Debate over austerity heats up
Since the European sovereign debt crisis began several years ago, forcing afflicted countries to turn to the European Commission, European Central Bank, and International Monetary Fund for financial rescue packages, the conditions specified by these institutions have been unambiguous: if you accept our money, you must implement reforms. These reforms, collectively known as austerity policies, have aimed to reduce budget deficits through sharp cuts in government spending and tax increases. Austerity policies have always aroused resentment in indebted countries, as the massive protests in Greece, Spain, Portugal and other countries indicate. But in the past few weeks, the anti-austerity backlash has gained momentum, with influential politicians joining the protesters in saying that the policies are not helping and could even be making the situation worse.
Perhaps the main catalyst behind the recent anti-austerity sentiment has been the emergence of Francois Hollande as a leading presidential contender in France. As we discussed at this blog a couple of weeks ago, Hollande has vowed to reexamine the EU fiscal compact that was signed at the beginning of March. This agreement will give the European Commission greater authority to monitor member countries’ efforts to reduce their budget deficits and impose penalties on countries that exceed the minimum allowable limit. After Hollande’s promise to revise the agreement sparked howls of protest from various quarters, the French leftist clarified that he didn’t want to rewrite it from scratch, but merely add some additional pro-growth and employment creation policies to complement the deficit-cutting measures. But regardless of Hollande’s softening of his language, his comments garnered support from left-leaning political parties in Germany, Spain, and elsewhere in Europe.
The motivation behind this deficit reduction emphasis is the need to reduce borrowing costs. Greece, Ireland, Italy, Portugal, and Spain have found it increasingly expensive to borrow on international markets, as lenders are unwilling to invest in risky, deficit-addled economies. Austerity measures are supposed to indicate a country’s commitment to economic discipline and reform. Critics argue the policies have not worked to ease market fears, and that they have even made the situation worse by increasing unemployment and suppressing economic demand and growth. Perhaps the most prominent American critic of austerity is Paul Krugman, who has labeled Europe’s push for austerity as “economic suicide.” He writes:
Europe has had several years of experience with harsh austerity programs, and the results are exactly what students of history told you would happen: such programs push depressed economies even deeper into depression. And because investors look at the state of a nation’s economy when assessing its ability to repay debt, austerity programs haven’t even worked as a way to reduce borrowing costs.
Martin Wolf of the Financial Times examines data over the past few years and finds a negative correlation between the size of a country’s fiscal adjustment (a proxy for the scale of a country’s austerity policies) and economic growth. In other words, countries which implemented the most extensive austerity policies have tended to have the worst economic performances over this time period. (Although Wolf’s graph does not specify the direction of causality; did austerity policies hurt economic growth, or is it the case that the countries with the worst economic growth were the ones implementing austerity policies?)
Fellow Financial Times columnist Gideon Rachman responds to the anti-austerity backlash in an article, succinctly title “No alternative to austerity.” Rachman argues that all the talk of “growth” as an alternative to austerity is vague and empty of content:
Mr Hollande says that he will replace austerity with growth. Why didn’t anybody think of that before? Unfortunately, a vacuous slogan is underpinned by ineffectual proposals. Mr Hollande’s programme stresses small, badly-targeted boosts to public spending, while virtually ignoring the structural reforms that are the only route to sustainable growth.
Rachman reminds readers that Spain and Italy were forced to implement austerity because they found it increasingly expensive to borrow, and that the markets will hardly reward them if they move away from austerity and start spending more. The “Free Exchange” blog at The Economist argues that Rachman sets up a false distinction between austerity and stimulus (government spending), and that one alternative to the current austerity programs being implemented in some euro zone countries is not more government spending but simply less austerity. The article points to Spain in particular as an example where austerity seems to be feeding a vicious circle in which austerity is decreasing growth, which in turn is decreasing Spain’s ability to borrow, which in turn leads to demands for further austerity measures.
This debate will intensify in the near future with elections coming up in several EU countries. In France, opinion polls show Hollande with a sizable lead over incumbent Nicolas Sarkozy. In Greek elections this weekend, voters could punish the two biggest parties, both of which support the terms of the bailout package that has been negotiated with the EU and the IMF. Opinion polls have shown growing popularity for smaller parties of the left and right. In the Netherlands, until recently regarded as one of the more fiscally prudent members of the euro zone, fears that the country’s budget deficit could lead to higher borrowing costs led to the government’s collapse. Hundreds of thousands of protesters throughout Europe took to the streets on May Day in various European countries to protest against austerity policies. Time will tell if the current season of discontent will mark a turning point in the discussion of the crisis and how the EU reacts to it.