Austerity plus growth: Europe's winning combination?

Amidst growing concerns about the Eurozone, widely perceived as the biggest risk for the global economy in the second half of 2012, Italy’s announcement that it will now start pursuing a “mixed” debt-management strategy combining “austerity” with “growth” has produced scepticism from international policy makers. Many Europeans, meanwhile, fear that new government incentive spending might mean that sacrifices made during the course of “austerity” policies have been in vain. Will the new “mixed” approach result in a more balanced response to the crisis, or rather be confirmation of Europe’s failure to convince?

Paradoxes of “mixed” crisis politics

At the end of May, Italy’s Foreign Minister Giulio Terzi announced at a meeting of UNESCO in New York that Italy would “back growth moves for Europe” by increasing, if necessary, governmental spending. “After all the political developments that we have seen in various European countries, though not only in Europe, we are profoundly convinced in Italy that the agenda for growth is now the highest priority”, Terzi said.

Well intentioned though his statement might have been, the problems it contains are multiple. In the wake of Italy’s debt crisis, which in 2011 brought down the elected government and put in power a “technocratic” government unelected by the population, the country vowed to do two things: first, cut public spending and increase taxes; second, undertake far-reaching reforms of the government, the administration and the labour market. Meritocracy was to be introduced at all levels, so as to counter the prevailing nepotistic mentality, while liberalization would target the overregulation that paralyzes the economy and society.

So far, what has happened has been much of the first but little of the second. Mario Monti’s government has raised taxes to an all-time high – currently at 45 per cent for average incomes, in addition to a new patrimony tax of 0.76 per cent per annum on the market value of real estate and a variety of additional taxes such as a “powerful car” tax, one of the world’s highest fuel taxes, wand a VAT of 21 per cent. An Italian citizen is today de facto taxed five times on one and the same income: income tax, patrimony tax, taxation of the rental income of this patrimony, disproportionate VAT, and disproportionate energy taxes, including special taxation of fuel.

It is not really surprising that introducing all this simultaneously has government triggered a crisis of demand, combined with a crisis of trust. This was – and is – one reason why the Italian economy is growing at only 1.3 per cent, causing unemployment to rise and placing hundreds of thousands of employees at risk. Social unrest is at unprecedented levels, with hundreds of “taxation suicides” and a new wave of anarchist violence. Monti’s “taxation ecstasy”, though not the sole cause of the downward spiral, has also led to the mass sale of foreign real estate, thus decreasing Italy’s formerly high levels of private wealth – once proudly described by the former treasury minister Giulio Tremonti as the “untouchable backbone of Italy’s status amongst the wealthiest and most reliable nations”.

All this was done to put the budget in order at the expense of private citizens and partly the basis of the economy. But with Terzi’s announcement of a new “mixed” strategy, it now seems that after half-a-year of the extreme and (in his own words) “necessarily cruel” politics of austerity, Monti’s “technocratic” government has already subliminally and subtly given up again – threatening to render the huge sacrifices of the population pointless. Because if you increase taxes to unprecedented levels and at the same time increase “stimulus spending” in order to revive an economy hit (not only, but also) by exactly the increase of taxes, you are shooting yourself in the foot.

Citizens’ fears

With Italy’s announcement of a “combination” of austerity and growth policies, the prophecy of Silvio Berlusconi that “these austerity measures will prove to be in vain and at the sole expense of the citizen’s private wealth, and thus harmful of the national economy at its very basis” seems in the eyes of many Italians to be coming true. With a GDP four times the size of Greece, Portugal and Ireland combined, Italy is far the biggest European crisis country, and many Italians know that “the future of the Eurozone will depend on Italy”, as the chief national economist of Deutsche Bank, Thomas Mayer, put it. But more and more Europeans now fear that the main result of the “zigzag” course between austerity and growth will be that the tax burden remains indefinitely at record levels (with the exceptions of Germany and France), while increased public spending means that debt fails to drop significantly.

What many leading enterprises therefore fear is not only a so-called “Grexit” but also the “zigzag” course between austerity and stimulus politics now gaining the overhand with the new government in France and Italy’s new “openness”. The inbuilt trend of these “mixed” approaches could result in neutralizing savings sacrifices, further choking the economy, reducing the basic wealth of the citizens and strengthening the downward spiral. It is no surprise, then, that the international markets seem to have little faith in the way the crisis is being managed: after a short period of relief, interest rates on Italian government bonds are again increasing rapidly.

Europe’s new right-left mix

Recent European election outcomes have reflected the “zigzag” course of crisis management. The gains of Syriza in Greece on 6 May 2012, of the Parti Socialiste in France on 22 April and May 6, and the huge gains of the leftist parties, including the communists, in the Italian communal administration elections of 6-7 May 2012, are to a significant extent the outcome of austerity politics – or, as it has been branded, of German “ordoliberalism” – pursued by the dominant conservative and (in the case of Italy) bourgeois European governments.

Ironically, what the voters elected was the promise to ease the burden of the reforms on the citizens. But what they have got is – at least partially – the return of the old “lending and spending” mentality of the 1980s and 1990 that triggered the debt crisis in the first place. One example? Notwithstanding François Hollande’s often very un-socialist pragmatism, his declared intention to re-negotiate austerity measures, to lower the pension age, to expand the social security net and to increase the budget for public welfare and labour incentive programmes points clearly towards a massive increase in government spending. Like the Italian leftists in the communal councils, Hollande was swept into power by an anti-Sarkozy vote, but also by citizen’s anger less about austerity policies as such, so much as their unclear course, unidentifiable outcome and contradictory praxis. Predictably – in this respect he was classically socialist – Hollande’s main response was to compensate for austerity politics through new measures to boost the economy, without being able to explain where the money for this new stimulus spending will come from. According to Hollande, the new debt will be paid for retroactively by a stronger economy and the resulting taxes raises – a classical assumption that led most European countries into a unsustainable method of handling of debt.

Another example? Hollande announced he would raise taxes for higher incomes to 75 per cent. While this will not inaugurate a “power shift from the West to the East”, as former conservative prime minister Francois Fillon asserted in November 2011, but it will mean that Europe risks losing its most talented people to global competitors. Would you stay in a country in which you had to pay 75 per cent income tax, in addition to 21 per cent VAT and a variety of other taxes, if you were one of the educated elite who able to move in a globalized labour market?

What does this mean? While continental Europe was, until May 2012, almost solely dominated by conservatives and thus “naturally” inclined to austerity politics, there now exists an uneasy coexistence of conservatives – with their “ordoliberalism” – and classical socialists – with their “increase taxes, increase spending” mentalities. That may be a good sign for a new phase of greater social equilibrium and a fairer distribution of European national wealth through the two main instruments governments have to create social justice and avoid inequality, i.e. taxation and spending. But it will also be the start of a more complex crisis management approach. On closer inspection, and despite all the diplomatic reassurances, European crisis management is already torn between the two factions. As a result, more and more European citizens, not to mention corporations, fear that they will be the ones to foot the bill for the resulting ambiguity – if not zigzag – between austerity and growth policies.

Taken together, what we are witnessing may be the birth of another phase of continental European unification process, one that has historically been torn between conservatives and socialists. Because of the systemic (political and bureaucratic) zigzag course that has resulted from the return of the left to power, Europe – now let’s not forget in its sixth consecutive crisis year since 2007 – risks damaging its structural (economic) fundaments.

Learning from the Asian economic crisis of 1997-98

To some extent, the structural shift that could potentially result from Italy’s austerity measures is not dissimilar to what happened to South Korea after the Asian economic crisis of 1997-98. Austerity politics, combined with economic restructuring, created deep-reaching social inequality. Today, Korea combines fast economic growth, near-on full employment and extraordinary technological progress with the second highest degree of income equality in the OECD, the largest gap between the richest and the poorest 10 per cent of the population, and a relative poverty rate of over 18 per cent. How is that possible? To quote The Korea Times:

Experts widely agree on tracing the glaring inequality (in today’s Korea) to the 1997-98 Asian financial crisis, and subsequent harsh austerity measures and economic restructuring here. Hundreds of thousands of workers lost their jobs and millions of others saw their wages fall as a result of the economic fiasco caused by incompetent policymakers and greedy conglomerates. Some chaebol [corporations] fell but those remaining became even stronger amid another mistaken policy of neoliberalism, which called for large export-oriented economic recovery amid an extremely softened job market. Let’s expand the pie first and then divide it later, they said. The pie has grown larger, but slices for the 90 per cent became ever thinner.1

The mechanisms in play teach us a lesson about the potential effects of what is currently happening in Europe. Italy, with a population increasingly impoverished by multi-dimensional taxation, inefficient administration, youth unemployment and austerity measures, shows all signs of wanting to “grow the pie” at the price of growing inequality and social disintegration. Just that, in the case of Italy, it is not neoliberalism but the politics of austerity, including tax increases, combined with – so it now seems – public spending increases. In times of austerity, re-distribution concerns are generally neglected as the price for budget soundness; that is also the case in today’s Italy. If austerity politics was one of the causes of growing social divisions in Korean society, something similar might result from the “half-reforms” of Italian society. Growing social unrest and unprecedented youth unemployment of close to 50 per cent are already all-too visible signs that can’t be ignored.

Do mixed crisis policies mean progress?

So where are the perspectives? What has to be done? First, the European constellation, though serious, is not as desperate as many sensationalists want it to appear. As two former European policy makers recently pointed out,2 Europe is much more solid in its economic foundations, in its mechanisms of redistribution, and in preventing inequality and fostering productivity, than the current crisis is leading the world believe. But it is also true that the forced co-existence of German ordoliberalism, French socialism, Italian taxation ecstasy and Greek economic and political disintegration is producing contradictions and inconsistencies.

Most importantly: it is producing rapidly growing imbalances and dependencies, including different speeds of development, between well-off countries like Germany – which, for the first time in post-war history, in May 2012 sold government bonds for 0 per cent interest and short term bonds for negative interest – and countries on the brink like Greece, which are no longer able to get any money through the international markets. It seems more and more incredible to many people that Germany and Greece still share the same currency, and they wonder how long this can be going on. As a result, single European countries that are sound tend to develop their own global economic policies, effectively excluding crisis states as well as the European Union authorities from their foreign economic policy-making. Due to the weakness of their EU partners, they tend to think that the best way is to go it alone, and maybe to share afterwards. One example is Germany, which is fostering very special bilateral ties with the other particularly well-off countries, above all China.3 China does not “want to buy up the Eurozone”, president Wen Jiabao asserted during Angela Merkel’s visit to China in February,4 because it doesn’t want to be involved in the euro’s problems; but it is interested in expanding its ties with single nations that are economically strong, such as Germany – thus excluding its own neighbours. Understandable as this trend might be in the present situation, it could create further imbalances and conflict within the Eurozone. These problems are not only a European, but in the meantime a global problem.

The return of financial problems in Spain’s regions and in other European nations, from the communal level upwards, demonstrate that Europe has simply lived above its means. The European welfare state is no longer financeable; the current system has proven unsustainable and will need to be reformed. But that is not the whole truth. While, in Europe, governments are heavily indebted and the citizens are held liable, in other globalized countries the system puts the threat of indebtedness directly upon the citizen. In the US, for example, the government is indebted to about 16 trillion dollars, but the overall level of private debt amounts to up to 45 trillion. Fixing Europe’s financial problems in a “concerted global effort in cooperation with all G-20 members”, as Britain’s former prime minister Gordon Brown recently proposed, is a much more complex endeavour than one might think at first glance.

The only viable solution for the Eurozone crisis will be to install a fully functional, politically independent European Central Bank; to get Greece to temporarily leave the Eurozone until its worst problems are fixed (which will probably take at least a generation or two); and to issue joint European government bonds, at least to a certain extent. Whether Germany likes it or not, there is hardly another option to “interest rate socialism” in the medium term. The French socialist Hollande is not the only one to know this. To prevent the impoverishment of European populations – which may be the real and lasting effect of combining tax increases with governmental “stimulus spending” – a combination of measures has to be enacted: lower taxes; lower government spending; liberalization of society, labour, higher education and the economy; and the introduction of meritocracy, radically and sustainably, into all European societies, in particular those in the South.

Second, a new, more critical assessment of the European unification process may be unavoidable. For example, many today would argue that Greece was doomed as soon as it began to share the euro with Germany and France. Like other less developed countries with almost no industrial basis, Greeks borrowed German and French money to buy German cars; the German economy made huge gains while Greeks could only pay back the interests rates on the loans, keeping the debts they had – and have to serve – with the banks over time, thus in a sense paying twice for one and the same car.

The lesson is this: if you get a very poor and structurally weak country to share a currency with a very rich and strong country that is much bigger, then mechanisms of dependency and growth and disparity of development will be the result. This is certainly no natural law. It must be avoided by a strong, political joint mechanism that makes sure that distribution and dependency remain within certain boundaries. If a joint European government had been in place since the introduction of the Euro, much of the unilateralism and dependency relationships would not have needed to occur.

What we have seen at work in Europe in recent years is monetary and, to a certain extent, economic integration, but no equivalent political union. This led economic disparities to run wild. As we can see from Italy, what Europe desperately needs to do now is to ponder true political and administrative union, among other things by creating a joint Ministry of Economy and Finance deserving of the name, along with concrete fiscal unity and a strong European government able to balance the growing economic discrepancies developing between the northern and southern countries of the Eurozone. It is encouraging that more and more leading politicians in the “creditor” countries are recognizing this. It is high time to act accordingly.