Austerity strategy – hopes and fears

The kind of anxiety that has enveloped the European Union right now is not an unexpected phenomenon. Ever since the German-backed austerity drive started to become a vogue on the continent, the economists and academia have been talking about the “gathering storm” that would eventually put the European Union on the wave of political and economic distress.

The recent buzz about a possible Greek exit has further jolted the EU that is struggling to recover from the results of the May elections in six European countries that gave clear message that the people on the continent are not happy with the austerity reforms. For many years, German leadership and technocrats had dictated to their profligate southern European neighbors to blatantly implement austerity to manage the continent’s simmering debt crisis.

This was the price the deficit-prone countries of southern Europe had to pay if they wanted the financial assistance from the big and rich brothers in the EU. The idea was that these countries would adopt German economic thinking and standards – lower price inflation and wage growth, more saving and less spending – to counter the debt issue.

Interestingly, this austerity philosophy was readily accepted by most of the EU countries as a novel prescription that would not only solve the acute debt crisis but it would also reduce the disparity among the European economies that would eventually converge to one. The prosperous countries in the EU were not ready to assume the liabilities of the deficit countries without these austerity reforms. The expectations were high and there was a sincere momentum across the continent to execute austerity program in its true spirit.

But the fact is that the austerity measures have so far resulted in some of the unexpected adverse effects that are widening the economic disparity in the EU and directly impacting the daily lives of the inhabitants. Going by the poll results in six countries -- France, Greece, Serbia, Germany, Italy, Armenia – it is very much clear that voters have punished the incumbent leadership which had been pushing for the region-wide austerity measures.

The vicious cycle generated by austerity is very swift one. The process is simple: when the government resorts to cost-cutting, the companies and manufacturers lose significant profits, so they are forced to lay off large numbers of employees to maintain profitability. Consumers have less money to spend. That reduces the government’s tax revenues, augments the nation’s unemployment rate and increases unemployment-benefit payouts.

All this has a direct impact on the living standards. This is exactly what is happening in the EU. For example, in Greece alone, more than 60,000 retailers have been forced to shut down, pushing even more people out of work, including the retailers’ suppliers ― and on and on. Austerity programmes catapult weak economies directly into recession.

So far, 12 of Europe’s 27 nations have been bracketed as “recession-laden.” Spain and Britain are the two most recent states to join the league, while many others are knocking at the door. However, the fact remains that Europe as a whole is still not in bad fiscal shape as such; its debt-to-GDP ratio is better than that of the United States. Similarly, housing and banking - that recently erupted across the Western world - are hardly specific to southern Europe.

Most eurozone crisis countries have relatively prudent fiscal policies; having smaller deficits than Japan, Britain and the United States. Europe s single-minded focus on austerity is a direct outcome of a misdiagnosis of its problems. It is hard to predict about the consequences of Europe s rush to austerity. Will it be long-lasting and severe? Will the crisis further spread? Will the euro survive the brunt of widening yawn among the European economies? At the moment, the answers to these and similar questions is quite difficult.

However, the eurozone members, during the last two years, have been relatively successful in managing some of the acute symptoms of the crisis, albeit at a very high cost. Yet the long-term and bigger challenge remains: making European economies converge — that is, ensuring that their domestic macro-economic behaviors are emphatically homogenized to roll out a single monetary policy at a reasonable cost.

To achieve this objective and to avert a long-term economic catastrophe, both the creditor states (like Germany and France) and the deficit countries in southern Europe must re-align their trends in government spending, competitiveness, inflation, labor costs, private-sector behavior and other areas.

Economies without growth cannot support or sustain debt reduction or structural reform in the European Union - perhaps the most ambitious, impressive and successful model of voluntary international cooperation in world history.

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