Wednesday, 8 May 2013

Austerity is not killing the patient, lack of reform is.


A junkie is forced into rehab in order to save his life. As the withdrawal symptoms kick in, he starts to scream with pain and curse the moment when he agreed to seek help. As an uninformed witness, you might feel sorry for him and brand the treatment as torture. Surely it is inhumane to let him go through such a pain, isn't it? Well, no. It is not. The pain is a result of his addiction and blaming the cure would be a mistake. Yet this is exactly what is happening in Europe. After decades of debt addiction, the European economies are struggling with the withdrawal symptoms and are blaming austerity for the pain.

However, there is a blame that can be laid at the doctors treating the European patient. The treatment could be more effective if other problems are also tackled yet this means even more pain in the short term. The austerity treatment prescribed to the European economies should be accompanied by an equally painful dose of reform. Structural reconstruction is as necessary as austerity and it is this exact reform that would bring back the solid growth policy makers desire so much. 

How Austerity (kind of) worked 

Since the beginning of the crisis, 5 of the 17 Eurozone countries - so far -  have run into significant financial problems and were forced into asking for EU and IMF help . In exchange for support, these countries have signed up to a painful program of austerity and reform. Cuts and tax hikes have hit hard yet reforms have barely been started. Because of external factors, in most of the EU countries the economic activity is now reaching pre-recession levels. While most financial indicators have stabilised -Ireland has even managed to exit the bailout program - the social pain is only now starting to hit. Unemployment is the clearest sign of this pain: record 12.1% Eurozone unemployment, 10.9% for the EU. 26.7% for Spain, 28% for Greece, 17.5% for Portugal. 24% of EU youth unemployed, 56% youth unemployment in Spain and 60% in Greece.  64%in Greece, 42% in Portugal (new figures released a few hours ago)

It is in this context that a significant majority of voices are warning that austerity has not helped Europe and that it has actually made things worse. Indeed, many of the fundamentals that the austerity policies have been based on have proven to be false. The now famous Reinhard and Rogoff  excel mistake and acknowledgments from the IMF that they have underestimated the fiscal multipliers of budget cuts  have embarrassed the European Commission who is left without the two big arguments it had in pushing austerity.

However, it is important to remember that austerity was not only adopted because of economic reasons. The high-politics game played at EU Councils resulted in countless agreements, all saying the same thing: Northern countries and the Commission would help Southern countries escape bankruptcy if these countries put their budgets in order and reform so they close the competitivity gap. It is interesting to note that before and immediately after the fiscal compact of March 2012, media kept referring to these adjustments as ‘budget balancing’ and ‘fiscal discipline’. Today, the same measures are being labelled as ‘austerity’.

The intention of these programmes was dual: on one hand, countries which lagged behind were supposed to become more competitive and, as such, make Europe as a whole stronger. Secondly, a chance for political compromise and a show of unity to reassure the markets was only possible if the Northern countries could present a deal acceptable to their electorate. It would have been impossible for Angela Merkel to pass a bailout deal without having anything to show for it.

It is this precise political factor that many of those who condemn austerity are now ignoring. At the height of the crisis, the political fractures of the Union were as a big of a risk to the EU economy as the recession itself. Widely divergent government debt yields were a sign of a fractured EU. And this fracture was obvious not just in economic indexes but in the philosophy behind policy as well. As Italian PM Monti very correctly underlined: "For Germany, economics is a branch of moral philosophy”. Transferring bailout money to countries that have broken this moral code without any strings attached would have created a ‘moral hazard’ that would have been unacceptable to the Germans. The only possible agreement included both money transfers (solidarity asked by South) and reform (budget balancing asked by North). Without a political agreement, the markets would have continued to take advantage of the cracks of the Eurozone pushing Italy and Spain to encounter problems in selling their debt. Furthermore, current criticism directed at austerity assumes that Mario Draghi would have made his ‘whatever it takes’ promise to save the euro – widely credited with saving Italy and Spain from the brink - even in the absence of deficit cutting measures, which I believe to be very unlikely.  

Was it fair for the EU to impose such measures on the Southern countries? If you consider the alternatives, either bankruptcy or an exit from the eurozone ( as bad as a bankruptcy, if not worse), the current social problems and unemployment levels are quite modest. Equally telling is the fact that real unemployment figure (not just benefits claim, implied for an average workforce participation of 65%) is close to 12%  in the US - a country that has applied the exact opposite cure to its economic problems. In effect, there is very little to show for the stimulus in the American economy other than significant increases in inequality (with the top earners benefiting the most from it) and debt levels.

But nothing has changed

While the high politics succeeded in reaching an agreement and the EU delivered on its promise to bail out countries in need, local politics failed to implement their promises. Reforms have been painfully slow exacerbating the pain caused by austerity. After six years of recession, it was only in the last week of April 2013 that Greece has voted into law part (not all) of the labour reform agreed in the first bailout. Greece and Cyprus are still having problems identifying property rights for much of the countries’ land because there is no clear record. In the last report on the EU economy, the IMF has yet again assessed that there has been no progress in tackling ‘notorious’ tax evasion in the South of Europe. The tax administrators in Cyprus, Italy and Greece are still politically named. The Spanish banking system has not yet been cleared of bad loans and new loans are very much impossible to get, asphyxiating the creation of new businesses and jobs. Even reforms that have been adopted are now at threat. The new Italian government is being forced to roll back  some of Monti’s reforms, like the property tax, at the request of Berlusconi, the new voice of anti-austerity in the country. Italians seem to have forgotten the country’s performance under Berlusconi when Italy's economy grew least in the world for a decade, bar Haiti and Zimbabwe, and reached the third highest debt-to-GDP level.

It is hard to say how much lower unemployment would be today if aggressive reforms would have actually been implemented. It is very possible that unemployment would have actually been higher as reforms would have also caused some extra pain to the economy but I can't see how the number of long term unemployed would have been as high as it is now. Undoubtedly, the EU would have been in a better position to deal with future problems.

Essentially, very little has changed.  Austerity has forced an internal devaluation and made southern countries slightly more competitive but there has been very little structural change. And the incentive for reforms is receding. While central banks are flooding the market with money and public dissatisfaction is causing social convulsions, governments around Europe are mistakenly looking to change course. There is little talk of stimulus as most commentators realise that is not acceptable for the Germans, but easing austerity is well under way. Unfortunately, the reform programs have also been eased.


After a few days in rehabilitation, the junkie exits treatment and goes back into the world. As there was no appropriate psychological support provided during treatment, the patient doesn’t change his life habits and is soon back on drugs. The treatment fails. At the hospital, one of the  doctors that treated the patient, Ms Dorothea, is facing an inquiry into her treatment which was described as ‘brutal’ and ‘inhumane’ by her colleague, Mr Silvio. Mr Silvio is the one who recommended a priest to help the patient change his lifestyle. The story doesn’t end.

For more comments and updates, follow @MariusStancu_

No comments:

Post a Comment