Semantics could help save the euro zone. There is a crying need to distinguish between fiscal austerity and structural reform. The endless austerity programs adopted by the GIIPS — Greece, Ireland, Italy, Portugal and Spain — threaten to crush their economies so much that they are socially unbearable. By contrast, reforming pensions, labor markets and the like would be good for long-term growth. A policy mix that emphasizes the latter and draws some sort of line under the former is needed to stop the euro crisis spinning out of control.
Europeans have become grimly familiar with austerity spirals over the past two years. A government that needs to cut its fiscal deficit embarks on a program of tax hikes and spending cuts. The snag is that this fiscal squeeze, in turn, squeezes the economy — partly via the direct impact of cash being sucked out of the private sector and partly because the private sector loses confidence. The depressed economy means the government’s tax take doesn’t rise nearly as much as envisaged. So the deficit doesn’t decline much and, as a percentage of shrunken GDP, it falls even less. The governments’ creditors, led by Germany, then demand another round of austerity to get the program back on track. With each round, the howls of pain from the population increase, belief that there is light at the end of the tunnel declines and the government’s political capital shrinks.
The Greeks, Irish and Portuguese have been trying to run up this down escalator the longest. Italy and Spain are now embarking on the same regime. Yet more doses will be required over the coming year if the policy mix is unchanged. After all, last year’s budget deficits are expected to be about 10 percent for Greece and Ireland, 7-8 percent for Spain and Portugal (if a one-off pension transfer is ignored) and 4 percent for Italy.
Some austerity was needed given that expenditure had run out of control in the boom times and that, in some cases, there was a deliberate fiscal boost in the aftermath of Lehman Brothers’ bankruptcy in 2008. In Greece’s case, there was also a failure to implement the programs properly, meaning time and credibility were lost. But endless rounds of austerity are debilitating. The better approach would be to have one chunky program that is properly implemented and then rebuild.
Of course, the creditors aren’t willing to give something for nothing. But this is where a semantic distinction between austerity and structural reform could be helpful. Both require political courage by a government and sacrifices by its people. But the former pushes an economy down, while the latter boosts it — albeit in the long term. A virtuous cycle is even possible with the economy reviving, tax income rising, the deficit falling and confidence returning.