Cyprus Mail 23 February 2025 - by Les Manison
 |
| Challenging the 'Brussels elite' US Vice President JD Vance at the Munich Security Conference (MSC) last week |
And the Cyprus government will need to make important choices on the composition of its expenditures
President Donald Trump and Vice President JD Vance of the new US administration have recently levelled pointed criticisms on the policies and democratic values of Europe.
They have criticised European states for not spending enough on defence and implying that in the event of a peace settlement of the Russian-Ukraine war, Europe would have to provide the financing and military means for securing Ukraine. In fact, Trump has called on EU national governments to raise substantially their defence expenditures to 5 per cent of GDP.
And Vance in a speech last week to the Munich Security Conference said that EU leaders are not listening to the people in formulating rules and policies, indeed, challenging the “Brussels elite” to carry out policies in line with the populist interests and aspirations of its citizens.
Fiscal policy challenges
While the criticisms of Trump and Vance on the rules and policies of European countries can be debated in terms of reflecting certain democratic values, such as free speech and catering excessively to the interests of minority groups, there is no doubt that their criticisms add significantly to the challenges facing the EU and national governments in the design and conduct of fiscal policies.
The deficiencies of the EU’S fiscal rulebook have been subject to much criticism. Even with recent adjustments emphasising the rule for governments to reduce their debt steadily toward 60 per cent of GDP, the current fiscal rules are misguided in their ability to contribute to advancing economies and society. The spokesperson of the “Jacque Delors Centre” has stated that the current EU fiscal rule book “prescribes economically harmful and politically unrealistic debt adjustment paths and fails to safeguard public investments from spending cuts”.
Undeniably, the economic policies of EU national governments are strongly influenced by their pursuit of adhering to the strict fiscal rules of the EU’s Stability and Growth Pact. With these rules calling for governments to balance their budgets and continually reduce debt, priority is placed on achieving stability, particularly debt sustainability, rather than on investment-led economic growth. Furthermore, the increased emphasis assigned to contracting public debt is inducing and even forcing governments to focus more on generating primary surpluses, often through fiscal austerity by cutting-back on social and infrastructure expenditures.
In addition, the EU in assessing the economic performance of countries focuses excessively on whether numerical fiscal targets are being attained, rather than on ascertaining progress in improving the actual and potential well-being of the citizens of EU countries. Indeed, the latter objective should be the main aim of national economic policies.
Going forward, the need for national governments of the EU to raise substantially their spending on defense will add to issues, such as demographic ageing, digitisation, climate change and European competitiveness, and accordingly, will augment challenges for fiscal policy over the longer term. And in this connection, how the EU formulates and enforces fiscal rules is likely to have a significant impact on the spending priorities and taxation policies of national governments.
Indeed, before the recent aforementioned criticisms of Europe by Trump and Vance, Nato chief, Mark Rutte, stated that for European governments to raise their defence expenditures, while at the same time meet fiscal targets, they should reduce payments for social protection. But given that government expenditure in many EU member states falls short in dealing effectively with social issues such as providing adequate income support for single parents and old age pensioners, and for implementing investments required to contribute to the smooth functioning and competitiveness of their economies, the recommendation of Rutte should be viewed as a non-starter.
The EU should at least adjust substantially its fiscal rules to exclude national government contributions to investments with EU-wide implications, such as certain of those recommended in the Draghi Report for enhancing the competitiveness of Europe, from the calculation of budget balances. Furthermore, with EU national governments expected and being pressured to raise defence expenditure, among other things, owing to the Russia-Ukraine military conflict, such expenditure could be excluded also from budget balances. In fact, EU Commission chief, Ursula von der Leyen has said that she would propose “EU capitals allowing a temporary easing of the bloc’s rules on deficits for defence spending specifically”.
Alternatively, the EU could engage in common borrowing through issuing bonds for financing increases in defence expenditures and for investments having EU wide implications so as to ease burdens on national budgets and help prevent the crowding-out of social and infrastructure spending.
Implications for Cyprus
In dealing with its ongoing and future fiscal policy challenges the Cyprus government will need to make important choices on the composition of its expenditures and on the adequacy and makeup of its revenues. To what extent will Cyprus conform to EU rules and directives in its policies and continue its fixation with producing government surpluses through exercising austerity over social and development expenditures?
In the years following the financial crisis of 2012/2013 the Cyprus government instituted austerity so as to make progress in bringing the government finances in line with EU fiscal rules. In consequence, over these years social and development expenditures were suppressed, despite government revenues being boosted by large increases in indirect tax receipts. And by 2021 the government was producing primary surpluses, and ever since has continually generated higher surpluses by being the best student in the class in over-doing it in sticking to EU fiscal rules.
Such management of the government finances has impressed the EU and the IMF, and has been most favourably greeted by credit rating agencies with regular upgrades of Cyprus government debt. However, fiscal austerity has been at the expense of keeping social protection outlays at relatively low levels and depressing expenditure on key public investment projects required for the smooth functioning of the economy and for protecting the natural environment.
Looking ahead, Cyprus like most European countries will be facing an ageing population and uncertainties over its external trade relations and will need to enhance its social security and health systems and upgrade its infrastructure, particularly for sustainably increasing the supply and distribution of energy and water.
More specifically, confronted by an ageing population and the need to improve adequacy and coverage of social benefits, future pressures on the government finances can be expected to mount considerably. Indeed, it will be a shrinking working age population that will have to provide the bulk of tax revenues including contributions to national health and social security systems, while the rising elderly population by living longer become an increasing drain on government resources with higher payment of pensions and health benefits.
And on infrastructure systems, the low priority given to executing essential investment projects has meant that less than 65 per cent of funds budgeted for development expenditures were disbursed during recent years. Indeed, it is striking that of the €1.2 billion of EU funds earmarked for Cyprus under the Recovery and Resilience plan, 2021 to 2026, two thirds of which is for financing the much-heralded green and digital transitions, only 28 per cent of this amount had been taken up by Cyprus by January 2025.
Most importantly, as stated repeatedly by energy expert Charles Ellinas in the Sunday Mail, there is an urgent need to upgrade the outdated electricity grid of Cyprus, which together with the lack of electricity storage and interconnection mean that every time the grid becomes overloaded, renewable energy sources such as photovoltaic (PV) systems are switched off, thus wasting precious energy. In fact, owing to such deficiencies the distribution of electricity to households was disrupted in January 2025 following similar, periodic curtailments of renewable energy supplies in 2024. And further related cutbacks in the provision of electricity to certain areas may occur in the coming days.
Finally, it is paramount that with the Cyprus government needing to raise substantially its social, infrastructure and possibly defence expenditures over the medium to longer-term it will have to elevate its revenues in order to at least balance its budget in accord with current EU fiscal rules. The promised tax reform should not be just populist in terms of reducing the tax burden on the middle-class and small businesses, as seems to be the want of President Christodoulides, but should aim at increasing considerably total government revenue to adequate levels via unpopular, albeit necessary, increased taxes on wealthy and high-income persons and corporations, as well as through effective action in combatting widespread tax evasion and avoidance.
Leslie G Manison is an economist. He is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus
