German Economy has the Blues

On Wednesday the EU Commission warned Germany and Portugal that they must cut their public deficit as established in the single monetary union’s budgetary guidelines. It is the first such reprimand to member countries since the euro was introduced in 1999.

The Commissioner for Economic and Monetary Affairs, Pedro Solbes, proposed the issuance of a "blue letter" of early warning because the two countries had suffered "serious slippage" from the budgetary targets set down in the Commission’s Stability and Convergence Program.

Solbes justified the need for an early warning to Germany and Portugal saying that an uncontrolled deficit in a member state jeopardizes the stability of the entire European common currency.

Although both Berlin and Lisbon were signaled out in Solbes’ report to the Commission, the cautionary words are likely to hurt more in Germany, which for many years was considered a pillar of the EU’s economic stability. Ironically, Germany was also the most vocal champion of the guidelines for the Stability and Convergence Growth Pact, which it now is in danger of violating.

Three percent threshold

Under the Commssion’s budgetary guidelines, member states pledged to keep their federal deficits under three percent of the Gross Domestic Product (GDP). This was a level determined to be sustainable for the euro-zone.

Last year Germany reported a deficit of 2.6 percent of its GDP. Finance Minister Hans Eichel estimates a deficit for 2002 of 2.5 percent, but the EU sees the deficit as closer to 2.7 percent. According to Solbes this would represent a significant widening of the gap between the target of one percent set by Germany and the economy’s actual outcome.

Because the economic forecast for 2002 is still so uncertain and the margin between deficit and threshold is too narrow, the Commission recommended instituting an early warning system for Germany.

Early warning system

"The issuance of an early warning should not necessarily be interpreted as a criticism of the budgetary strategy being pursued by a member state", Solbes said in his report. It is merely designed as a system for the Commission to identify and monitor euro-zone countries which run a risk of overstepping the three percent threshold.

The key approach of the Commission’s early warning system is to prevent a member state’s deficit from approaching three percent of the GDP. This can be done by requiring a potentially at-risk nation to submit annual reports on the state of the economy, and by establishing regular surveillance of the nation’s economy by the Commission and the Council.

Cautious words for Germany

The Commission’s report recognized the impact of the world economy on Germany and the particularly difficult position the country is in.

"It is true that the German economy has suffered more than other EU economies from the world economic slowdown and this has had an impact on the nominal budget deficit," Solbes said as explanation for Germany’s negative listing.

While the Commission strongly urges Germany to bring its deficit down, it does not provide any specific guidelines on how this should happen. The best course, Solbes says, is to follow the budget proposals of Minister Eichel.

"The Commission does not state that Germany should raise taxes or cut expenditures. Instead it makes clear that Eichel’s 2002 budget should be implemented as planned."

Final decision

The Commission’s report from Wednesday will be submitted to the Council for final approval on February 12. The plan for an early warning system for Germany and Portugal will only be instituted with the approval of the EU finance ministers.

The German government does not expect that the Council will issue a blue letter and an early warning system. For this there would need to be a clear majority. And at the moment Germany can count on at least 10 larger member states standing behind it. Those openly in favor of issuing a warning are Belgium, the Netherlands, Denmark and Austria.