Economists warn government spending cuts in the EU will hit investment and growth at a time when the region is struggling to keep up with the US.
After years of fiscal excesses during the Covid-19 pandemic and the energy crisis sparked by Russia’s invasion of Ukraine, Brussels has reinstated regulations requiring member states to limit budget deficits to a maximum of 3 years. % GDP. The ultimate goal is to reduce government debt to 60% of GDP.
However, this restriction comes at a time when Europe’s economic powerhouse, Germany, is facing existential threats to its export-led business model and is in dire need of more investment globally. whole block.
Donald Trump’s decisive victory – and his threat of 10-20% tariffs on European manufacturers – has increased concerns about long-term growth prospects.
“I don’t think we’ll get the investment we need, and that’s bad,” said Jeromin Zettelmeyer, director of the Bruegel Research Institute. “We cannot effectively implement these [EU’s] fiscal framework, a significant increase in public investment and no new funding at EU level at the same time.”
Filippo Taddei, senior Europe economist at Goldman Sachs, said consolidation would not help close the “huge investment gap between the US and European economies”.
The investment bank believes consolidation will cut around 0.35 percentage points off Eurozone growth each year in 2025, 2026 and 2027.
The IMF, which recently lowered its growth forecast for the euro zone to 1.2% next year, also predicts financial regulations will put additional strain on the economy, reducing it by 0.1%. percentage points from annual GDP.
Meanwhile, the US economy is expected to grow 2.2% in the same period. Policymakers there are also expected to maintain a more expansionary fiscal policy.
The Congressional Budget Office, an independent fiscal watchdog, predicted deficits of 6.5% in 2025 and 6% in 2026 before Trump’s victory.
Many economists believe the president-elect’s pledge to make tax cuts permanent in 2017 will widen the budget deficit by several percentage points and temporarily lift demand.
Trump announced that he would reduce the deficit by sharply limiting government spending, appointing Tesla founder Elon Musk and fellow businessman Vivek Ramaswamy to find drastic cuts.
According to estimates, the EU needs public and private investment worth 800 billion euros per year to address threats to its long-term economic competitiveness. report of former ECB president Mario Draghi was announced earlier this year.
While private investment is expected to contribute the majority, significant public investment is still considered important.
“There is a tendency to tighten fiscal policy [several years],” said Adam Posen, director of the Peterson Institute in Washington. “It’s very difficult for you to increase public investment in that environment.”
The European economy is facing a number of long-term challenges – from aging societies to shrinking workforces to combating climate change and strengthening defense capabilities.
Trump’s return to power next year has led to a rethink of security spending, with Brussels potentially redirecting tens of billions of euros in the general budget.
Economists believe a more radical rethink of stimulus is needed.
Posen said the lack of an “aspirational” debate about more investment was “extremely short-sighted” when the need was so great – and likely to become more so.
Economists acknowledge that governments around the world need to address growing deficits.
Since the pandemic first struck, sovereign debt stocks have skyrocketed. The IMF said last month that global public debt has now reached $100 trillion and is at risk of rising further in the coming years.
While Eurozone member states have cut spending more than the UK, US and China, the region’s debt-to-GDP ratio still increased from 83.6% in 2019 to 88.7% in early 2024. Deficits in some of the largest economies – including France – have also widened.
After suspending EU financial regulations at the start of the pandemic, Brussels reinstated them this year. As a result, financial conditions have tightened and this will continue in the coming years.
So far, 21 member states have submitted plans on how they intend to limit spending over the next four to seven years.
Among the most closely watched is new French prime minister Michel Barnier’s proposal to reduce the deficit in the EU’s second-largest economy to a ceiling of 3% by 2029.
Spain and Italy both plan to reach this threshold sooner, in 2024 and 2026 respectively. While Spain’s target appears achievable thanks to one of the strongest growth rates in Europe, Europe, economists consider Italy’s plan ambitious.
Both France and Spain have helped boost regional growth in 2024 at a time when the German economy is stagnant.
Political chaos in Berlin means the country has yet to present its spending plans to Brussels. The region’s largest economy has more fiscal space than other EU member states, with the deficit expected to reach just 1.6% of GDP this year – well within the 3% limit.
With interest rates still relatively high, Zettelmeyer noted that monetary policy could provide a temporary boost. “The ECB has enough firepower to offset the fiscal drag,” he said.
While cutting interest rates would boost growth, such a solution is “not ideal,” Posen said.
Posen said lower interest rates and spending cuts combined would increase inequality – tighter fiscal policy typically affects the poor more, while looser monetary policy would bring benefits asset holders first – and leaves the ECB in a difficult position if inflation returns.
Data visualization by Janina Conboye
