He has many things to say about Europe. The Old Continent is mired in anemic growth – it foresees a meager advance of 1.1% for this year – and the pace of progress of its reforms is exasperating for many. But this time, the Fund’s economists have placed emphasis on the response to the consequences of the Iran war. In their diagnosis released this Friday, they warn that governments “must avoid waste” in the design of public aid packages for households and companies to alleviate the rise in fuel prices.
“Economic policymakers face intense pressure: to act quickly, visibly and for the benefit of all. This often results in the adoption of policies whose long-term adverse effects outweigh their short-term benefits,” warns the director of European affairs at the IMF. “Focused support measures are, however, much more effective.”
The US and Israeli bombing of Tehran has strained global oil markets. The retaliation of Iran’s Revolutionary Guard has been to block the Strait of Hormuz, through which a fifth of the world’s crude oil and a quarter of the liquefied gas from the Gulf countries transited. As a consequence, the price of energy has skyrocketed and threatens to create a new inflationary spiral, the dimension of which will depend on the duration of the war.
Krammer, a prestigious German economist, who will leave his position at the Fund this year, advises that “Europe’s response to this shock should be governed by two imperatives: first, the adoption of a sound macroeconomic policy adapted to an environment characterized by frequent and unpredictable shocks; and, second, the construction of resilience that does not involve the waste of fiscal resources or interfere with the functioning of markets.”
Many European countries have launched publicly funded aid packages to ease the blow to their economies. Spain, for example, approved a few weeks ago a plan of 80 measures, valued at around 5,000 million, with a reduction in VAT on fuel, a reduction in taxes on electricity, direct subsidies for transporters and fishermen, as well as other aid to the most affected sectors.
Against price caps
The Fund does not want past mistakes to be made. In the last energy crisis triggered by the Russian invasion of Ukraine, some countries approved measures to cushion the blow of rising energy prices to their citizens.
“The temptation is simply to prevent price increases through tariff caps, universal subsidies or cuts in fuel taxes,” warns Krammer. “These are unwise measures,” he remarks.
The Fund insists that some of the measures that governments are approving to protect their citizens from the consequences of the crisis are general and are not focused on the most vulnerable households. “Untargeted support disproportionately benefits higher-income households, which consume the most energy,” he warns. Generalized tax cuts on fuels, such as the one approved by Spain, are an example of this.
Officials of the multilateral institution recall that during the energy and inflation crisis of 2022, European governments allocated an average of 2.5% of their GDP to energy support packages. “Of that figure, more than two-thirds corresponded to non-targeted measures,” Krammer recalls. IMF analyzes calculate that compensating 40% of the lowest-income households for all the increase in energy costs would have required only 0.9% of GDP. “It is required to get it right in the design and execution of monetary and fiscal policies,” emphasizes the German economist.
The risk of prolonging measures
But the budgetary cost, the agency reminds, is only part of the problem. “Generalized support also suppresses the price signal, the market incentive that drives people and companies to reduce consumption, improve efficiency and invest in alternatives,” the organization points out in its analysis of the European economy.
But not only that. The institution created after the Second World War within the framework of the Bretton Woods conference to provide financial support to countries warns that many countries that approved measures that affected fuel prices in 2022 “were forced to maintain costly measures” long after the crisis had passed. And he points out: “As countries plan their responses, they should not repeat the same costly mistakes. Broad and indefinite support measures are difficult to reverse and should be avoided.” The Fund advises that the measures that are approved be accompanied by an end date “to ensure that budgetary resources are not wasted or investments necessary to strengthen Europe’s energy system and reduce its vulnerability to future shocks are not displaced.”
Because, in addition, there are community countries that carry a heavy burden in the form of debt accumulated in the latest crises, from the Great Recession, the pandemic, the energy crisis due to the , the subsequent inflationary crisis or the disturbances created by tariffs last year. “Countries with high levels of debt and no fiscal space cannot afford to widen their deficits; any energy-related measures must be fully compensated to avoid overloading public finances that are already under pressure,” warns Krammer.
The war in Iran occurs at a complex moment for Europe, when it reflects on the scope of the reforms to recover lost competitiveness, strengthen the internal market and advance the union of capitals, among other pending issues.
“Europe’s choice is not between helping people now or reforming later, but between choosing costly measures that do not actually reduce vulnerabilities; …and policies that instead protect those most exposed today, while laying the foundation for a more resilient tomorrow,” Krammer proclaimed during the press conference to explain the IMF report on Europe.
Pending reforms
The document, presented within the framework of the spring assembly of the World Bank, emphasizes Europe’s pending reform agenda. “Fully closing internal structural policy gaps and integrating labor and product markets to reach the levels observed in the United States could raise European productivity by 20%, mobilizing up to €800 billion in additional private investment over ten years,” the institution’s analysts calculate.
The energy reform is one of those that is pending to be addressed by Brussels. In the current context it becomes important. “Industrial energy prices in the EU are currently approximately double their pre-2022 levels and are substantially higher than those in the US. This is a chronic disadvantage rooted in dependence on oil and gas imports, as well as the fragmentation of energy markets,” reflects the document on Europe.
The Fund applauds the progress made by EU member countries caused by the war in Ukraine. Many accelerated the adoption of energy from renewable sources to replace fossil fuels. “More than 50% of electricity generation in the EU now comes from low-carbon sources, significantly reducing exposure to fluctuations in oil prices.”
But remember that there are still pending tasks: completing the single energy market, maintaining the EU emissions trading system and accelerating the cross-border interconnection of electricity networks, among others, to reduce energy costs and be more competitive.
