Europe’s fiscal tug of war

Welcome back. At the heart of European economic policymaking, there’s a problem that cries out for a solution. On one hand, EU governments need to keep their budget deficits and public debts under control.

On the other, they need to spend large sums on defence, infrastructure, clean energy, digitalisation and other areas in order to strengthen Europe’s security and improve economic performance.

At first sight, these two objectives appear irreconcilable. Is there an answer that makes economic sense and is politically plausible? Let me know at tony.barber@ft.com.

First, the result of last week’s poll. Asked if Russia would win the war in Ukraine, 45 per cent of you said no, 30 per cent said yes and 20 per cent were on the fence. Thanks for voting!

France’s daunting deficit

Europe’s conundrum is on full show in France. In a report this week on the belt-tightening proposals of Michel Barnier, the prime minister, the FT’s Leila Abboud, Delphine Strauss and Alex Irwin-Hunt wrote:

After 50 years of failing to balance its budget, France wants to narrow its deficit next year with €60bn worth of tax rises and spending cuts . . . 

The budget shows that [President Emmanuel] Macron’s era of business-friendly reforms are on the backburner as cleaning up public finances becomes a priority both for Brussels and investors.

Barnier and his advisers are right to be concerned about financial markets. The French 10-year government bond yield rose last month above that of Spain, which has often been seen (unfairly, many in Madrid would say) as a riskier investment than France.

This reflects unease on three fronts. France’s budget deficit is expected to exceed 6 per cent of GDP by the end of this year; Barnier’s government lacks a parliamentary majority; and Macron is essentially a lame duck who could be replaced by a far-right president after the 2027 elections.

So, yes, markets and the business community in general want France to put its fiscal house in order. However, they don’t want to see a reversal of the pro-business reforms introduced after Macron won the presidency in 2017.

In another FT report from Paris this month, one banker summed up the question that senior executives are asking each other: “Is France still business-friendly?”

Another question is how France is supposed to boost investment in defence and infrastructure when a no less urgent priority is to curb the deficit.

In theory, the government could slash spending on the welfare state and related areas — but who is willing or able to do that in a polarized political atmosphere ahead of the 2027 elections?

Italy’s colossal debt

A similar dilemma confronts Italy’s government. As regards the public finances, the conventional wisdom has it that the chief problem is Italy’s sky-high public debt, illustrated in the chart below:

However, since the euro’s launch in 1999, Italian governments of all political complexions, including the present right-wing coalition, have generally taken a cautious approach in budgetary matters. They often run primary surpluses — that’s to say, net of debt interest payments — as is expected to be the case next year.

Moreover, Italy’s public debt management agency is skilled at keeping debt repayment schedules under control. A final point is that, when we consider the relatively low levels of indebtedness among non-bank corporations and households, Italy’s overall debt picture looks less alarming.

All the same, there is an Italian problem — chronically low economic growth, and a reluctance among the political classes to grasp the nettle of structural reforms that would raise productivity, competitiveness and the efficiency of public spending.

Underused investment funds

In this assessment for Scope Ratings, a credit-rating agency, Eiko Sievert and Alessandra Poli make a telling point about Italy’s use of EU money, including the multibillion-euro grants and loans available as part of the bloc’s post-pandemic recovery fund:

Under [its recovery fund plan], the country has so far received €113.5bn out of an allocated €194.4bn (around 9 per cent of GDP in 2023), but only about €52bn has been spent to date.

Similarly, out of €129bn in [EU] cohesion funds for 2014-2020 (since extended due to the pandemic), less than a fifth of more than a million projects have been completed to date.

One structural weakness is highlighted in this fascinating report by Emiliano Feresin for Nature Italy. He cites a study by the National Agency for the Evaluation of Universities and Research Institutes, which calculates that Italy had almost 2mn students in 2021, up from 1.7mn in 2011.

It seems a promising trend — except that, in the historically less developed south of Italy, the number of students stood at more than 600,000 in 2011 but has since fallen by about 100,000.

Such imbalances between north and south have preoccupied Italian governments since 1945 — indeed, much earlier — without receiving a convincing solution.