According to Daniel Hannan, the Conservative MEP, “every other continent on the planet has recovered fully from the 2008 crash. The eurozone alone has contracted a chronic condition, a bug it can’t shake off.”
When he wrote that last week, what he mistook for a disease is actually a cure. Austerity in Europe is doing what it’s supposed to — bringing spending back in line with production and laying the foundations for sustainable growth.
It’s true that the eurozone’s recovery remains grindingly slow, with GDP growth of only 0.3 per cent in the last quarter of 2014, but this sluggishness compared with the United States and Britain isn’t because of the euro: it’s because policy is tighter. An alliance of Keynesian economists and eurosceptics maintains that austerity is crushing the life out of the European economy. That isn’t right and these critics’ prescription of debt forgiveness and easier fiscal policy is irrelevant to Europe’s real needs.
Austerity is sometimes right and sometimes wrong. For the indebted economies of Europe, it’s the right course now. The same problems would exist if the euro were not there and they’d need the same remedy.
Granted, the European Central Bank has been insouciant since the 2008 crash. It kept interest rates far too high for an economy mired in recession and its new quantitative easing programme of €60 billion a month should have been adopted long ago. Yet economies where public spending is out of control need to cut it. That was obviously true in the case of Greece, which before the crash was spending more than 14 per cent more of GDP than it was producing. It was also true in the case of Spain and the Republic of Ireland, even though these economies’ weaknesses were different from those of Greece: they were undermined by the implosion of a construction boom and its effect on an undercapitalised banking sector.
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While the mix of problems was different for each of the peripheral eurozone economies, the outcome was the same: international investors lost confidence in these countries’ creditworthiness. Hence the pain of reducing spending to what the economy can afford. And with domestic living standards squeezed, the only way to ease the pain of adjustment is to increase exports.
The remedy urged by eurosceptics is to leave the euro and devalue. Even supposing that course were available, it wouldn’t work. Name a Greek export and most people would cite tourism, which has little room to expand in a competitive market. A similar point applies to Spain.
The remedy urged by Keynesians is to boost domestic demand through public spending and higher benefits. That’s not going to work, either, and it would undermine even any small competitive boost from the devaluation urged by the eurosceptics. The way a devaluation works is to cut real wages (by raising import prices) while keeping nominal wages constant. The programmes of the left-wing parties Syriza in Greece and Podemos in Spain envisage the opposite: a rise in wages and subsidies.
The crucial variable for the indebted economies is that what were once big current account deficits have been swinging into balance. Before the crash, these economies ran up big foreign debts without boosting their exports.
Public debt owed to domestic investors can be repaid either by higher taxes or (not very sensibly) reduced in real terms by running inflationary policies. Yet debt owed to foreigners can be serviced only by selling more abroad. That’s the idea behind austerity. It isn’t about imposing hardship for its own sake. Coupled with structural reforms to liberalise the labour market and raise retirement ages, and reforms to attract international business, it’s what Europe needs.
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Oliver Kamm is a Times leader writer and columnist. Twitter @OliverKamm