EU defence fiscal holiday will backfire
BERLIN, March 28 (Reuters Breakingviews) - Ursula von der Leyen is using the wrong tool with the right intention. The European Commission president wants to suspend the Union's fiscal rules to allow member states to accelerate their defence ramp up. Yet the measure she suggests may only increase the risk of a crash.
With the rising Russian threat and growing signs that the U.S. is cooling on its 80-year commitment to defend the continent, Europe needs to spend an extra 1% to 1.5% of GDP on its defence every year. It won't be able to find the 200 billion euros to 300 billion euros it needs if governments prepare for war while trying to limit their budget deficits to 3% of GDP and public debts at 60% of output.
The problem is von der Leyen's method. She is proposing activating the EU treaties' so-called national escape clause, conceived for country-specific emergencies, for four years. But the legal consequence is that it would for all practical matters 'unplug' the fiscal surveillance regime altogether, notes Lucas Guttenberg, an economist and senior advisor at the Bertelsmann Foundation in Berlin. Brussels insists that the flexibility would only apply to defence, but it is on shaky legal grounds: triggering the escape clause also means the Commission will no longer be allowed to track the evolution of public spending in other areas. In other words, the rules will no longer apply, whatever the category of public spending.
Fast forward to 2029, and the problem is obvious. If it only relies on borrowing to finance its defence push, the EU would add 4% to 6% of GDP to its overall debt load, which would then approach 90% of output. That is not an unsustainable level. But large countries already struggling with heavy debt loads - France already at 114% of GDP, Italy at 136% in 2024 - would face serious market headwinds. And with fiscal surveillance out the window, the impact on government debt levels is likely to be bigger than just the increase in military spending.
The increase in defence spending will be permanent, and not limited to the four years of the EU's offered exemption. The Commission will then be put in a difficult position. It could insist on fresh austerity to bring debt under control. Or, it will struggle to make member states abide again by its rules, making a mockery of the fiscal regime that was only recently revamped after Covid-19.
A better approach would be to seize the opportunity to reform the system, while exempting defence investment - and only defence investment. It would give the EU predictable guidelines and bond markets more visibility. For now, the EU is facing the risk of four years without fiscal rules followed by a hard financial landing once the party is over.
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CONTEXT NEWS
EU leaders said after a summit on March 6 that they 'welcomed' a proposal by the European Commission to activate the national escape clause under their Stability and Growth Pact, which would exempt security and defence spending from rules limiting budget deficits to 3% of GDP and gross public debts to 60% of GDP.
Under the Commission's proposals, EU member states would not be subjected to the so-called excessive deficit procedure for having increased their military spending, for a period of four years.
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