Recession in the Eurozone reminds us why economic reform is so vital
MUCH of the Eurozone has now tipped back into recession, prompting cries for pro-growth policies and increased spending. In these difficult times, austerity has become a dirty word, but this masks the wider failings of individual government policies and is a diversion from the collective challenge of keeping the Eurozone intact.
Any attack on austerity looks premature. The Eurozone six-pack and fiscal pact, the main EU-led drivers of austerity, were only really fleshed out last year with the latter yet to be fully in force. This means that few real austerity measures have come into place in countries such as Spain, Italy, Belgium and France, not least because the first three did not have governments willing or able to introduce them until at least mid-way through 2011.
Furthermore, many of the spending cuts are spread over the next few years, and it will take time for the impact of such policies to be felt. The bailed-out countries such as Greece and Portugal are exceptions, but then they have had very high spending and fairly low growth for many years. Clearly increasing spending is no panacea for boosting growth in these economies.
There are a huge number of factors at play here. Many of these countries are undertaking a large rebalancing away from sectors of the economy that used to drive economic growth (for instance, financial services and real estate in countries such as Spain and Ireland). Other countries such as Italy and Portugal are undertaking widespread reform of their political and economic institutions to tackle permanently sluggish growth. These are bound to have a temporary negative impact on growth and employment, but will deliver long-term benefits.
It’s true banks aren’t lending as much to the real economy – which is exacerbating things. However, this is to be expected. Many people seem to forget that the past decade saw a huge expansion of credit and excessive borrowing in the public and private sectors across the Eurozone – deleveraging is a must. Given the unknowns that are now lurking within balance sheets, the sooner this is dealt with the better. Just look at the pressure which the shaky Spanish banking sector is now putting on the economy as a whole.
On top of this, much of previous spending was lavished on infrastructure and, at least partly, state-sponsored projects. This did little to create sustainable growth, but also left many Eurozone states with bloated and inefficient public sectors which are in dire need of reform. Delaying this further and funnelling even more money through defunct institutions would only serve to reward and engrain bad practices. In fact, there is a case to be made that, given the inefficiencies present in many of these institutions, cutting their wasteful spending should not have a lasting negative impact on economic growth.
Finally, and most importantly, this debate takes away from the real problem which the Eurozone is still failing to address. The crisis is still depicted by those in charge as selective problems in a few countries rather than a structural crisis within the Eurozone. There is no clear approach for how to deal with the competitiveness imbalances and the clearly differing needs on monetary and now fiscal policy. Germany still seems unable to accept that this cannot be a bloc of 17 like-minded export-oriented economies.
A singular focus on austerity is not desirable but woolly talk of growth only helps to further distort the debate. Growth is of course vital for the Eurozone, but it has to be the right type of growth. This must come from structural reforms which improve labour and product markets and boost the competitiveness of the economies, not unsustainable, short-term injections of spending. And such reform must be targeted: not all countries can or need to be hemmed into rigid fiscal constraints. The Netherlands, for example, has reasonable debt and deficit levels and requires some measures to boost growth and clean up its banking system: this should not be constrained by a rigid fiscal and monetary framework.
Addressing the real structural problems in the Eurozone will ultimately be the only way to find a desirable balance between fiscal consolidation and growth. Once again avoiding some necessary short-term pain could be detrimental to the Eurozone as a whole in the long term.
Raoul Ruparel is the head of economic research for Open Europe.