The Austerity Experiment

BRUSSELS—Depending on whose narrative you believe, the deepening economic crisis in Greece proves (a) that the dysfunctional and dissolute Greeks just couldn’t get their act together and keep the reform commitments that they made in exchange for debt relief from the European authorities; or (b) it only proves that austerity breeds more austerity.

Cut public spending and wages, and raise taxes in a recession, and you just dig yourself a deeper hole. Since only about 20 percent of the Greek economy is exports and less than 40 percent of export costs are wages, slashing wages just doesn’t produce much of a bounce, especially when the rest of Europe’s economy is contracting too.

Greece is a lousy test of the austerity-as-cure hypothesis, because left, right, and center agree that Greece has an encrusted system. When I recently interviewed former Prime Minister George Papandreou, he referred to Greece as a “clientist” state—meaning government by crony constituency. When the right governs, its clients are big business; when the left governs, the clients are civil servants and trade unions. In a depressed economy, constituents cling to what they have.

Leftist Greeks whom I interviewed did not defend the encrusted Greek state. They rejected the austerity program, but pointed out that the two parties that have dominated Greek politics for the past 30 years did little to reform a failed system.

In repeated meetings with other European leaders since early 2010, Greek officials regularly got railed for failing to deliver on commitments. In part, they failed to deliver because the entire system, with its corrupt tax collector bureaucracy, takes time to reform and the leaders of the rich nations of Europe were demanding reform overnight.

In the meantime, Greek unemployment rose to more than 20 percent, and the Greek economy will shrink by about 21 percent over three years as purchasing power implodes. There is no end in sight.

So was austerity the wrong cure? Or did Greece fail to follow the recipe?

Interestingly, we have a laboratory-esque experiment to answer that question: Portugal.

When the recession hit the peripheral economies of Europe and speculators began betting against the government bonds of the nations, Portugal got slammed along with Greece. The Portuguese government was unable to roll over its bonds. Like Greece, it became a ward of the “Troika” of the International Monetary Fund: the European Central Bank and the European Commission.

In return for assistance with Portuguese government debt—which had grown rapidly because of the recession and the speculative attacks which raised borrowing costs—the Troika demanded stringent austerity.

But unlike Greece, Portugal complied. If Greece was the problem child of Europe, Portugal was the poster child. It has a relatively clean and efficient government, and it volunteered for austerity. “We did everything they asked of us, and we even went beyond their demands,” former Cabinet Minister Elisa Ferreira told me.

Portugal intensified privatization, raised taxes, cut spending, and reduced pensions.  Portugal has a system where salaried workers are paid wages in 14 monthly installments, so they get seasonal bonus checks before Christmas and in the summer. It’s part of their regular pay. As part of the austerity package, the Christmas check and the summer check were eliminated—a 14 percent pay cut.

The Troika showered Portugal with praise ... but guess what? Austerity didn’t work any better as a recovery strategy in Portugal than it did in Greece.  

Unemployment has risen to 15 percent. The Portuguese economy will shrink by 3.3 percent this year, one of the worst downward spirals in Europe. Reduced wages and idled workers, of course, reduce revenue collections. The debt ratio is still rising. Portugal still cannot access money markets to roll over its bonds, absent IMF support.

Greece has serious problems of governance. Even progressive Greeks who detest the austerity policies imposed by the coalition of speculators and Euro-crats will tell you that Greece is a “failed state,” which will take many years to reform.

But that doesn’t make austerity a smart policy.

Yesterday, however, Olli Rein, the European Union’s commissioner in charge of economic policy, released his semi-annual report. It loosened the screws just a bit on Spain, which is under assault from speculators. Spain, whose economy is reeling, was given an extra year to meet its austerity targets. Small chance.

But Rehn’s larger message was to stay the course on austerity. And, in a signal squarely aimed at President Francois Hollande, France was tacitly threatened with sanctions if it failed to meet its budget targets.

You’d think somebody might notice that austerity is a perverse policy, before the entire, noble European project goes down the tubes.

Comments

It seems to most Europeans "austerity" means raising taxes and reducing entitlement spending. While higher taxes will depress economic activity reducing entitlement spending should help the private sector.

Austerity to a peon like me means not spending money on anything but essentials. I have yet to see any government practice that.

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