Eurozone austerity: will the medicine kill the patient?

PositionA SYMPOSIUM OF VIEWS

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Will the various EU summits' fiscal austerity measures alone be enough to resolve the sovereign debt crisis, or will the proposed reforms simply stymie economic growth? Is the eurozone entering a vicious cycle in which efforts at fiscal reform to demonstrate fiscal rectitude to financial markets actually lead to a weaker economy and lower tax receipts, thus exacerbating the debt situation? Does austerity by itself represent a medicine that could kill the patient?

More than twenty important global strategists weigh in.

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SAMUEL BRITTAN

Columnist, Financial Times

Near the beginning of Paul Samuelson's introductory economics text, there is a warning about the "fallacy of composition"--the belief that what is true for the individual holds good for a collectivity such as a nation or group of nations. Although that book sold in the millions, for all the notice that is now taken of the warning it might never have been written.

The national budget is not like a personal or family budget and needs to go into deficit when monetary policy on its own is unable to prevent a severe recession. The opposite belief in so-called "sound finance" is a drag on growth in many European countries. The pacemaker for this mistaken belief is Germany. But few if any leaders of other countries have had the courage to oppose it openly.

Conventional cuts in national budgets are, by their adverse effects on growth, undermining the budget balancing strategy. Germany has escaped these effects because an export surplus has maintained demand. But not every country can have an export surplus. The single currency-the euro--while it lasts stops other countries from allowing movements of the exchange rate to help achieve external balance and leaves the whole burden to be borne by restrictionist domestic policies.

No doubt if austerity went beyond "cuts" and involved tearing up state social security pledges and abandoning health and education programs, budgets could be balanced at very low levels of activity and employment. But I sincerely hope the so-called "social unrest" would prevent that from happening.

There is much to be said for privatization in countries like Italy as a structural measure, but not as a cosmetic means for reducing public debt. Eurobonds are simply a roundabout way for Germany to finance the budget deficits of peripheral euro members. The German public is understandably opposed. So should be the supposed beneficiaries. There is an old saying, "Beware of the Greeks when they come bearing gifts." The saying now needs to be reversed and applied to Germany. There is no substitute for the peripheral countries regaining control of their own exchange rates, that is, leaving the ill-begotten euro.

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YVES MERSCH

President, Luxembourg Central Bank

Since spring 2010, the sovereign debt crisis has been weighing heavily on the euro area. Several of the single currency s member states face a combination of elevated debt levels, high budget deficits, and anemic growth. Although the public finances of the currency area as a bloc are in a much better position than those in other currency areas of similar size, market distrust and the risk of contagion has called for decisive action and disclosed the need to fix the mistakes of the past.

As the sustainability of public finance in several countries is being questioned, confidence needs to be restored. Suspicious markets have a huge appetite for quick fixes. In this respect, Eurobonds seem to be beneficial for financial stability in the short term as they would pool liquidity immediately. But the transfer of risk to stronger euro area sovereigns might undermine incentives for governments to lower their national levels of public debt. Sound fiscal policies, however, are indispensable in an economic and monetary union.

Therefore, the issuance of common debt instruments is only feasible after a comprehensive governance reform process that includes a significant transfer of fiscal sovereignty to the Union level.

In the meantime, the public debt burden still has to be reduced. But some argue that fiscal consolidation kills growth and by doing so it would lead to a vicious circle of weakening economic activity and ever lower tax receipts.

Arguably, in the current environment it is essential to buttress sustainable growth and this is by no means an easy task.

However, the combination of fiscal consolidation and growth is possible. Even within a monetary union--that is, without recourse to nominal devaluation of a country's own currency--individual countries can regain competitiveness. Historical experience from the euro area has proved this already:

* Germany had a serious competitiveness problem after its post-unification boom, but introduced structural reforms and sound fiscal policies, focusing on unit labor costs.

* More recently, in Ireland public wages were cut, and benefits and services were reduced. At the same time, unit labor costs have fallen by 8 percent nationwide. The economy expanded by 1.6 percent in the second quarter of 2011.

* Estonia, which introduced the euro in 2011, imposed even more severe austerity measures--and still managed to regain competitiveness. After a deep recession in 2009, growth and employment have soared since then.

Higher competitiveness will increase the flexibility of the economy and lift the longer-term growth potential. Structural reforms can strengthen confidence, market dynamics, and job creation. In particular, rigidities in labor markets should be removed to increase wage flexibility.

Improved supply side conditions should also help to dampen the negative short-term impacts on aggregate demand that kick in while fiscal consolidation measures are implemented. Moreover, they can generate a wealth effect that motivates consumption and reduces excessive incentives to save.

Fiscal consolidation is unavoidable and necessary, and national governments need to correct excessive deficits and move to balanced structural budgets in the coming years. However, fiscal consolidation is not a sufficient condition to resolve the crisis. It needs to be paired with ambitious structural reforms to bolster confidence, lift potential growth, and strengthen job creation.

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BARTON M. BIGGS

Managing Partner, Traxis Partners

I was an English major, not an economist, and am light on the technicalities, but my more philosophical perspective is that for better or worse, we are where we are in Europe's crisis. Frau Merkel may not like it, but the markets--not the politicians--rule and have the last word. Summits, words, veiled hints of policy changes are "sound and fury signifying nothing." It's unfortunate that the authorities seem unaware of Walter Bagehot's long-ago but still brilliant dictum that in the face of a crisis, policymakers must always err on the side of doing too much because the cost of doing too little is always so much higher eventually.

A year ago or even a few months ago the dilemma for me was Keynes versus Hegel and I would have voted for Keynes. Now it's too late; too much water has flowed under the bridge, the disease of sloth is too entrenched, and so Europe will have to endure a severe regime of Austrian austerity and creative destruction. Today Keynes, a man who famously said, "When the facts change, I change my mind. What would you do, sir?" might well agree with a dose of austerity. He would have been appalled by economies running huge deficits and debts instead of creating surpluses and paying down debt when growth was strong. Today we are where we are, and I'm afraid it's too late for Keynesian medications. Austerity will be very painful and social stability will be at risk. However, the vicious cycle suggested in the original question could be steep but relatively short and eventually transformed into a virtuous circle if confidence is restored and progressive reforms such as privatizations are implemented.

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NIGEL LAWSON

U.K. Chancellor of the Exchequer, 1983-89

There are three separate but interconnected issues here. The first is the future of the eurozone. I was only Bone of several who, right from the start, pointed out publicly that it could not work without a full fiscal union and therefore a full political union, the United States of Europe, which the peoples of Europe did not want; and that therefore it was doomed to disaster, both economically and politically. Of course the principal promoters of this irresponsible venture well understood the connection. It was always an entirely political enterprise designed to bring about full European political union. Arrogantly, they believed that their determination should--and could--override the democratic veto. Clearly, the only rational course is an orderly dissolution of the eurozone, the sooner the better.

The second issue is the present danger arising from this misconceived venture: a European banking meltdown caused largely by the toxic eurozone sovereign debt the banks hold* There will inevitably be sovereign defaults, politely described as rescheduling (or even "reprofiling"); which makes the case for buying time along the lines that the Latin American sovereign debt crisis was successfully managed during the mid-1980s. Where individual eurozone countries do believe they need to step in to avert a major bank failure, this should be done by the injection of fresh equity capital on a scale that would make the existing bank shares virtually worthless, and it goes without saying that the entire top management of the banks concerned should be sacked. Capitalism and the market economy work satisfactorily only if the rewards of success are fully matched by the penalties of failure. This is particularly important in banking.

The third issue is that of the least bad response of the heavily-indebted countries of the eurozone--and indeed of those outside the eurozone, such as the United...

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