Europe “Essentially Makes Keynesianism Illegal”

Britain stands on the sidelines as the rest of Europe moves toward closer economic and fiscal integration.

European leaders on Monday prepared to enact a fiscal pact that will write balanced budget rules into their national laws despite British opposition to such far-reaching fiscal integration. “To write into law a Germanic view of how one should run an economy and that essentially makes Keynesianism illegal is not something we would do,” was how one official from the island nation put it.

Britain effectively deserted the Franco-German led push for economic integration in December when Prime Minister David Cameron vetoed a pan-European reform effort. The seventeen nations in the single currency area will move ahead nevertheless. Most other European Union member states, except Great Britain, are expected to join them, if not formally then de facto.

German demands for strict fiscal consolidation have been watered down significantly in anticipation of Monday’s European Council summit. Where the 1997 Stability and Growth Pact demanded that public deficits remained under 3 percent of gross domestic product, drafts for the latest fiscal pact refer to “structural deficits” which may still allow the sort of short-term Keynesian stimulus which the British fear will be “illegal.”

There will still be semi-automatic sanctions for profligate governments that only a supermajority of European countries can overturn and fines imposed by the European Court of Justice worth up to 0.1 percent of a nation’s GDPs.

The northern eurozone countries, led by Germany, insist that deficits must be reduced in the short term and the competitiveness of peripheral states improved for the continent to grow out of its debt crisis. There is mounting apprehension in the south about this plan as people there have seen markedly little progress in recent months.

In Greece and Spain, nearly one out of five workers is unemployed. The jobless rate in Italy and Portugal hovers near or above 10 percent.

Italy, where Prime Minister Mario Monti and his cabinet of technocrats are rushing through reforms to rein in public spending and liberalize the economy, has seen its borrowing costs fall but Greece, Portugal and Spain remain mired in recession with dismal growth forecasts for 2012.

Greece is expected to reach an agreement with banks and investors about reducing its debt obligations this week. Its bailout financing from other European countries could be in peril however if there isn’t a more convincing effort to balance the budget and modernize the economy.

Portugal’s slide toward becoming the next Greece has gathered pace as banks recently raised the cost of insuring government bonds against default. The conservative administration, in power there since last summer, has been enacting cuts and reforms to balance the budget but like other eurozone countries, including France, it is relying mostly on tax hikes to reduce the shortfall in the short term.

If there isn’t more robust growth in Portugal this year, the country could need a second bailout to avoid bankruptcy.

In Spain, where conservatives have also recently taken power, growth is lackluster and unlikely to meet the 2.3 percent target this year. That raises the question whether Madrid will manage to cut its deficit from around 8 percent of economic output last year to 4.4 percent by the end of 2012 as promised.

The Germans, meanwhile, are still reluctant to pour more money into the European rescue fund which many analysts and Southern European governments believe will calm markets.

In Davos, Switzerland last week, Chancellor Angela Merkel pointed out that despite last year’s expansion of the European Financial Stability Facility, which now has an effective lending capacity of €440 billion, there is pressure to expand it again. “Now they say it should be twice as big,” she lamented.

Some say, “it should even be three times as big, then we’d really believe you.” And I always ask myself how long is that credible and when is that no longer credible?

What Germany doesn’t want, she added, “is a situation in which we promise something we can’t back up in the end.”

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