Mario Monti: Bridging Europe’s Economic Culture Gap

For a few years now, I have felt as if I live intellectually in the Alps. That is because, in European debates and in the European Council, I have often acted as a sort of translator of the virtues of discipline into Mediterranean languages.

A prime minister as North-South interpreter

At the same time, for the northern countries I have served as an interpreter of some difficulties felt by southern Europe.

A mutual learning process is now essential for Europe’s future. The South, as it becomes more attuned to the merits of the social market economy, must be more determined in pursuing fiscal discipline and structural reforms.

Likewise the North, Germany in particular, must appreciate that such efforts by Southern countries are unlikely to generate sustainable improvements unless Europe’s policy framework becomes more growth-friendly.

As if leaving a prison

When in May 2013 the EU acknowledged that Italy, after two years of very tight fiscal policy, no longer needed to be under the EU’s so-called “excessive deficit procedure”, that was almost seen within the country as the moment of leaving a prison, a newfound liberty.

That is definitely not the case, although the new situation certainly contributes to a reduction of interest rates, thus having a favorable feed-back effect on the budget itself.

Some even took the EU decision as an admission by the EU that it had been too tight-fisted in the first place. Others jumped from the recognition achieved by Italy to discussions on new ways of spending money, as if there were no longer the usual constraints on the budget, intended to safeguard stability and to protect future generations.

Changing the culture

In fact, for the countries of southern Europe to achieve a stable budgetary condition that is sustainable will require further cultural adjustments. In particular, the general public must come to the correct, but not obvious, view that budgetary discipline pays off.

I think it is critical, in the next phase of policymaking, to persuade people that fiscal discipline is not a forced tribute paid to gods residing in more northern parts of Europe. It simply is appropriate economic behavior.

Northern Europe, however, has to give something as well. That is a deeper understanding of the role of investment in economic activity. The Maastricht treaty did not distinguish sufficiently between public expenditure for consumption and for investment.

Consequently, since the day the Stability Pact was introduced in the late Nineties, many European countries have achieved budgetary discipline by disproportionately cutting public investment, which is usually less painful in political terms – though more damaging for the economic and social future of a country – than cutting public current expenditure.

Of course, it is far from easy to distinguish among different sorts of public investments — whether they are productive investments or pseudo-investments (as when a government transfers funds to state-owned companies to cover their current losses).

Meaningful definitions

Serious and rigorous work must be carried out on definitions and measurement, and there will always remain some margin of appreciation. However, these are not good enough justifications for assuming that all investment by the public sector is essentially like consumption, or lacks any economic merit and productive purpose. Yet, this is exactly the Pact means if taken at face value.

Now that the South is at last coming closer to the economic and fiscal concepts of central and northern Europe, it is encouraging to notice that the European Commission and the European Council, in their respective roles in shaping EU policies and practices, and possibly behind them Germany itself to some extent, seem to be cautiously becoming willing to enforce the pact in a more meaningful — but no more lenient — way.

For example, last year it was decided that countries which are not in a situation of excessive deficit may be granted some limited flexibility with regard to public sector investments.

But what about structural reforms? More countries have succeeded in adjusting their budgets than in the arduous task of deep structural change, although the latter has come to be recognized as a top priority, particularly as we all realize that competitiveness is the name of the game.

Fiscal discipline vs. structural reform

Why then do we see better results in coping with fiscal discipline than with structural reforms? I have come to the conclusion that there are two reasons. The first concerns the game of pitting government against organized interest groups.

The task of government is harder when proper reform measures directly affect the interests of well-organized groups, businesses, professionals or public sector employees. Such steps will usually inject more competition into a market, thereby wiping out comfortable rents from specific groups. The effects of budgetary measures such as tax rises are, by comparison, more diffuse.

The second factor is that Europe provides less help on what is ultimately the more important task: structural reforms. The focus of European monetary union has been on obtaining budgetary discipline. That is why the constraints, the monitoring and the sanctions have been stronger for that part of the work of member states’ governments.

Ultimately, this boils down to a simple rule of thumb: if you meet stronger opposition to structural reforms domestically, and receive less of a push from Europe on this than on budgetary consolidation, the likelihood is that you make less progress on structural reforms.

Country-specific reforms

That is why I welcome the recent reorientation of EU policy — not away from fiscal discipline but towards emphasis on country-specific recommendations on structural reforms. One example would be to make labor markets more flexible and product markets more competitive.

When I was a member of the European Council, I favored the idea of contractual arrangements between the European Commission and individual countries on specific reforms as the way forward.

This strengthens the influence of the EU on governments and strengthens the hand of each government in relation to domestic organized groups, all in the interest of achieving structural reforms.

Coupled with some accompanying mechanisms to facilitate the financing of the reforms in those countries that still face high spreads but are pursuing the policies recommended by the EU, these arrangements may be helpful to push Europe on a path of more reforms for growth and employment.

Editor’s note: An abridged version of this article appeared in the Financial Times.