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Austerity unpopular in Europe because it's not working

Europeans are rebelling against austerity. That's the read on Sunday's elections in Greece and France. But why do voters loathe austerity so much? Perhaps because, as economists have found, efforts to rein in budget deficits can take a wrenching toll on living standards, especially in a recession.

In a recent paper for the International Monetary Fund, Laurence Ball, Daniel Leigh and Prakash Loungani looked at 173 episodes of fiscal austerity over the past 30 years. These were countries that, for one reason or another, cut spending and raised taxes to shrink their budget deficits. And the results were typically painful: Austerity, the IMF paper found, "lowers incomes in the short term, with wage-earners taking more of a hit than others; it also raises unemployment, particularly long-term unemployment."

Specifically, an austerity program that curbs the deficit by 1 percent of GDP reduces real incomes by about 0.6 percent and raises unemployment by almost 0.5 percentage points. What's more, the IMF found, the losses are twice as high when the central bank can't or won't cut interest rates (that's a good description of what Europe's central bank is doing right now). Income and employment don't fully recover even five years after the austerity program is enacted.

This is more or less the situation that Europe's been facing. And many of these countries were already struggling with soaring unemployment.

The IMF authors argue that fiscal consolidation is still worth pursuing in certain cases. Some countries really do run up against unmanageable debt levels. Greece, for instance, is broke. For years, the government was essentially lying about its finances. At this point, Greece's only options are to exit the eurozone — with all the chaos that entails — or to stagger along with a bailout from the EU and the IMF. So far, Greece has chosen the bailout.

But as a condition of the funds, EU and IMF officials have demanded big budget cuts. Those measures are having a devastating effect on ordinary Greeks. Not surprisingly, Greek voters threw out the pro-bailout parties Sunday.

But Greece is something of a special case within Europe. Other now-troubled European countries, such as Spain and Ireland, were behaving quite responsibly, budgetwise, before the 2007 recession hit. Their deficits went up because their housing bubbles burst and their economies collapsed. And the rules of the eurozone decreed that these countries now curtail their deficits. But the resulting austerity has been crippling growth — and, in the case of countries like Spain, seems to be actually making the deficit situation worse, not better. Austerity seems to be hurting, not helping.

But if austerity's not working, what's the alternative? Francois Hollande, France's new president, has argued that European countries need growth, and not simply austerity, to get through its crisis.

It's still not clear that Europe's leaders will move in this direction. But with voters now in revolt, it's unclear how long Europe will be able to stay the course.

Austerity unpopular in Europe because it's not working 05/07/12 [Last modified: Monday, May 7, 2012 7:41pm]
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