Europe’s soaring levels of public debt should force governments to fundamentally “rethink” their role in providing essential services to EU citizens, according to the International Monetary Fund (IMF).
In a note published on Tuesday, the IMF said that Europe’s debt levels risk becoming “explosive” if business and labour reforms are not implemented, and deficits are not slashed by boosting tax revenue, curbing social spending, and improving government efficiency.
But the Fund also cautioned that Europe’s debt levels – which are on course to double to 130% on average by 2040 – are now so high that, even with swift reforms, “a rethink of the role of government may be unavoidable in some countries.”
“If reforms and medium-term consolidation are insufficient, then more radical fiscal measures could include reassessing the scope of public services and other government functions, potentially affecting the social contract,” the IMF said.
Surging debt levels come as EU governments are increasingly squeezed by the need to support ageing populations while boosting strategic investments, especially in green technologies and defence.
Last year, former European Central Bank chief Mario Draghi said the EU should boost annual investments by at least €800 billion annually, or 4-5% of the bloc’s annual GDP, to avoid falling behind the US and China. Up to half of this amount should be provided by the public sector, he said.
Twelve of the EU’s 27 countries now have debt-to-GDP ratios above the bloc’s 60% threshold. Several major economies, including Italy, France, and Spain, have debt ratios above 100%. Italy and France are also among the nine EU countries subject to an ‘excessive deficit procedure’ – or formal reprimand – by the European Commission for breaching the EU’s 3% deficit threshold.
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The IMF, however, suggested that relatively low borrowing costs, greater tax revenue, and deeper and more liquid financial markets mean most EU governments can now safely maintain a debt ratio of 90% without jeopardising their fiscal sustainability.
It also noted that the need to slash deficits and debt levels could be significantly offset through “growth-enhancing” reforms. These include deepening the bloc’s single market for capital and energy, streamlining business regulations, and issuing common EU debt to finance critical “public goods,” such as energy and military infrastructure.
Even then, a “moderate” reform package would likely fall short of restoring debt sustainability in many member states, the IMF said.
Around a quarter of European countries would need to cut net spending by over one percentage point of GDP each year for five years – significantly more than the fiscal consolidation typically experienced by European countries in recent decades.
“In these countries, a discussion on the scope and sustainability of the ‘European model’ seems unavoidable,” the Fund noted.
Governments could seek to “differentiate between basic and premium services” in key areas including pensions, education, and health, with only the basic services remaining publicly funded and freely available, the Fund noted.
However, it acknowledged that such measures are likely to meet stiff public resistance, with anti-government sentiment already being fuelled in many EU countries by deteriorating government services, rampant deindustrialisation, and declining or stagnant wages.
Alfred Kammer, director of the IMF’s European Department, said “some parts” of Europe’s population would experience the proposed reforms “as painful, but then you need to deal with that pain”.
“When you are doing reform, you don’t want to create pain, nothing but pain, over the years to come,” Kammer told reporters, adding that governments should “be honest” and seek to “find compromises” with European citizens.
“Incremental steps are most likely to be feasible and gain public support,” the Fund said. “Governments should clearly explain the rationale behind the reforms, identify the spending pressures they address, and reset public expectations.”
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