; namely that its current budget will be upset by unpaid items inherited from the socialist government of Monsieur Hollande, and thus the new budget will be unbalanced. It will have a greater than expected deficit of perhaps eight billion euros instead of the three billion euros permitted by the Maastricht treaty. The Macron administration wanted to break with the French tradition which is as old as the Maastricht treaty itself, by which Paris promises to present a budget of 3% or less and then breaks the promise by presenting a deficit above the Maastricht limit and pretending nothing wrong has happened. The Macron government wanted to “restore French credibility”. It has therefore reduced the budget allocation of the spending ministries, including that of the army, which was supposed to escape the cut by virtue of preceding promises. The army’s chief of staff was made to resign under somewhat humiliating circumstances. The army budget was cut and the approval rating of President Macron has sunk from the mid-fifties to 36%. The Macron presidency will survive this, but it will hardly praise the Maastricht treaty, which forced it to seek some credibility by paying a high price.

The Maastricht Treaty

The Maastricht treaty1 is supposed to ensure that the member states will grow in good years and bad at an average of 3% per annum. With such an average growth rate, the treaty allows each a budget deficit of 3% per annum (as a percentage of GDP). With good years and bad ones, 3% growth in the economy combined with a 3% annual growth in the budget deficit would result in growth of the national debt of the same percentage; that is, the national debt would be a constant load on the economy. However, unlike most of the well-bred mechanisms of economics, the Maastricht mechanism is seriously unstable, if not to say ill-bred. Once the average economy of the currency union has fallen below 3% growth—and we have become used to about 1.5% of late—an individual nation’s economy would presumably produce a budget deficit uncomfortably above the maximum 3% of GDP. Such an excessive deficit would transmit itself into an increase in the national debt by more than would allow the debt to be just a constant of the GDP. With each year that passed, the national debt as a percentage of GDP would be higher, while a budget deficit low enough to permit the national debt to again become constant would have to be lower and lower, and indeed the economy would need to run a surplus rather than a deficit. Very low economic growth would hardly be able to produce this. The best outcome we could hope for at this stage is to try an “austerity” budget with the lowest possible deficit, accompanied by a savage cut in the investment side of the budget, so as to make the consumption side with its welfare expenditures less severely treated. With lesser investment expenditures, the public sector (i.e., government and local authorities) will be even less able to produce an acceptable budget deficit. Again, it would have to be a budget surplus to arrest the growth of the national debt. Eventually, the solvency of the currency union would be in a danger zone.

It is plausible to conclude that the Maastricht mechanism is thoroughly unstable because once a nation is in this sort of disequilibrium, it cannot help but then move further and further away from Maastricht’s intended equilibrium. Is there any more stable alternative that would make the currency union more pleasant to live with? We are not arguing that the union is a good thing, but merely to try and discuss what would be a better kind of Maastricht treaty that might improve the union without threatening to abolish it.

A budget deficit, which is just a small residue compared to such much larger magnitudes as the total of the public revenue and expenditure, should not be the main factor or the sole guidepost for economic policy or indeed of a treaty that is supposed to regulate the behaviour of members of a currency union. A less fragile target would be the investment expenditure of the public sector. A new Maastricht treaty would ignore or subordinate the budget deficit. Instead, it would oblige the member state to maintain some normal investment budget, reducing it when economic growth is healthy and increasing it when it is below normal. The yield of such investments would be expected to be reflected in the budget and therefore by the increase or decrease in the national debt by a time lag estimated on the grounds of the quantity and the nature of the investment. In order to maintain the solvency of the national debt, the member state would cut consumption spending but would maintain investment expenditure. This would be taken as cruel by a large proportion of the public and indeed it would be cruel, but perhaps less so than the rather hopeless arrangements that the current mechanism of the Maastricht treaty obliges countries to respect.

Such a new arrangement would involve a good deal of study to adopt. There would be a temptation of trickery by member states to pass off consumption as if it were investment, for instance by subsidising kindergartens so as to permit the mothers to enter into the labour force while the state was looking after their small children. In fact, almost every consumption expenditure by the government would arguably be classified as investment of a somewhat philosophical kind. Health care expenditure would clearly be a candidate for being an investment in having people leading useful lives. However, most of these problems are likely to be resolved by practice.

Most worthwhile economic mechanisms have some self-correcting feature. The Euro currency union has not got one. Its mechanism depends on a fixed 3% maximum of the balance of the budget, and if that is not respected, the mechanism turns into a disequilibrium that feeds on itself. Investment is sacrificed and the growth of the economy sinks below its natural capacity. The alternative Maastricht sketch touched upon in this column is perhaps not much better, but it is at least worthy of some consideration given the current outlook.