Limiting public debt has been a key element of the EU’s Economic and Monetary Union since its inception. The so-called Maastricht criteria require member states to maintain budget deficits and public debt below 3 and 60 per cent of GDP respectively. After the 2008 financial crisis, the EU developed these “fiscal rules” further, making debt sustainability central to how members were expected to run their economies. This political obsession with debt reduction has permanently lowered incomes and undermined investment in environmental and climate protection. Its legacy has been to leave people across Europe more vulnerable to cost of living increases.

The last few years have exposed the unsuitability of the current fiscal framework to an era of crises. The rules around government borrowing were first suspended in 2020 in response to the economic fallout of the pandemic. This was repeated in 2021 and again in 2022 following the Russian invasion of Ukraine. The current period of flexibility is expected to come to an end in 2024. Amid the Covid-19 crisis, the European Commission was also authorised to borrow from financial markets for the first time to fund its response. Rather than relying on ad hoc responses to each new crisis, what Europe needs beyond 2024 is a long-term approach that is fit for purpose. National governments should be empowered to invest in public services such as health and education and in cutting carbon emissions. For its part, the European Commission should also be equipped to support national spending.

In November 2022, the Commission proposed new rules on government borrowing levels and debt reduction timetables. This proposal acknowledges the increase in debt levels due to the pandemic, the war in Ukraine, and ecological breakdown and sketches a system that would allow member states to plan investments via a Commission-monitored process. Under the proposal, member states would have greater ownership over debt reduction plans instead of being subject to a one-size-fits-all rule to bring down spending. Nevertheless, the main priority remains low debt rather than building an economy that works for all. This represents a missed opportunity to propose permanent borrowing at the EU level to reduce costs for less economically strong member states and complement national spending.

The fiscal straitjacket

Designed to reduce member-state debt, the EU’s fiscal rules have failed on their own terms. In the years following the global financial crisis, government spending was choked off. As a result, demand fell, and economic output declined. The permanent economic scarring this caused reduced household incomes and led to job losses, particularly for people on the lowest incomes. The European countries that pursued greater austerity and cuts to public expenditure also had higher, rather than lower, debt levels. The political focus on reducing public debt was therefore ultimately counterproductive.

Member states are required to keep their public debt below 60 per cent of GDP. But this debt-to-GDP ratio says little about a country’s economic strength or its people’s well being. Looking at high-income nations globally, Japan’s debt-to-GDP ratio has been over 200 per cent for well over a decade without any hint of default. Similarly, the US debt-to-GDP ratio reached 135 per cent during the pandemic.

Implementing harmful austerity policies based on such arbitrary targets is fiscally irresponsible. Results of a recent empirical study conducted by economist Philipp Heimberger suggest that higher debt-to-GDP ratios in high-income nations do not significantly impact economic growth. The same study found that increased borrowing in situations such as the pandemic does not act as a “drag on growth” going forward. Instead, reductions in spending and investment, particularly in periods of recession and economic weakness, cause lasting damage to the productive capacity of the economy.

An overhauled economic framework should work towards an economy that ties green and social infrastructure spending to achieving full employment. The aim should be to create well-paid jobs while kicking our addiction to fossil fuels and limiting energy and resource use. Even as interest rates rise, spending is essential to tackle ecological breakdown and sidestep the need for huge crisis interventions down the line. Human, economic, and environmental well-being should be the primary objectives of EU economic policy.

This is not to say that debt levels are unimportant, or that all borrowing is good. The financial instability caused by increasing debt to finance tax cuts benefitting the richest in Britain is a clear demonstration of why unproductive borrowing should be restricted.

Without fiscal policy reforms, it will be near impossible to cut emission sufficiently.

The consequences of falling short

A decade of austerity economics has dragged down living standards across the continent. Cuts to public services, health, and education budgets as well as the privatisation of critical health and care infrastructure had the most severe impact on the poorest among us. By the time the pandemic struck, the real disposable annual income of the average EU citizen was nearly 3000 euros lower than if incomes had continued to grow at their pre-financial crisis rate. Behind this average lie significant differences between EU member states. In Germany, the average income in 2020 only dropped by 1 per cent compared to pre-2008 trends, while incomes in Finland and the Netherlands were 15 to 16 per cent lower. Ireland and Spain were hardest hit with average incomes dropping lower than projected by 29 and 25 per cent respectively. Reduced government spending went hand in hand with stagnating incomes. Cutting back on workers’ rights led to an increase in precarious and underpaid labour.

Prior to the pandemic, the EU had an estimated social infrastructure investment gap of at least 142 billion euros per year. This has only grown. Had investment in social services followed its pre-crisis trajectory, EU governments would now be spending an additional 1000 euros per person compared to what they were spending in 2019. Between 2000 and 2009, real public spending on the social sectors increased at an average of 2.4 per cent per year. For the decade that followed, the annual increase fell by two-thirds to 0.8 per cent, causing European societies to forgo the positive impacts on economic output, private investment levels, and unemployment that accompany higher social spending. This public service underfunding and privatisation have undermined Europeans’ resilience, including against the Covid-19 pandemic.

The International Monetary Fund recently estimated that the surge in energy prices will raise the cost of living for European families by an average of 7 per cent in 2022. While some of this will be offset by recent EU and national measures to limit inflation, long-term targeted government spending is necessary to guarantee a good quality of life for everyone in Europe.

The EU’s concerns about debt obscure the much greater climate, environmental, and socio-economic challenges that Europe is facing. As the damage inflicted by global warming will be impossible to reverse, pre-emptive investments are needed to limit the worst effects. Without fiscal policy reforms, it will be near impossible to cut emissions sufficiently.

In 2019, the European Commission estimated that Europe needs an extra 490 billion euros per year in investment to keep our environment healthy. Other estimates suggest annual investments of up to 855 billion euros (excluding transport) in the EU27 could be required to tackle climate breakdown alone. The Commission’s Green Deal is only set to mobilise a third of this investment from both private and public sector sources. Private investment alone will not be willing or able to cover the gap, nor will it necessarily result in investments that benefit those most in need.

Long-term targeted government spending is necessary to guarantee a good quality of life for everyone in Europe.

Shifting lines

Economic downturns breed distrust in politics, which fuels support for extremist parties. Across Europe, the backlash against austerity led to a significant increase in extremist parties, lower voter turnout, and greater political fragmentation. How can we avoid a repeat of this in the years to come?

During the Eurozone crisis, southern European countries were hardest hit by debt crises and austerity. This explains the more flexible approach to government spending and deficit reduction long favoured by the French, Italian, and Spanish governments. Northern Europe, on the other hand, was less severely affected. Germany’s export-driven economy even benefitted from a weak euro.

Today, however, Germany is one of the countries most exposed to energy price increases. The national measures proposed by Germany in September to protect its industrial base triggered significant backlash from other European countries. Nevertheless, Germany remains one of the countries with most to gain from European cooperation in the current energy crisis.

The German government has long pursued low-debt economic policies. Germany was one of the main proponents of fiscal discipline within the European Monetary Union and during the Eurozone crisis. A debt brake (Schuldenbremse) is written into the German constitution, and, under the famous schwarze Null (“black zero”) budget policy introduced following the 2008 financial crisis, the country is required to maintain a balanced federal budget with no new borrowing.

The crises of recent years have, however, resulted in a shift. During the pandemic, the German government agreed on EU debt as a short-term measure for the first time. Elected in 2021, Germany’s current government now includes the Greens, who call for greater public investment and advocate a common European approach. The co-governing liberal Free Democratic Party continues to treat limits on borrowing as a red line, representing a major obstacle to deep reform of the EU’s fiscal policy. This stance is increasingly out of step with traditionally fiscally conservative but evolving public opinion in Germany. Almost two-thirds (64 per cent) of respondents to a survey conducted in 2022 were concerned about a return to austerity politics and largely supported an increase in government spending on public services, as well as green investment.

The so-called “frugal four” – Austria, Denmark, the Netherlands, and Sweden – have also habitually opposed more flexibility for government spending across the Eurozone. Yet, here as well, government policy is at variance with public opinion. When asked whether the European Union had spent too much on its Covid-19 recovery fund, for instance, almost 8 in 10 voters disagreed. The concerns that do exist tend to focus on waste and corruption linked to member states’ use of the fund, rather than spending itself.

An opportunity for systemic change

Post 2008 austerity did not make Europeans healthier or happier, nor did it raise their living standards. Indeed, the obsession with narrowly conceived debt and deficit thresholds made European societies less resilient. This winter will be particularly hard for many in Europe and across the world; the same may be true for the years to come. Faced with mounting ecological and social challenges, we need states that are empowered to invest.

The debate around economic policy and in particular fiscal rules is likely to be one of the most important political topics in the run-up to the European elections in 2024. Progressive parties and voices need to present a positive alternative to the failed policies of the past. Fiscal policy goes to the heart of how to deliver both climate and social justice. Reforming Europe’s fiscal rules is an opportunity to show how economic policy can deliver for both people and planet.