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Europe pact: Members must balance budgets or suffer sanctions

Leaders also pledged to promote growth and target high unemployment, in a sign that the relentless focus on austerity measures alone to battle Europe’s economic woes is wearing thin.

The fiscal pact signed by Europe‘s leaders Monday aims to enforce budget discipline through the threat of automatic sanctions on countries that breach deficit limits and do not present a balanced budget by prescribed deadlines.

But leaders also pledged to promote growth and target high unemployment, in a sign that the relentless focus on austerity measures alone to battle Europe’s economic woes is wearing thin.

Critics have argued for some time that the EU‘s tough austerity drive was undermining countries struggling to gain the economic momentum that will win the confidence of financial markets, and was actually driving these countries into a recession.

“Austerity needs to come in very carefully administered doses, otherwise you kill demand,” says Holger Schmieding, chief economist with Berenberg Bank in London. “At the same time you need to reform the labor market, make it easier for people to find jobs and easier for businesses to start.”

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In a joint statement on economic growth after the summit, EU leaders acknowledged that cutting budgets was “not in itself sufficient.” The European Union will dedicate €82 billion ($107 billion) to fighting unemployment, Herman Van Rompuy, the EU president announced. The money will come out of so-called structural funds, which were set up to subsidize economically weak regions in the union.

German Chancellor Angela Merkel called the treaty “an important step forward in Europe’s efforts to overcome the sovereign debt crisis.” Britain and the Czech Republic refused to sign the pact, which still needs ratification in the other 25 EU member states. Most member states are likely to ratify, though Ireland may threaten to hold a referendum on it, while in France, presidential elections could affect French participation. The UK government has in the past made it clear that it was not prepared to yield any budgetary control to Brussels.

The accord was an initiative by Chancellor Merkel. But Germany is seen by many as one of the main culprits for the lack of progress in solving the debt crisis. Europe’s biggest economy and the main contributor to bailout packages and rescue funds, Germany has been trying to implement a strict therapy of cutting deficits throughout the eurozone, where a range of countries including Greece, Portugal, Spain, and Italy have amassed critically high levels of sovereign debt and at the same time lost the trust of international investors because of weak economic performance.

Leaders in Brussels appeared to agree that more should be done to promote growth throughout Europe and to facilitate the movement of labor. “If we just keep cutting back on spending, our children won’t inherit a house, they’ll just inherit a mortgage,” said Martin Schulz, president of the European Parliament.

Mr. Schmeiding, the economist, echoed that sentiment, saying the EU must target more growth measures. “I don’t think they got the mix quite right yet,” he says. “There is still too much focus on austerity.”

Rising joblessness

The latest figures from Europe are cause for concern. Unemployment is now averaging 10 percent across the Continent, with more than 23 million people in the European Union out of a job.

Spain’s economy shrunk by 0.3 percent in the fourth quarter of last year. Nearly a quarter of the working population there is out of a job, and youth unemployment is close to 50 percent. In Italy, Portugal, and Greece 30 percent of young people are looking for work.

“The job situation in Europe is very serious,” says Raymond Torres from the International Labor Organisation (ILO) in Geneva. “After several months of improvement we are seeing an increase in unemployment again. Clearly enterprises do not believe the crisis is going to be over any time soon.”

If any reminder was needed that austerity measures are unpopular, EU leaders on their way to Brussels were greeted by a national strike in Belgium. Trade unions protested against plans to raise the retirement age. Trains and buses stood still, the country’s main airport was closed, so in order to get to the summit the politicians had to land at an army airbase.

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The meeting also approved the installation of a new, permanent bailout fund, the European Stability Mechanism (ESM), with a capacity of €500 billion ($659 billion), starting in July 2012.

One glaring omission on the summit agenda was Greece. The country needs money out of a second bailout package worth €130 billion ($171 billion) very soon in order to pay back debt due in March — otherwise it defaults. But this aid won’t come unless Greece strikes a deal with its private creditors on a haircut — a write-off of Greek sovereign debt of at least 50 percent. Negotiations on the haircut have been dragging on for months and are reported to be close to a deal — but not quite there yet.

Plans aired before the summit by the German finance ministry to impose budgetary control on Greece through a special commissioner were dropped quickly when they met with almost universal opposition from European leaders. “It’s a debate we shouldn’t be having,” said Ms. Merkel.