Fearful of becoming the next Greece, European governments are lining up to demonstrate to investors, who have long helped finance their spending, that an era of austerity has begun.
The latest example is Italy, which on Tuesday joined Britain, Spain, Portugal and other European Union members in announcing plans to cut billions to help close yawning budget deficits.
The severity of the steps being enacted varies by country, as does the timing, but most of the measures centre on freezing or cutting public-sector pay, increasing retirement ages and reversing temporary tax breaks and other cushions that were encouraged in 2008 and 2009 to help beat back the worst recession in decades.
In most European capitals, the case for fiscal rectitude is now trumping fears that pulling away those props will hobble the fragile recovery. The voices opposing the budgetary turnaround come from unions and some opposition parties, like Labour in Britain and the Socialists in France, as well as some analysts.
“The euro area is adopting the wrong policy at the wrong moment and is thus making people suffer, which could lead to nationalistic reactions,” said Jean-Paul Fitoussi, a professor of economics at the Institut d'Etudes Politiques de Paris, now teaching at the Luiss business school in Rome.
But other economists stressed that there was a way out. Denmark sharply cut its deficit during the mid-1980s, after which private consumption and investment rebounded strongly.
In a recent research report on the euro area, economists at Deutsche Bank, led by Thomas Mayer, said that euro area countries “can learn some valuable lessons from the Baltics' experience over recent quarters.” Those countries survived drastic budget consolidation without devaluing their currencies.
“Restoration of competitiveness and weighty fiscal consolidation in the absence of currency adjustment is difficult but doable,” they said, “as long as politicians and the general public are willing to accept some upfront pain in return to longer-term gains.”
The protracted saga of the recent Greek bailout, when investors effectively forced Athens to accept deep budget cuts and monitoring from the International Monetary Fund and Brussels, appears to have focused the minds of policy makers across Europe, many of whom had long paid lip service to fiscal rectitude while failing to use periods of growth to balance their books.
Economists said the duration and effects on growth of cuts enacted now will depend on the starting point in each economy. Greece is likely to contract for years as a result of the steps, while Germany can hope to offset the impact by benefiting from an export-led recovery, especially as the euro declines in value. “What is clear is that markets are becoming increasingly nervous about the high levels of public debt in some countries and what is perceived as inadequate efforts to put public finances on a sustainable path,” said Fleming Larsen, the former head of the IMF in Europe. “Such policy changes can no longer be postponed.”
Economists cite a number of benefits to reducing deficits. These include so-called Ricardian effects, after the work of the 19th-century British economist David Ricardo, where private spending actually rises as consumers are assured that they will have more income in the future, when taxes fall. Lowering deficits also assumes lower interest rates on refinancing, which will help tackle longer-term debt.
Italy announced details of its proposed cuts on Tuesday night in a statement after a Cabinet meeting. The statement said the objective was to cut its budget deficit to below three per cent of gross domestic product by 2012, from 5.3 per cent last year.
The measures “centre on cuts to public spending, and reducing the costs of politics and public administration,” while pledging a more concentrated crackdown on tax evasion and on people fraudulently collecting disability pensions.
No new taxes would be introduced and no existing taxes would be raised, the government said.
Pay for civil servants would be frozen for three years, top-level civil servants' wages would be cut and the retirement of state employees would be delayed.
The measures are subject to approval by the Italian Parliament.
The most significant retrenchment programmes on a per capita basis have been those of Greece. The steps included increasing the broader retirement age to 65 and cutting public salaries to bring the deficit down from the current 13.6 per cent of GDP to less than three per cent in 2014.
In Madrid, Prime Minister Jose Luis Rodriguez Zapatero also presented sweeping spending cuts this month, reversing promises to spare pensions and public-sector salaries. He announced pay cuts of about five percent for civil servants — and 15 per cent for government ministers — as well as other measures totalling €15 billion. He also reversed a previous decision to increase pensions next year and said Spain would scrap a subsidy of €2,500 for new parents.
This month, the Portuguese government agreed with the main opposition party on more austerity measures to cut its deficit faster than planned, to 4.6 per cent of Portugal's gross domestic product next year from 9.4 per cent last year. Prime Minister Jose Socrates, a Socialist, will rely on tax increases and cuts in public-sector wages and corporate subsidies.
In Britain, the new Chancellor of the Exchequer, George Osborne, said on Monday that he would push through six billion pounds ($8.65 billion) in spending cuts in an effort to convince skittish markets that the new government led by David Cameron was committed to fiscal restraint.
In France, the government is approaching the issue gingerly. It has acknowledged that the deficit, forecast at eight per cent of GDP this year, needs to fall. Paris is aware that if it is unable to tackle the issue of its pension shortfall, France's triple-A credit rating may be cut. The government is currently negotiating with unions over the tricky issue of retirement. It is expected to increase the retirement age to 62 or 63 from 60, while lengthening the duration of contributions required for a full pension. — New York Times News Service
