War Could Help Ease Germany's Financial Woes

A war with Iraq may have an unintended positive side-effect for Germany, helping the government get out of a sticky situation with the EU.

In the event of a war, an „exception clause“ in the Stability and Growth Pact could be cited as a reason for suspending its criteria, giving Germany a much needed reprieve: hefty fines for recent violations would be dismissed and the road for increased deficit spending to spur the economy would be cleared.

In an interview on German TV last night, German Finance Minister Hans Eichel said that, should the economy deteriorate further, deficit spending may increase.

Voices within the Finance Ministry feel increased spending is necessary to stimulate the flagging economy. An insider told the German daily newspaper, Tagesspiegel, “If things get worse, we’re not going to drive ourselves further into the ground by saving.” An official Social Democratic paper advocates lower taxes and further investment in business, both of which mean bigger deficits.

In response to reports that Germany, France and England were hoping to invoke the clause, the European Commission yesterday confirmed that it was not ruling out the possibility. “If there were to be a war we would look at any measures that were appropriate and might need to be taken,” said an EC spokesman. “We’ll cross that bridge when we come to it.”

The so-called “exception clause” in the Stability and Growth Pact states that should an “unusual event outside the control of the member state concerned” occur, the criteria could be suspended. Though this was meant to apply to natural disasters, it could be cited in the event of a war, something German officials are reportedly pushing for.

Keeping Spending in Check

The Growth and Stability Pact was created in 1997 to enforce financial discipline on the 12 member states of the Monetary Union. The Pact imposes a 3 percent of the GDP limit on budget deficit spending. Governments, whose budgets are not balanced within a year of violating the criteria, are subject to censure and heavy EU fines in excess of 10 million Euros.

Germany became the second EU country to violate the criteria when finance officials announced last month that deficit spending had reached 3.75 percent of the GDP in 2002 (Portugal was the first in November 2001, with a deficit of 4.2 percent). German Labor Minster Wolfgang Clement’s subsequent announcement that the government was reducing the growth forecast from 1.5 percent to 1 percent indicated that Germany would probably violate the criteria again in 2003

Germany and Portugal may soon be joined by France. Economists say deficit spending straddles the acceptable limit at 2.9 or 3 percent of the GDP.

A need for reform?

It’s not surprising that France and Germany, now joined by Great Britain, have led the charge to suspend the criteria. Their position, however, predates the situation with Iraq. Though once a great supporter of the Growth and Stability Pact, Chancellor Schroeder has -- for many months now --been a critic, arguing that the criteria force austerity measures (budgets cuts and tax increases), that can damage an already struggling economy.

Daniel Gros, director of the Center for European Policy Studies in Brussels, speculated in Tagesspiegel that the German government was not only hoping to invoke the “exception clause” in the event of a war, but use the opportunity to push for wide-reaching reforms and a watering- down of the criteria. It's a view that was mirrored in press reports in many German papers.

In response, a spokesman for Finance Minister Hans Eichel denied the allegations saying, “We are not talking at the moment about weakening or reinterpreting the Growth and Stability Pact but how to adapt it to the current economic situation.” Any revisions would be subject to the approval of EcoFin, the European Commission’s business and finance governing body.

The debate over reform

Germany clearly stands to benefit -- in the short term. Not only would the suspension of the criteria help Germany avoid EU fines (and the possibility of violating the criteria for an embarrassing second year in a row), it would free up finance officials to increase government spending to stimulate the struggling economy.

Critics argue that deficit spending could backfire, creating short term “flash in the pan” benefits while racking up long lasting debts. An editorial in the German daily Frankfurter Allgemeine Zeitung said, “Experience shows that such short-cited efforts soon fizzle: investors know that higher deficit spending today means higher taxes tomorrow.”