10 June 2010
One after another, the heavily indebted eurozone countries – Greece, Portugal, Spain – have announced stringent austerity measures in order to regain credibility and raise market confidence. Italy has recently joined them by approving an austerity package worth €24bn. Even Germany, the EU’s biggest economy whose budget deficit will be smaller than previously expected (5% of GDP instead of 5.5%), has announced “the biggest austerity drive since World War Two” (€80bn by the end of 2014) to bring the budget deficit within EU limits by 2012 (3% of GDP, as set by the Stability and Growth Pact). Other countries are likely to follow, as the eurozone leaders are trying hard to prove that they can get their houses in order.
It was under this wave of stoic commitment to austerity that the EU’s finance ministers met in Luxembourg on 7-8 June. They finalised arrangements for a special purpose vehicle (the European Financial Stability Facility [EFSF]) to raise up to €440bn in loans and loan guarantees for the eurozone countries that run into financial difficulties. The EFSF, a limited liability company based in Luxembourg, will be able to raise money on markets by issuing bonds guaranteed by governments of the euro zone. Luxembourg’s Prime Minister and chairman of the eurozone Jean-Claude Juncker said the EFSF would be operational this month. The ministers also agreed in principle on the need to submit national budgets to peer review and to impose tougher penalties for countries that breach EU deficit limits or misrepresent their statistics, as Greece infamously did. Simultaneously, ministers agreed to strengthen Eurostat’s auditing powers. This is an important step forward, since many countries initially were unfavourable to the Commission’s proposal. Still, the British have stressed that they would not agree on budgets being submitted to Brussels prior to offering for approval at Westminster. This will be still discussed in the coming EU summit in Brussels on 17 June.
Despite all these efforts to overcome the crisis, the markets are still very cautious. Many economists have also warned about the adverse effects that simultaneous cuts in so many countries could pose to the fragile economic recovery in the EU, currently at meagre 0.2%. That the austerity measures could “derail the global recovery” is also feared in Washington, where the US and IMF have been calling on the EU’s financially sounder Member States to postpone cuts in order to stimulate economic growth. These concerns are similar to the ones previously voiced by some eurozone countries, especially France which has criticized Germany in recent months for adopting policies that dampen demand in Germany and aggravate imbalances within the eurozone. However, now everyone seems to be focused on restoring healthy public finances. This was echoed by all participants, except the US, at the G20 finance ministers and central bank governors meeting on 4-5 June in South Korea, pressing the EU to sort out its finances as soon as possible. South Korean Finance Minister Yoon Jeung-hyun said that “the recent events in Europe and volatility in the financial markets clearly shown us the global recovery is still fragile,” stressing that “we can’t afford to be complacent”. French Finance Minister Christine Lagarde confirmed: “For the vast majority, addressing finances, budget consolidation, is priority number one.” However, the final communiqué only said that “those countries with serious fiscal challenges need to accelerate the pace of consolidation”, avoiding more precise or concrete initiatives due to the variety of views, thus creating an “impression of a group on the back foot”, as described by Reuters.
Not only the eurozone countries, but the whole of the EU will have to face some lean years. British Prime Minister David Cameron lamented that the country’s finances are “even worse than we thought”, requiring decisions that will affect “our whole way of life”. Hungary has also hit the headlines last week, when a spokesman for the recently elected Prime Minister Viktor Orban said that the Hungarian economy was in a “very grave situation”, saying that a possibility of a default is not “an exaggeration”. This was apparently a misleading statement, since the Hungarian government later tried to reassure investors that it was nowhere near bankrupt. Also, Jean-Claude Juncker said that there is “no problem at all” with Hungary, except that “politicians from Hungary talk too much”. In the meantime, the euro had already reached four-year lows.
This, however, is not so bad for the EU, since the sliding euro is set to increase eurozone exports (over the first quarter, exports rose by 2.5%). For years to come, exports will have to be the main driving force behind the recovery of eurozone countries, since the harsh austerity measures will undoubtedly affect household spending. European consumers are expected to bear the heavy burden of measures such as direct or indirect-tax increases and public-sector pay cuts. Besides, the average unemployment rate in the eurozone has already reached a 10-year high of 10.1% in April (with up to 19.7% in Spain). Apart from extra welfare expenditures for governments, rising unemployment comes with heavy economic and social consequences, as the unemployment benefits do not allow to maintain the same level of living (and consumption), and these are granted for limited time only. The latest data from Eurostat show that the household spending and consumer confidence are both declining. This will probably weaken demand for imports and the growing need to export will have to be accommodated by consumption in other regions. In fact, what is good for the EU is not always good for other regions. As it was said by the Japan’s Deputy Finance Minister Naoki Minezaki at the G20 meeting in Busan: “Weak euro has a significant impact on exports from Japan and other countries to EU, as well as on stock markets (…) In a short term, it has a negative impact on Japanese exports.” The good news is that the global growth is expected to reach from 4.25% (IMF’s forecasts) to 4.5% (OECD’s forecasts), even if these numbers are judged as rather optimistic by many, given recent developments in the EU.
The EU is entering into an era of austerity, which will, in fact, only bring things back to normal: the countries will have to spend within their own means. The hope is that this will give a more solid base for future growth. The European Central Bank President Jean-Claude Trichet said: “There is a real problem of terminology here. What you call austerity, I call gradual return to wise budgets. Wise policies always foster growth because they boost the confidence of households, companies and investors – and confidence is vital for recovery.”
Sources and links to further information:
- Decision of the 16 euro area Member States, European Council, 7 Jun 2010
- European Financial Stability Facility, Terms of reference of the Eurogroup, European Council, 7 Jun 2010
- Remarks by Herman Van Rompuy, President of the European Council, following the second meeting of the Task force on economic governance, European Council, 7 Jun 2010
- Orientations for fiscal policies in euro area Member States, Eurogroup, European Council, 7 Jun 2010
- Concluding Statement of the IMF Mission on Euro-Area Policies, IMF, 7 Jun 2010
- G20 communiqué after meeting in South Korea, Reuters, 5 Jun 2010
- “EU ministers discuss sanctions for debt-laden economies,” EurActiv, 8 Jun 2010
- “Euro finance ministers set to finalise eurozone aid,” EUobserver, 7 Jun 2010
- “Europe and US clash over timing of austerity measures,” EUobserver, 7 Jun 2010
- “G20 drops support for fiscal stimulus,” Financial Times, 5 Jun 2010
- Policymakers’ comments at G20 meeting in South Korea, Reuters, 5 Jun 2010
- “Hungary Is Playing Political Games on Debt,” The New York Times, 6 Jun 2010
Research papers, policy briefs
- Wheatley, A. “G20 doesn’t even try to put brave face on debt mess,” Reuters, 6 Jun 2010
- “EU woes to weigh on global growth – Stiglitz,” Reuters, 1 Jun 2010
- Moravcsik, A. “In Defense of Europe,” Newsweek, 30 May 2010
- “World Economy: Fear Returns,” The Economist, 27 May 2010
- “Economist Debates: Euro,” The Economist, 25 May – 4 Jun 2010