The Problem with Europe’s
Austerity Debate
Anders Åslund
Senior Fellow
Cato Institute
June 5, 2013
1
2
What Is Austerity?
• Fiscal responsibility! = Money is
not free
• The real questions:
1. Fiscal responsibility: Now or
later?
2. Who is prepared to pay?
3. To frontload or backload?
3
Six Reasons why early fiscal
adjustment preferable
1. Early return to growth
2. Politically easier
3. Better fiscal adjustment
4. More structural reform
5. Financial sustainability
6. Earlier restoration of confidence
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1. Early Return to Growth &
Higher Growth Trajectory
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2. Politically Easier
Rahm Emmanuel: “A crisis is a terrible thing to
waste.”
•Latvia: One riot in January 2009. PM Valdis
Dombrovskis – reelected twice & longest serving
PM in Latvia: “In this situation we have only two
alternatives – one bad and a worse one. I prefer
the bad one.”
•Greece: years of riots, strikes & demonstrations;
radicalization of electorate; is democracy in
danger?
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•
•
•
3. Better Fiscal Adjustment:
Get ahead of the curve!
Latvia 2/3 expenditure cuts, 1/3
tax hikes
Greece: Little decline in public
expenditures, lingering around
54% of GDP – GDP falls faster
than expenditure cuts…
Greece: Little prospect for growth
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Latvia: Public Expenditure as % of
GDP Normalizing
8
Latvia Brought Down Budget Deficit,
Greece Stuck at Huge Deficit
0
Percent of GDP
-2
-4
-6
-8
-10
-12
-14
-16
-18
2005
2006
2007
Greece
2008
2009
2010
Latvia
2011
2012
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4. More Structural Reforms
Expenditure cuts drive growth
•Vested interest are not mobilized
early on
•More deregulation
•More public sector reform – Latvia
sacked 30% of civil servants instantly
– Greece just starting
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Latvia: Sharply Falling Real Unit Labor
Cost, 20%, 2008-12, Greece Less
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5. Financial Sustainability Vital
•
•
•
•
Public debt in euro area on average
91% of GDP, end 2012
Nine of 27 EU countries have lost
market access and needed
assistance
Financial assistance limited
If no financing, little choice
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6. Confidence Restored Early
• In Latvia bond yields peaked in
June 2009 but in February 2012
in Greece
• Much lower yields and market
interest rates in Latvia
• More domestic and foreign
investment
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•
•
•
•
•
Greatest Mistake:
Greece May 2010 Program
Too large credits given caused
default
No structural reforms
No reduction of public
expenditures as %GDP
Too small fiscal adjustment
No confidence & no growth
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Focus on Education!
The key problem of Southern
Europe:
• Little education
• Education of poor quality
Only 38% of the Portuguese
labor force has graduated from
high school (US: 88%)
15
Share of Labor Force That Has
Graduated from High School, 2012
Age 25-64
100
90
80
70
60
50
40
30
20
10
0
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560
Performance on PISA Math Test,
2009
540
520
500
480
460
440
420
400
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Conclusions
• Europe’s fiscally conservative north thrives:
Latvia’s GDP growth 5.5% in 2011 and 2012
• The backloaded South suffers: Meanwhile
Greece GDP fell about 6% each year
• IMF advice seriously flawed
• Overestimated fiscal space in Spain,
Cyprus & Slovenia
• Intentionally delays crisis resolution in the
South
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