The negative evidence has been piling up, say critics of the strict austerity imposed on many European countries to force budgetary and economic reforms. While those reforms are intended to usher in more sustainable growth eventually, today several European economies are slipping back into recession (Spain, Italy, Portugal, Ireland, Greece and the UK).
It’s evidence that policies that might work over the long term can have devastating consequences in the short term if they are jammed in over too-short a period, critics contend. But what has most turned the screw on austerity views are two recent developments that sent political tremors across the continent.
First, Mark Rutte, the Prime Minister of the Netherlands, resigned after a collapse in talks over the country’s budget, which included deep cuts. The resignation followed a refusal of far-right leader Geert Wilders to agree to some 16 billion euros of budget reductions as part of an austerity package. And second, in France, incumbent President Nicolas Sarkozy looks likely to be bested by Socialist challenger Francois Hollande, who strongly advocates a watering down of austerity measures in France and in Europe more generally. Hollande says he has support throughout Europe for a plan that would encourage more economic growth measures.
Hollande says he will not sign on to Europe’s fiscal-discipline treaty unless it is retooled to include a package of growth measures. As it stands, the European Union austerity budget treaty signed in March would send the continent into a deep recession, he argues. If he wins this Sunday’s election, as looks likely, Hollande vows he will offer ideas on how to recast the treaty the following day.
The bottom line is that politics is pushing back strongly against economic policies of austerity in Europe.
Wharton finance professor Franklin Allen calls the political developments significant. “Let’s see if Hollande wins on Sunday. If he does, then this may well impact what happens in elections Ireland on May 31 and in the Netherlands in September. I think Greece’s outcome on Sunday will also be interesting.”
As many European countries slip back into recession, there are signs of a shift to “those of us who have argued for economic growth first and a gradual fiscal adjustment,” says Wharton management professor Mauro Guillen. “We all hope now that the fiscal hawks realize that their strategy is not working.” But any meaningful pivot away from austerity and toward more stimulus “will only happen if GDP continues to shrink or grow very slowly. But then, I am not wishing for that.” In any case, expect strong headwinds for global firms in Europe.
Guillen adds that the best outcome “would be for governments to commit to fiscal balance over a period of three to four years, giving time for the economy to recover, tax revenue to increase and so on. But the problem is that the markets don’t believe the politicians’ commitment to fiscal austerity years down the road. They believe that if they reduce the pressure now, the politicians will relax.”
Allen thinks changes in Europe’s austerity stance are likely, at least in Spain, Italy and France (if Hollande wins).
But what will that change look like? “The problem is there are no good answers to this question,” Allen says. “If we rule out Keynesian demand stimulation, then product market reforms are the fastest acting. But these are still measured in years. Labor reforms [take] a decade and education is even more. The fastest is exchange rate changes. These act within months. This is why, in the end, I think it would be better if Greece, Portugal and Spain temporarily left the Eurozone.”
In Allen’s view, any shifts from austerity to more growth-oriented policies will be modest and likely slow to bring any change.