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The Problem with Europe ’ s Austerity Debate

Explore the impact of early fiscal adjustment in Europe's austerity debate. Learn why prioritizing growth, structural reforms, and financial sustainability is crucial for resolving economic crises. Discover the consequences of delayed action and the importance of regaining confidence. Understand the significance of education in boosting Southern Europe's recovery.

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The Problem with Europe ’ s Austerity Debate

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  1. The Problem with Europe’s Austerity Debate Anders Åslund Senior Fellow Cato Institute June 5, 2013

  2. What Is Austerity? • Fiscal responsibility! = Money is not free • The real questions: • 1. Fiscal responsibility: Now or later? • 2. Who is prepared to pay? • 3. To frontload or backload?

  3. Six Reasons why early fiscal adjustment preferable • Early return to growth • Politically easier • Better fiscal adjustment • More structural reform • Financial sustainability • Earlier restoration of confidence

  4. 1. Early Return to Growth & Higher Growth Trajectory

  5. 2. Politically Easier • Rahm Emmanuel: “A crisis is a terrible thing to waste.” • Latvia: One riot in January 2009. PM Valdis Dombrovskis – reelected twice & longest serving PM in Latvia: “In this situation we have only two alternatives – one bad and a worse one. I prefer the bad one.” • Greece: years of riots, strikes & demonstrations; radicalization of electorate; is democracy in danger?

  6. 3. Better Fiscal Adjustment: Get ahead of the curve! • Latvia 2/3 expenditure cuts, 1/3 tax hikes • Greece: Little decline in public expenditures, lingering around 54% of GDP – GDP falls faster than expenditure cuts… • Greece: Little prospect for growth

  7. Latvia: Public Expenditure as % of GDP Normalizing

  8. Latvia Brought Down Budget Deficit, Greece Stuck at Huge Deficit

  9. 4. More Structural Reforms Expenditure cuts drive growth • Vested interest are not mobilized early on • More deregulation • More public sector reform – Latvia sacked 30% of civil servants instantly – Greece just starting

  10. Latvia: Sharply Falling Real Unit Labor Cost, 20%, 2008-12, Greece Less

  11. 5. Financial Sustainability Vital • Public debt in euro area on average 91% of GDP, end 2012 • Nine of 27 EU countries have lost market access and needed assistance • Financial assistance limited • If no financing, little choice

  12. 6. Confidence Restored Early • In Latvia bond yields peaked in June 2009 but in February 2012 in Greece • Much lower yields and market interest rates in Latvia • More domestic and foreign investment

  13. Greatest Mistake:Greece May 2010 Program • Too large credits given caused default • No structural reforms • No reduction of public expenditures as %GDP • Too small fiscal adjustment • No confidence & no growth

  14. Focus on Education! The key problem of Southern Europe: • Little education • Education of poor quality Only 38% of the Portuguese labor force has graduated from high school (US: 88%)

  15. Share of Labor Force That Has Graduated from High School, 2012

  16. Performance on PISA Math Test, 2009

  17. Conclusions • Europe’s fiscally conservative north thrives: Latvia’s GDP growth 5.5% in 2011 and 2012 • The backloaded South suffers: Meanwhile Greece GDP fell about 6% each year • IMF advice seriously flawed • Overestimated fiscal space in Spain, Cyprus & Slovenia • Intentionally delays crisis resolution in the South

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