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A return to austerity in Europe: Feasible or fictional?

Federico Steinberg
01 Oct 2022 00:00:00 | Update: 30 Sep 2022 22:43:38
A return to austerity in Europe: Feasible or fictional?

The war in Ukraine has cast a dark shadow over the EU’s economic recovery. Strong inflationary pressures, growing public debt, rising public deficits and increasing interest rates bode ill for the future, suggesting the expediency of a return to the austerity policies implemented after the crisis a decade ago.

However, as this analysis shows, the international context may not favour this sort of fiscal adjustment in the eurozone. The new economic and geopolitical reality, characterised by deglobalisation and rivalries and clashes between major powers, means we must rethink the ‘Germanised’ model of wage devaluation and export-driven European growth that has come to dominate in Europe. The path forward for European fiscal policy will be defined by the debate between strategic and normative considerations. Germany’s vision will play a fundamental role. There are many recipes for prosperity. One is a wealthy country with full employment, abundant opportunities, a predominantly export-oriented economy and a strict tradition of fiscal discipline, as is the case with Germany.

Another is a less austere economy driven by internal demand, along the lines of the US. However, if there is one lesson to be learned from the academic literature on different types of capitalism, transitioning from one model to another is far from easy. Yet the eurozone as a whole –above all the countries of the south, such as Spain– emerged from the financial and euro crises of 2008-13 with ‘Germanised’ economies, characterised by internal wage devaluations and austerity. The measures brought a boom in exports and led to a

structural current account surplus for the eurozone as a whole. Yet they also fuelled social discontent and inequality and the rise of anti-establishment parties. The period 2014-20 can be characterised by growth,

‘austerity light’, monetary expansion and low inflation, despite Brexit and Trump’s neo-mercantilist presidency exposing export-reliant Europe to the risks of economic disintegration. Then came the pandemic, creating an interval in which European

countries joined others around the world in an unprecedented but necessary exercise in fiscal and monetary expansion. In the EU, this was combined with a coordinated and cooperative response that resulted in the Next Generation EU funds.

However, the war in Ukraine, the slowdown in the Chinese economy and rising interest rates have cast a dark shadow over Europe’s prospects for economic recovery. Strong inflationary pressures, together with high levels of debt and public deficits, mean there are real concerns about what the future holds. While European fiscal rules have been put on ice until the end of 2023 (while also pending reform), some voices are already calling for a return to austerity along the lines of 2010. However, the global economic landscape has changed, with geostrategic rivalries between major powers and risks of deglobalisation. Such a context means we must now ask ourselves whether fiscal restrictions and faith in the export-driven model are the best way forward for the EU as a whole. Reflections along these lines invariably lead to the debate on the role of the State in a post-COVID world, characterised by the decline of the international liberal order and the EU’s need to build its strategic autonomy and find its place in the world.

There can be no doubt that countries with a structural public deficit, such as Spain, must balance their public accounts by boosting income and/or cutting spending, and that this must be accompanied by a credible long-term strategy for fiscal consolidation. However, the EU as a whole, and the eurozone in particular, must reflect on their model of growth to give more space to internal demand.

The case for early fiscal consolidation is intuitive. It was easier to sustain higher levels of debt and public deficits at the end of 2021, when forecasts pointed to a strong economic recovery with moderate inflation, without risks of the financial fragmentation of the eurozone. However, the outbreak of war in Ukraine in February 2022 has slashed growth expectations, at the same time as surging inflation has led central banks throughout the world to raise interest rates. The question is thus to what extent we will see a hard landing after the boom that followed the post-pandemic rebound and what role fiscal policy should play in a context of tighter monetary policy.

In the 2010s, rising public debt and high risk premia in certain eurozone countries were the ‘sticks’ used to justify the austerity policies adopted across the continent. However, in this roadmap (occasionally referred to as ‘austericide’ in southern Europe), the ‘sticks’ were combined with significant ‘carrots’. Under the most optimistic take on ‘expansionary austerity’, cuts in public spending should be amply compensated by the rise in foreign direct investment as a result of the confidence generated by the commitment to fiscal consolidation.


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