A summer of discontent

  • Business
  • Saturday, 19 May 2012

Europe revolts against austerity not just because its painful but because it isnt working

BRUSSELS is known for its fickle weather. I have written repeatedly on the prospect of the eurozone witnessing more winters so long as politicians (and politics will decide Europes fate) avoid addressing its underlying problems.

For a little while, the crisis enjoyed a hint of summer when the ECB (European Central Bank) injected more than one trillion euros in short-term money into Europes banks. Alas, it has now returned to a wintry gloom as new storm clouds begun to blow from Spain and Italy. Yields on Spanish bonds have risen dangerously, with Italian ones close behind. Like Spain, Italy is already in recession and will miss its deficit target this year. The big surprise has been the Netherlands which, too, will miss its fiscal target. So will France and Greece.

A chance for change happened on May 6. France elected a new president with an alternative to the unexpurgated diet of austerity, demanding that the EU treaty limiting debt be expanded to include measures to stimulate economic growth. Despite many years of belt tightening, growth in Europe has stagnated and a record 11% of its labour force is still out of work. In France, 10% are unemployed, competitiveness is sliding and labour costs are among the highest in Europe.

On the same day, the Greeks delivered their verdict on the bail-out: nearly 70% of the electorate voted against the barbarous austerity rescue policies and signalled the depth of their anger over the political establishment and its parasitic political system fuelled by patronage and cronyism, and corruption. Greece did make big inroads into its deficit: between 2010-11 six percentage points were cut-off the budget through sharp tax increases and painful budget cuts. By the end of 2012, Greece will have lost 20% of its pre-crisis GDP. Unemployment stands at 21%. The euro has since sank to hit its lowest level since January against the US dollar (1.2845). Investor confidence dropped to its lowest level in three years, as the deepening crisis stoked anxiety in Asia and US; stock markets plummeted throughout Asia.

Austerity backlash

The anti-austerity wave that voted in a new French president and pulverised the Greek government has had broad resonance that cant be ignored. France and Greece arent the only ones revolting against austerity. In Britain, the ruling party suffered heavy losses in local elections as voters vented anger against severe spending and welfare cuts. In Italy, voter discontent with harsh fiscal restraints has given rising support to angry protests. Even in Germany, state elections this week repudiated tough austerity. The Netherlands government also fell on too much budget cuts.

All these can destabilise an already fragile euro area and worsen recession in larger nations like, the UK, Italy and Spain. Besides, there appears to be a growing disconnect between public support for the euro and public anger on the harsh austerity prescribed to save it. The new sentiment is best expressed by a Greek parliamentarian: we want to stay in the eurozone so we can change its policies, because they are unfair to people. But we wont stay if Europe gives us no choice but austerity. Even the German Chancellor was reconciliatory on May 7: We are talking about two sides of the same coin. Progress is achievable only via solid finances plus growth.

France fumbles: Unlike its robust German neighbour, the French economy remains moribund. The Bank of France expects no growth in Q2 2012, marking two quarters running of stagnation (+1.7% GDP growth in 2011 and +0.2% in Q4 2011). Unemployment has risen above 10%, more lay-offs are due from corporates, and government spends the equivalent of 57% of its GDP, the highest in Europe. In France, the states strong role in public life remains broadly cherished. Nevertheless, the need is being acknowledged to reduce its huge US$2.2 trillion public debt (90% of GDP).

Already, Brussels had raised a red flag on Frances budget deficit next year at 4.2% of GDP, exceeding EUs target of 3%; for this year, it is expected to reach its 4.5% target. Voters rejected the severe austerity not just because its painful at a time of high unemployment and deep social discontent, but more so because it isnt working. Hollande had pledged to create 150,000 state subsidised jobs for youth (unemployment at 22%) and reform the swamped pension system by rolling back the retirement age to 60 from 62.

To lower unemployment, France also has to address crucial social conflict. It is a platform made for Frances 99%: There need to be signs of fairness and of equal treatment across society. The youngs outrage reflected a national discontent best expressed in a wildly popular pamphlet by a WWII resistance fighter, Stephane Hassel: Indignez-Vous! (Time for Outrage) calling on young people to revolt in a peaceful insurrection against injustice, mass consumption... and the endless competition of all against all.

Greece crumbles: Elections in Greece reflected a widespread cry of rage. The economy will have shrunk by a fifth since 2008; its GDP will fall 4.7% this year (-6.2% in Q1 2012), with no signs of recovery and youth unemployment topping 50%. Overall, unemployment spiked to a record 21%; more than 100,000 small businesses have closed; and wages and pensions have been badly cut. Homelessness is on the rise, and suicides had jumped 40% in the past two years. Its budget deficit, despite stringent efforts to consolidate, will reach 7.3% of GDP, and increase to 8.4% in 2013; by then, its debt/GDP ratio will rise to 168%.

Complains a typical 45-year old school teacher: Ill had my salary cut 30%. I am paying taxes through the nose and they are talking about more cuts. If that is what it takes to stay in Europe, I dont want Europe. Greece will run out of money this summer. Citigroup has placed the odds of a Greek euro exit at 50%-75% over the next 12-18 months. People with no prospects are beginning to feel they have nothing to lose by leaving the euro. The long speculated Greek default and euro exit just wont go away. A Grexit will surely test the firewalls. Also, there will be contagion. All these prolong market uncertainty.

Spain stumbles: Spain remains a bigger problem because of its size. Like Greece, Spain has endured austerity that pushed unemployment to 25% and led to a severe recession (GDP -1.8% in 2012). Pensions are slashed; government workers fired and taxes hiked. It still has a budget shortfall of 6.4% of GDP in 2012 (EU target, 5.3%). It struggles to live with austerity and rebuild its banking sector following the housing bubble collapse. Resentment is growing against politicians and beneficiaries of bank bailouts. Spain will succumb to corrosion not collapse. More serious, Spain faces being shut-out of financial markets.

Berlin scrambles: Like it or not, the Germans keeper of fiscal rectitude, will need to shift policy to do more for growth. The cry of rage cannot be ignored. Germany needs to compromise. There is a range of pro-growth policies on the table, including the creation of a public investment bank and tax breaks for small businesses, incentives for enterprises to retain workers and on new hires, and deployment of EU financial institutions to ease the crisis and underwrite infrastructure projects. The presidents of Germany and France have since pledged to forge a joint approach on a growth pact in time for the EU Summit in June.

Stiffest test ever

Europe is in a mess. Growth has been falling back for decades. In the 70s, GDP growth averaged 3.2% annually; in the 80s, 2.5%; in the 90s, 2.2% and in the 00s, 1.2%. The 2008 crash was bad for most, but Europe continued to slide. This year, it will hardly grow at best an anaemic 0.5%-1%. While the US share of global GDP was held steady at 26% for two generations, the EUs share has since dropped to 26%, from 35% in 1970.

The odd-man-out is Germany. Joblessness is down to 6.7%; the budget deficit is heading to zero; and its debt/GDP ratio held at a steady 76%. Within the EU, there is definitely austerity fatigue. You just cant cut and grow. Austerity begets more austerity. IMF studies showed that the debt/GDP ratio will rise (not fall) in every year from 2008-2013 in Ireland, Italy, Spain and Portugal. Because of severe debt restructuring, the ratio in Greece fell briefly.

More scary are the unemployment numbers: among youth (15-25 years), those without a job represented 51% in Greece and Spain; 36% in Portugal and Italy, and 30% in Ireland. France fares better, but the situation is dire: one in five youths is unemployed. Politically, eight leaders were swept from office in the past year. The economic outlook is poor. GDP will shrink in Greece, Italy, Portugal and Spain. With luck, it will stagnate in France and Ireland. Optimistically, as a whole, they can be expected to grow just 0.5%-1.0% in 2013. This is politically unacceptable.

Austerity rebuked

The French and Greek elections sent a common message that voters wont stomach tough austerity anymore. So change must happen: a better balance of austerity and growth, perhaps. The head of the Deutsche Bundesbank has insisted (i) monetary policy has reached its limits; (ii) the fiscal compact precludes discretionary fiscal policy; and (iii) the currency union lacks fiscal solidarity. How then to square the circle to restore confidence, as more economies plunge deeper into recession'

For the Germans, this leaves only structural reform what they now call growth policy. Growth proponents say such reforms dont offer a swift return to growth. It took the 1980s Thatcher reforms more than a decade to derive benefit for the UK. Nobel laureate Prof Stigliz contends that there is no example of a large economy (Europe is the worlds largest) recovering as a result of austerity. Also, Prof Le Grauwe stresses the current adjustment process is asymmetric: countries in difficulties disinflate, but those in a strong position dont inflate (e.g. Germany). Thats the crux of the problem.

Growth pact: But, all is not lost. Stigliz suggested two ways to grow: (a) Nations like Germany with fiscal room to manoeuvre should use it to push for more investment to enhance growth, with positive spill-over for Europe the balanced expansion of taxes and spending can stimulate growth; (b) Europe as a whole is still in good fiscal shape. The whole is more than the sum of its parts. Europe has much capacity to borrow and re-cycle (especially the ECB) by on-lending to promote growth and jobs.

It all depends on Germany. It could become the locomotive to the rest of Europe, spurred by very low borrowing costs. Coupled with a sharp fall in the euro (say, by 15% to 20%), the German economy can lift-off, enhancing economic prospects for the eurozone. It has been argued that a cheap currency, by giving an artificial boost to competitiveness, is more palatable than austerity. To really help struggling euro nations, the ferocity of fiscal contraction needs to be lessened by slowing down budget adjustment, while finding a realistic and credible path to budget balance. Start by pushing back fiscal targets; e.g. allow Spain to meet its goal in 2014 (not 2013).

Furthermore, there are already institutions within Europe, e.g. European Investment Bank (EIB) that could help finance the much needed investment, including giving EIB more clout (new capital injection) and allowing it to issue project bonds to fund new energy technology and infrastructure, and small business expansions (to offset credit denial by banks). Then, the structural funds within EU can be deployed as growth stimuli. Finally, create new financial capabilities to promote for growth and jobs. There is no need to reject the budget compact. Just add-on growth stimulus measures as a companion. This is one way to avert the vicious cycle of recession and austerity.

What, then, are we to do'

The pain in Europe is self-inflicted and quite unnecessary, especially the suffering of the poor and the young. Relentless austerity is not working. Fortunately, there are serious alternatives to austerity economics. It was Keynesian Sir Roy Harrod who gave an erudite refutation in the 1950s entitled: Are the hardships really necessary'

Controlling deficits is important. But sharp reductions in public spending as the one-size-fits-all answer to Europes problems is dangerous. It stalls recovery; worse, wrecks havoc on human lives. Social discontent and grim numbers and a poor outlook prove that. Surely, voters in Europe have figured it out. Nations must be allowed to grow. According to Hollande: People need to see that while the collective effort may be long and difficult, its going to be fair and involve everyone. But all eyes now are on Greece and Spain. Europes voters know what to do with leaders who dont or wont meet their expectations. And, Europe is running out of time.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who speaks, writes and consults on economic & financial issues. Feedback is most welcome; email: starbizweek@thestar.com.my

Article type: metered
User Type: anonymous web
User Status:
Campaign ID: 1
Cxense type: free
User access status: 3

Did you find this article insightful?


Across the site