Europe's Twin Messages: Spend! Stop Spending!

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Front, from left: British Prime Minister Gordon Brown, German Chancellor Angela Merkel and French President Nicolas Sarkozy take their places for a group photo after a G20 preparatory meeting in Berlin on Feb. 22

There's an odd game going on in Europe. As European governments dip into their coffers and borrow madly in an attempt to repair their economies, the European Union is cheering and jeering at the same time. The cheers are for the economic-stimulus packages; the jeers come because all that spending is blowing budgets by margins that E.U. rules expressly forbid.

The simultaneous applause and admonition reflect the paradoxical role of the European Commission. Often described as the engine of European integration, the Commission also is responsible for disciplining individual member states that violate E.U. rules. The rules in question are part of Europe's Stability and Growth Pact set up in 1997 amid German concerns over budgetary discipline in countries about to join the euro zone. Designed to discourage governments from destabilizing the euro zone by borrowing too much, the rules limit national deficits to no more than 3% of gross domestic product. Countries that go over that limit can face fines. (See pictures of Europe in peril.)

But the need for urgent action during the financial crisis has caused some schizophrenic behavior. Last fall, the commission encouraged E.U. member states to agree to stimulus programs worth around $250 billion, arguing that the crisis demanded radical action. But last week, the very same body said six E.U. countries — France, Greece, Spain, Ireland, Latvia and Malta — had breached the 3% limit and might now be punished.

To be fair, the Stability and Growth Pact's credibility was straining long before the downturn. Most E.U. member states have run budget deficits beyond the 3% ceiling from time to time, while many have breached the pact's other main criterion: that national debt stay below 60% of GDP. Germany, the pact's main proponent, has been one of the most consistent abusers of the budgetary rules. In 2002, then president of the European Commission Romano Prodi even described the rules as "stupid."

So why threaten countries now? Simon Tilford, chief economist at the London-based Centre for European Reform, says any attempt to stick with the pact through the global economic crisis could unleash a political crisis. "Against a backdrop of recession or economic stagnation, painful spending cuts would be extremely difficult for any government to sell to voters," he says, questioning whether such reductions would even succeed. "Drastic cuts in spending or [raising] tax risks deepening the recession, which would in itself prevent an improvement in the fiscal position."

The commission predicts the E.U. economy will shrink 1.8% in 2009. That's going to make borrowing crucial. Ireland's budget deficit is projected to rise to 13% of GDP by 2010; Britain's could hit 9.6%. France and Germany are both expected to blast through the 3% ceiling. The region's debt figures are just as dire. (See pictures of the financial crisis hitting London.)

Facing such a woeful economic outlook, E.U. monetary-affairs commissioner Joaquin Almunia has struggled to make the case for fiscal rectitude. He insists the pact is flexible enough to allow short-term stimulus programs. "During the recession, the pact is not about sanctions," he said last week. "But in the medium term, we need to continue a process of consolidation of the public finances. The rules were established for everybody and must be respected."

Yet all but one (Luxembourg) of the E.U.'s 27 members expect to break the deficit ceiling in the coming year. In such circumstances, the E.U. should suspend the pact immediately, says Daniel Gros, director of the Brussels-based Centre for European Policy Studies. "It means it doesn't break — it bends. And it is ready to bounce back," he says. "We could then reaffirm them when we have a better idea of where the economy is going." Not that anyone knows when that will be.

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