Effectiveness of Austerity in Europe (Portfolio)

MIN READJun 21, 2012 | 13:53 GMT

Video Transcript:

Greece's elections this weekend offered voters a basic choice: accept austerity or risk leaving the eurozone. Parties advocating that Greece remain committed to its bailout agreement won a narrow victory —suggesting that the majority of Greeks are not prepared to risk the country's position in the EU over harsh austerity reforms.

Despite a pro-bailout result, EU and Greek officials alike continue to debate softening the terms of Greece's loan agreements — a debate which is illustrative of the deeper question being asked in Europe: How effective is austerity?

Across Europe, harsh austerity measures are proving economically painful, politically untenable and socially dangerous. The ongoing debate among European leaders is beginning to reflect these realities. The failures of austerity are most evident in Greece — where two years of harsh reforms have resulted in increased unemployment, deepening recession, political instability and a dramatic rise in violence. But Greece is hardly an exception.

Italian Premier Mario Monti and Spanish Prime Minister Mariano Rajoy were ardent supporters of the German-led campaign for austerity reforms and fiscal discipline when they first assumed office. Both have since changed their tune.

When Monti was appointed, his push for greater economic reforms was largely accepted by the population and enjoyed the support of the Parliament. But that support was short-lived. Competition amongst parties has slowed down the legislative process, while the effects of the reforms themselves have cost Monti much of his popular support.

Although Italy is not struggling with high budget deficits, its debt to GDP ratio is the second highest in the EU — right behind Greece. As Italy backs off austerity reforms, pressure from bond markets is rising – forcing Monti to search for options while attempting to balance both.

Meanwhile, Spain is grappling with the highest unemployment rate in the European Union. Despite Rajoy's initially strong political mandate, economic and social realities are quickly constraining his room to maneuver. Rajoy is attempting to implement austerity measures and cut spending but has still needed to revise the country's budget targets twice this year, disregarding protests from Brussels. Ironically, the recent announcement of the eurozone's pledge to provide Spain with up to 100 billion euros to prevent a collapse of the country's banking sector has put Madrid in the most precarious financial position it has experienced this year.

The proposed Spanish bank bailout marked a significant shift in the EU's responses to the financial crisis thus far. The hasty agreement to provide such a large sum of money did not reinforce the credibility of Europe's guarantees, but rather emphasized the weakness of its position. EU officials are insisting that the conditions attached will apply only to reforming Spain's banking sector, and, thus, there is no need for Spain to seek a sovereign bailout. But investors are not convinced and have pushed Spain's borrowing costs to nearly unsustainable levels. 

The problem with austerity measures is they deliver diminishing returns in the long run. As economic conditions worsen, spending cuts and tax increases generate less and less revenue for the state. As long as unemployment continues to increase, the number of citizens dependent on state welfare increases, while the number of citizens contributing to welfare funds diminishes.  

France's newly elected president Francois Hollande is spearheading the push back against austerity and appears to have co-opted Spanish and Italian leaders to his cause. When EU leaders hold their next summit, there is likely to be a change of tone.

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