The EU’s Debt Dilemma

Henrik Mogensen Nielsen // 16 March 2023

The EU is in an existential debt crisis. This crisis is often overlooked, and if it is not brought under control, it may lead to the formation of a federal state though undemocratic means, the breaking apart of the Union, or both. In any case, it could be the end of the EU as we know it unless the member states and the European Commission bring the debt crisis under control.

The COVID-19 crisis, the Ukraine crisis, the energy crisis, and the general cost-of-living crisis have caused severe financial deficits in member states and caused debt to rise significantly. This is despite the EU Treaty’s basic budget rules, which stipulate that a member state must not have public debt that exceeds 60 per cent of its gross domestic product (GDP) and that a member state’s public deficit must not amount to more than 3 per cent of its GDP.

In a forthcoming paper from our Danish member think tank, Center for Political Studies (CEPOS), which was the focal point of a seminar on EU fiscal policy hosted by CEPOS in February, the Head of Analysis at CEPOS and EPICENTER Fellow, Otto Brøns-Petersen, described how several member states have had a structural deficit since the introduction of the euro at the beginning of the new millennium.

Brøns-Petersen showed, among other things, that a significant number of member states have a debt burden far above the limit of the prescribed 60 per cent of GDP, with the average debt obligation closer to 100 per cent. The current crises have resulted in the de facto suspension of the EU Treaty’s rules; the member states continue to increase their debt burden unhindered.

Increasing debt in Europe has led to the initial steps of what is shaping up to be a debt and transfer union. One sign of this is that the EU has started taking on joint debt on behalf of its member states, as it did during the COVID-19 crisis. Taking on joint debt is yet another breach of the rules of the EU Treaty, but it has nevertheless been undertaken.

We are left with the challenge of figuring out what can be done to prevent member states from passing debt burdens onto each other. In this regard, Brøns-Petersen proposes three solutions:

1. Remove the possibility of joint liability. This is the most decentralised solution and the starting point in the EU Treaty. The problem with this solution is that it is difficult to return to the original principles when the member states have already found methods to circumvent the rules.

2. Impose sanctions. Another decentralised solution to the debt problem is to set up automatic sanction mechanisms that occur as soon as a country violates the applicable budget rules. Levying sanctions and fines is already an existing solution, which the Commission may choose to use to enforce the rules. The challenge, however, is that the incentives for taking on debt are so great that taking on debt will continue to be lucrative – so the problem will persist since the rules and practices have been violated for too long to have a noticeable effect.

3. Create central regulation. A third, highly centralised solution, is for the EU to create a central authority that is strong enough to regulate the member states’ public finances. Historically, this has been an effective solution for debt management, as we saw after the American War of Independence, when the newly independent states were deeply in debt. The solution at the time was to create the American central bank, which could take over the debts of the states, thus becoming the foundation of a strong American federal power, although this was not the original wish of the founding fathers. The same risk exists if we start solving the member states’ debt problems centrally rather than through decentralised solutions. We may end up with a considerably stronger fiscal policy, centrally managed by the EU, rather than what was originally intended. Increased central control and EU federalism, based on crisis management rather than democratic elections, can also damage the Union’s cohesion further – and create the breeding ground for greater EU scepticism, a risk that should not be underestimated considering Brexit.

None of the three solutions are immediate fixes, but for a start, the Commission, the member states, and the European Central Bank (ECB) should work on maintaining and implementing the rules on which the union is based: automated penalties and no joint debt creation.

EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).


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