Europe can learn a lot on fiscal arrangements from India. But it won't

For several decades now the IMF has been doling out advice on fiscal good sense to developing countries. The core of the advice, regardless of the situation of the country and the responsibilities of its government, has been don’t spend hugely in excess of your revenues.

It’s therefore interesting to see the same advice being doled out now to European countries. A new research paper has this to say:

“The EU’s fiscal framework needs reform. While existing fiscal rules have had some impact in constraining deficits, they did not prevent deficits and debt ratios that have threatened the stability of the monetary union in the past and that continue to create vulnerabilities today.”

That’s strong words indeed. Such phraseology was reserved for the poor countries who were doing no more than what the Europeans have been doing for several years now, namely, spending far in excess of their revenue.

Suddenly, we also find that Europe is faced with a problem very similar to India. Thus, “The (fiscal) framework does not provide sufficient tools for EU-wide stabilisation.” This has led to what the IMF politely calls “a persistent undershooting of its inflation target.” 

In India this is the Centre-state fiscal mismatch. The states spend recklessly knowing the Centre will bail them out. It’s the same in Europe where the ‘Centre’ comprises Germany and, in a fair measure, France. The rest of the countries are the fiscal equivalent of our states.

So what does the IMF want the Europeans to do? The paper proposes a new fiscal framework. It’s couched in typically ambivalent IMF phraseology.

Thus Europe needs “risk-based EU-level fiscal rules, strengthened national institutions, and a central fiscal capacity.”

What in heaven’s name does this mean? The IMF calls for a Fiscal Council, which will decide what, how much and who. It will develop a common methodology for all this. They can ask India to advise them on this common methodology.

But “the 3 per cent deficit and 60 per cent debt reference values would remain.” Really? Why?

Here the paper runs into a problem. Europe is a large number of independent countries. How do you get them to cooperate within a common framework? Again they can learn from India, or at least it’s institutional arrangements fir fiscal cooperation between different constituents of a federation.

Thus “all member countries would be required to enact medium-term fiscal frameworks consistent with the EU-level rules… Independent national fiscal councils (NFCs) would have a much stronger role to strengthen checks and balances at the national level (including undertaking or endorsing macroeconomic projections…”

The paper unwittingly draws attention to a problem that India has been dealing with for 40 years now, namely, if you have democracy and political competition for office, how do you make sure that everyone behaves in a fiscally responsible way?

The short answer is you don’t because you can’t, at least not without a hard budget constraint which, in a democracy, is just not possible. Politicians will always find a way to behave irresponsibly when faced with elections.

In India we call this freebies. In IMF parlance it’s called output stabilisation. True, that the specific means adopted are different. But the basic objective is the same: giving citizens things that they cannot pay for, oftentimes even with a a 90 per cent subsidy.

If I were guiding IMF research I’d ask a different question: can fiscal rules like 3 per cent fiscal deficit and 60 per cent debt work in developing countries without taking into account population size and without taking into account the backward bending supply curve of labour in the developed countries?

The short point is that if you don’t ask the right questions, you will not get sensible answers.