Analysis: Europe's austerity zeal risks killing the patient

DUBLIN/ROME Wed Dec 14, 2011 1:37pm EST

A man walks past a shop which displayed discount signs in Nice, southeastern France, December 13, 2011. REUTERS/Eric Gaillard

A man walks past a shop which displayed discount signs in Nice, southeastern France, December 13, 2011.

Credit: Reuters/Eric Gaillard

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DUBLIN/ROME (Reuters) - Europe's "no pain no gain" attitude to solving its sovereign crisis risks exacerbating the bloc's problems, choking off the very growth needed to raise the money to pay down the debt.

From Athens to Dublin, and almost everywhere in between, administrations are imposing wave after wave of spending cuts and tax increases to persuade investors they are serious about improving their public finances and persuade them to start buying euro zone sovereign debt again.

The austerity zeal risks tipping the continent back into recession and a downward spiral of austerity as pitiful growth prospects undermine budgetary targets and ramp up debt burdens, meaning further austerity is required.

"The expansionary fiscal contraction story says that you cut, you show you are serious about cutting and then the confidence fairy will come along and she will start pulling in private investment," said Stephen Kinsella, professor of economics at the University of Limerick.

"The expansionary fiscal contraction story is a lie. You don't cut your way to growth."

With the crisis spreading like wildfire through the currency bloc's core, pushing up borrowing costs to unsustainable levels, countries are relying more on blunt budget cuts, than time-consuming and difficult structural reforms, to get results.

The upshot is ballooning dole queues, shuttered businesses and public services stretched to breaking point.

On the streets of Athens and Dublin poverty has visibly increased with more and more homeless people huddling in doorways. In Spain, emergency wards have been shut and in Italy, retailers are struggling to get by.

"Consumption has been falling pretty steadily since the winter of 2008. Normally in a crisis, it starts with menswear and goes to womenswear and children. This time, it's hit them all at once," said Attilio Lebole, head of Textura, a mid-range clothing wholesaler based in Florence.

"Demand is falling, there's no doubt about that. Only foreigners are still shopping."

Despite having an estimated budget deficit this year of 3.8 percent of GDP, below the European average of four percent, Italy has been piling on austerity since the summer, destroying its already poor growth prospects and then responding with still more austerity to make up for the weaker growth.

Italy's dismal growth prospects and an inability to pass growth-enhancing reforms have been the key reasons given by ratings agencies for downgrading the country, not deficit slippage.

"Italy is paying a very high price for lending credibility to Germany's push for greater fiscal discipline across the eurozone," said Nicholas Spiro, head of Spiro Sovereign Strategy.


In the pre-euro days, currency devaluation was the quick-fire route to getting overblown economies back on track. What's needed now is "internal devaluation" to get wages and domestic prices down. But if everyone is cutting back where will the demand come from?

Global growth was meant to be the secret ingredient that kept the Irish economy ticking over while it slashed household income -- down by an estimated 16 percent so far and counting -- but the spread of austerity measures across the euro zone has shrunk its growth prospects and forced Dublin to cut even harder.

Held up as a role model for other indebted nations, the irony is that Ireland's recovery story looks set to be tripped up as others follow suit.

In Spain, the incoming government is hoping that changes to a labor laws, which would untie wages from inflation, as well as measures to aid new businesses would help spur growth despite painful cutbacks.

But analysts are unconvinced and say inevitable austerity measures needed to make tough public deficit targets in 2012 will serve to trim growth even further.

A Reuters poll on November 24 showed the economy not growing at all in 2012. Others like savings bank foundation FUNCAS predict the economy will contract 0.5 percent next year as a result of the impending austerity measures.

"The deficit objectives are so tough that in the short-term it's not going to allow the government room to stimulate the economy or create jobs. There is no fiscal margin to do so," said Angel Laborda, head of research at FUNCAS.

Across the euro zone, retailers are bracing themselves for yet another drop in Christmas cheer as sales taxes are hiked in Italy, Greece and Ireland.

The Greek Commerce Confederation (ESEE) is predicting a 22 to 30 percent fall in retail sales, with per capita spending seen dropping to 288 euros from 410 last year and 550 euros in 2009.

And the New Year isn't looking much better. Last week's European summit laid out plans for balanced budgets implying austerity budgets for years ahead for many European states.

Hilary Behan has already closed three of her six children's clothes stores in Ireland, cut her staff from 38 to 20 and asked her store managers to take pay cuts of between 10 and 15 percent. Sales are down by over a third since 2008.

"It just keeps getting worse and that's the worrying thing there is no sign of any recovery. Every time the government get a chance they remove any chance of there being any sort of a recovery," she said.

"It's not even the amount of money that they are taking from people it's the constant battering. People are terrified to spend."

(Additional reporting by Giulio Piovaccari in Rome, George Georgiopoulos in Athens and Nigel Davies in Madrid. Editing by Jeremy Gaunt.)

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Comments (16)
Intriped wrote:
Risk? I believe they are in one.

Dec 14, 2011 8:17am EST  --  Report as abuse
thinkest wrote:
watch video!

Dec 14, 2011 8:23am EST  --  Report as abuse
GivaFromOz wrote:
The situation is difficult for all European countries (with one or two exceptions) and the article is right in stating that austerity measures will hamper the growth that’s needed. But government stimulus is no longer possible. Most of the governments have been doing it for many years (hence their huge debts) even if those were not their intentions. The ineffectiveness of government stimulus has been due, in part, to the export to other countries of production that creates real wealth. So other countries have enjoyed some of the benefits of the multiplier effects. I expect that Europe will be in recession next year and that the recession will last for years.

The efforts to maintain Europe as a free trade zone are obviously correct but a way must be found to align individual countries’ exchange rates with their economic efficiencies. There needs to be acceptance that the countries will never be able to all have similar economic efficiencies (and their populations will not want to). That is, the Euro cannot remain the single currency. So efforts should not be made to achieve such a goal.

Europe may not have to do this on its own as I expect that the current manner in setting world exchange rates will be altered drastically, sooner or later.

In the short term the EU needs to concentrate on keeping its financial system functioning. That should be done directly, even if it involves some nationalisation of banks. Recent attempts at saving the system are going off at a tangent and are clearly not having the required effects..

Dec 14, 2011 8:51am EST  --  Report as abuse
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