View from London: A fiscal squeeze in 2025 will harm economic growth

The European Union does not seem to have a debt problem, stresses ‘The Economist’.

At around 84% of gdp, its member countries’ overall public-debt ratio is a lot lower than Britain’s 104% or America’s 123%, let alone Japan’s 255%. Even if the roughly €1trn ($1.1trn) of collective debt — such as the eu bonds funding the bloc’s post-pandemic recovery fund — are included, the ratio does not exceed 90% of gdp. Yet the continent faces a fiscal squeeze in 2025 and beyond that will fuel divisions and cut European growth to almost zero, and may undermine its efforts to step up security spending and continue to support Ukraine.

Low growth is one factor behind the squeeze. Germany’s economic growth is practically zero, and there is little prospect of improvement before its federal election in February 2025. France and Italy are still growing, but the oecd, a club of mostly rich countries, reckons both will grow by barely more than 1% in 2025. The downturn is not cyclical but reflects poor growth potential. That will lead to low tax-revenue growth, while spending demands pile up.

The threat of a trade war with America will add to pressures on growth, with the continent especially vulnerable to new trade frictions. Investment banks sharply revised down estimates of European growth after Donald Trump’s victory.

Another factor is demography. Ageing European populations add to their states’ bills not just via pension spending but also in the health and social-care sectors. An older population is also less productive and innovative, reducing growth further. The eu reckons that, as costs rise, age-related spending will consume a larger share of output in the future: 1.2 percentage points more of gdp by 2070.

Finally, there are the self-imposed rules that mandate cuts. The eu’s fiscal rulebook, recently reformed, says countries with high deficits must devise plans to reduce them. Germany has its own constitutional “debt brake” that imposes cuts, even with reasonable deficits. Bruegel, a think-tank, reckons that France, Italy and Spain will have to reduce their deficits by about 0.5% of gdp per year to comply with the rules.

The effect of the fiscal squeeze in 2025 will be even slower growth than forecasters currently project. China will continue to challenge European manufacturing in markets around the world, even as its own domestic weakness hurts European exporters. Mr Trump’s victory will entrench and extend protectionist policies put in place by his predecessor. Europe’s domestic consumption is increasing, but adding a fiscal squeeze will sap the little growth that will result.

The main victim may be Ukraine. The country’s military strength and financial health depend on American and European support. For 2025 the g7 agreed on a scheme, still to be finalised, to use profits from frozen Russian state assets to fund about $50bn of aid, in part because financing it from domestic resources proved increasingly difficult. Should that money run out, Europe will have to make even deeper cuts to fund Ukraine’s security — and its own.

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