The hidden side of the debt: how to rescue Europe

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The hidden side of the debt: how to rescue Europe

Alfonso Pierantonio

The analysis of the debt-related financial figures drives the public debate across Europe for years. Almost without exception politicians and consequently, people assume — whether deliberately or not — a definition of debt that is universal and unambiguous. The Maastricht Treaty formalizes four criteria (article 121) that impose control over inflation, public debt and the public deficit, exchange rate stability and the convergence of interest rates. In particular, debt and central government deficit are particularly monitored. The debt corresponds to the outstanding of liabilities evaluated at the end of a given period, whereas deficit corresponds to the borrowing need observed during the same period.

The debt in the sense of Maastricht [5] is defined in a specific way and consists only of the following financial liabilities

  • cash and deposits,
  • treasury bonds (BTF and BTAN),
  • ungible treasury bonds (OAT),
  • Euro medium term notes (EMTN), as well as loans.

According to this definition, the debt of the EU Member States is given in Figure 1 with a number of countries that are far beyond the fateful threshold of 60% prescribed by the treaty.

2017 Maastricht debt in the EU Member States Figure 1 — 2017 Maastricht debt in the EU Member States [1]

Conventional wisdom suggests that the Mediterranean debt, i.e., the debt of the EU Member States in Southern Europe, is a major problem in the Eurozone that can put the existence of the Euro currency and the EU in jeopardy. However, in 2015 Eurostat for the first time ever produced a report on the liabilities that do not fall under the umbrella of the definition of the Maastricht Treaty.

The newspaper Die Welt, in an article by Von Anja Ettel and Holger Zschäpitz (“Europa sitzt auf einem Berg heimlicher Schulden”) [2], defined such liabilities as the hidden debt — a form of financial wizardry that certain countries pursue “to massage their public accounts and respect official deficit and debt limits.” as depicted by the Financial Times (“Does Germany have a bigger public debt problem than Greece?”) [3].

But how Eurostat defines such hidden debt? here what they say

Liabilities of government controlled entities classified outside general government (public corporations) are defined as the stock of liabilities at the end of the year, based on the business accounts of corporations. Those government controlled entities are classified outside general government due to their behaviour as market units.

A debt that may become actual government liabilities if specific conditions prevail as stated by Eurostat. In other words, the governments are the guarantee of last resort for such contingent liabilities and non-performing loans. To have an idea about the scale of the problem, please have a look at Figure 2 where the hidden debt for the EU Member States is reported.

2017 contingent liabilities and non- performing loans in the EU Member States (2018) [4]
Figure 2–2017 contingent liabilities and non- performing loans in the EU Member States (2018) [4]

Countries, like Germany and Netherlands, often considered the best students in EU classroom, are the most indebted ones when contingent liabilities are considered. In Germany, this is mostly due to the federal architecture that let the Länder (the regional states) and the federal state share concurrent powers, including public health and higher education. This has led to a considerable distribution of public expenditure across layers of government that includes also municipalities, as illustrated in Fig. 3.

expenditure distribution by layers of government (Source: Ministry of Finance) Figure 3 — expenditure distribution by layers of government (Source: Ministry of Finance)

In 2015, only the 35% of the overall German expenditure has been under the control of the Bundesrigierung, the rest was administrated by the regional and local authorities.

How the regional authorities can sustain such an expenditure?

The Länder enjoy access to deep and liquid capital markets (stable and inexpensive funding) since they are large customers of their respective Landesbanken in areas including the distribution of public funds. However, Länder have ultimate responsibility for the liabilities of the financial health of financial institutions and municipalities whose liabilities might crystallise on the already burdened balance sheets of the Länder.

A contradicting scenario emerges since

  1. because of the definition of the debt in the sense of Maastricht, Länder securities fall outside the treaty;
  2. Länder securities are included in the ECB’s public-sector asset purchase programme (which increases demand for securities issued by Länder while lowering borrowing costs).

In other words, on the one hand, the Maastricht Treaty does not pose any restriction to the hidden debt of the EU Member States, on the other hand, such debt (at least that represented by the Länder securities) is in the ECB’s purchase program. In the period 2000–2006 (with the exception of 2007) the majority of German Länder have recorded persistent budget deficits that led to exceptionally high debt levels. Soft budget constraints, which are motivated by the politically sensitive matter of autonomy, resulted in little intrinsic incentives for budgetary discipline, ie. limited flexibility in raising revenue, weak incentives to increase tax bases, and low efficiency of tax collection.

With EU on the verge of killing itself, it can be of crucial relevance to analyze and better understand the uneven impact of contingent liabilities outside the Maastricht Treaty. In particular, it can be important to let the German taxpayer note that Germany has a debt problem as well: austerity has been a principle that has been applied across Europe to the debt in the sense of Maastricht only, e.g., strong budget constraints have been applied to only 36% of the German public expenditure — with large parts of the public sectors, including public health and higher-education, benefitting of softer budget constraints.

The founding principles of the European Union are not abstract categories. The Treaty of Amsterdam (1997) enunciated a set of values held in common by the member States and which they decided to incorporate into the foundations of the Union. These values include liberty, democracy, a respect for human rights and basic civil liberties, and rule by law. They are proclaimed in the treaty founding the Union, to which the Charter of Fundamental Rights added the dignity of the human being, equality, and solidarity. That translates into practice as the longest period of peace and prosperity Europe has experienced in its long turmoiled history.

Next European Election depending on the result might represent a concrete possibility to put such principles in danger. Re-discussing values such as the dignity of the human being, equality, and solidarity will open scenarios whose limits are beyond history. Regional conflicts are part of our near past, getting beyond them and having moral, ethical and material destruction is not impossible because we are nullifying what we have built together: the basement of a common house.

Let’s start to discuss frankly and honestly about the debt, that of Maastricht and the hidden one. In figure 4 the overall debt, i.e., that in the sense of Maastricht and the hidden one among the EU Member States, is given.

the overall debt of EU Member States Figure 4 — the overall debt of EU Member States

It won’t be easy and it won’t be easy to convince Germans (and others) that Italians love their children too, but it is necessary because if we understand that there are good reasons for sharing the debt, then the political Union is much closer than what we think. And that’s the only way to rescue Europe!

References

  1. General government gross debt — annual data, Eurostat, last accessed on Oct 2018, https://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=teina225&plugin=1

  2. Anja Ettel, Holger Zschäpitz, Europa sitzt auf einem Berg heimlicher Schulden. Die Welt, last accessed on Oct 2018, https://www.welt.de/finanzen/article173037693/Buergschaften-So-hoch-sind-die-EU-Staaten-verschuldet.html?wtmc=socialmedia.twitter.shared.web

  3. Ferdinando Giugliano, Does Germany have a bigger public debt problem than Greece? Financial Times, last accessed on Oct 2018, https://www.ft.com/content/0a43570a-059c-3ead-9bed-e33b735dc76b (under paywall)

  4. Eurostat. The extent of contingent liabilities and non- performing loans in the EU Member States (2018), last accessed on Oct 2018, https://ec.europa.eu/eurostat/documents/2995521/8624398/2-29012018-AP-EN.pdf/ee504046-6ccc-4b79-8dfb-7a5e1d38328f

  5. Debt in the sense of Maastricht (national accounts), Institut national de la statistique et des études économique , last accessed on Oct 2018, https://www.insee.fr/en/metadonnees/definition/c1091