Critics of austerity need to demonstrate that alternative strategy can work
Opinion: Moral issue of transferring more debt to our children and grandchildren downplayed by opponents of existing policy
Demonstrators against austerity in Paris at the weekend. They also called for the establishment of a “sixth republic” with a new constitution for France. Photograph: Charles Platiau/Reuters
The last couple of weeks have seen an intensification of the so-called austerity debate. President Michael D Higgins, in widely publicised interventions, called for a radical rethink of the handling of the euro crisis. This followed European Commission head José Manuel Barroso’s suggestion that “the limits of austerity have been reached” and the earlier remarks of a now retired member of the International Monetary Fund team that negotiated the Irish bailout, Ashoka Mody, that the austerity programme was a mistake.
In contrast, Taoiseach Enda Kenny reiterated last week the Government’s intention to stick with its budget deficit reduction trajectory, while Central Bank governor Patrick Honohan emphasised forcefully that, in Ireland’s circumstances, “austerity” was not an abstract experiment but a requirement. Also, European Central Bank president Mario Draghi expressed his broad satisfaction with the ECB’s policy approach to date.
Leaving aside procedural considerations regarding the specific policy commentaries by the President (as well as whether the traditional “civil service ” role of IMF staff such as Mody has been put into question), what is one to make of all these comments? Many austerity critics tend to claim the high moral ground, stressing the human costs of the deep recession. However, the practical issue is whether better alternatives exist. Addressing this question requires drawing a distinction between individual debt-stressed countries and the euro zone as a whole.
Austerity is generally taken to mean reducing a fiscal deficit, while also pursuing a “tight” monetary policy. While Ireland’s budget deficit has fallen from about 12 per cent of gross domestic product in 2009, it still remains very high, at about 7.5 per cent. As a matter of arithmetic, every euro of a budget deficit implies a corresponding increase in public indebtedness. Assuming continuation of the current austerity plan, even with some pick-up in growth, Ireland’s debt is likely to exceed 120 per cent of GDP in 2015 .
Those calling for less austerity may in part believe that increasing Ireland’s debt even further does not greatly matter. From this perspective, the need to regain market creditworthiness so as to avoid any possible second bailout, as well as the moral issue raised by transferring a larger debt burden to our children and grandchildren, appears to be downplayed.
Austerity critics argue that less austerity will boost growth and help the debt outlook. While this is certainly true to some extent (especially in the short term), in Ireland’s case the positive impact on output and growth is dampened by the very high import content of expenditures.
The challenge is to find a reasonable balance between supporting growth and not incurring excessive debt. Those who dismiss the existing strategy should spell out more clearly why, in their view, the possible negative implications of a slower pace of deficit reduction are outweighed by their assumed positive impact. Otherwise, their views remain assertions, insufficiently supported by analytical reasoning or explicit value judgments regarding intergenerational equity.
The debate concerning the euro zone as a whole is somewhat different. It is suggested that the ECB’s mandate, as spelled out in the Maastricht Treaty, focuses too narrowly on limiting inflation. The role assigned to the ECB reflects German (and others’) historical fears of European inflationary tendencies. This is partly due to a lesser degree of wage/price flexibility in Europe compared with, say, the United States, where the US Federal Reserve is permitted to take into account growth and unemployment concerns.
Could the ECB nevertheless “do more” and with what degree of effectiveness? A further small cut in interest rates (to just above zero) would hardly make a dramatic difference. Weak balance sheets and uncertainty about the future fiscal and debt outlook, rather than a lack of bank liquidity, appear to be a major factor underlying the current reticence of both borrowers and lenders.
The ECB’s unprecedented commitment “to do whatever it takes” to restrain a rise in sovereign debt spreads has been criticised strongly by the German Bundesbank as creating moral hazard and letting governments “off the hook”.
The ECB can make a strong case that it has gone quite far out on a limb on the monetary side and that the responsibility for any further stimulus lies with national governments. And for all practical purposes, treaty change (even if judged meritorious by some commentators) is an entirely unrealistic proposition any time soon.
Arguably, Germany is in a better position than most to pursue a less contractionary (or more expansionary) fiscal approach, although many Germans (and not only Chancellor Angela Merkel’s supporters ) point to high current and prospective levels of public debt. A more relaxed wage policy could help but the goal of maintaining external competitiveness continues to loom large in German thinking.
Those defending current fiscal austerity typically emphasise structural policy reforms in the labour and product markets as key to improving growth and employment prospects, especially over the medium term. However, such policies often meet resistance from vested interests, who naturally tend to advocate relaxing austerity and increasing indebtedness instead.
Many of the specific policies advocated by some austerity critics (such as money printing by the ECB, the injection of taxpayer funds into banks without a government guarantee, and the issuance of eurobonds – the latter two referred to explicitly by Higgins) could imply an increased financial burden for northern country taxpayers.
Moreover, national debt that becomes unsustainable as a result of incurring larger budget deficits might require an eventual writedown at the expense of official and/or private creditors. It would seem only fair that such a possible “burden transfer” outcome be acknowledged explicitly by proponents of lessened austerity.
Given the importance of these issues, critics of the strategy need to go beyond broad statements of moral principle.They need to spell out more concretely the assumptions and the implicit judgments as to who should ultimately foot the bill that underlie their alternative proposals.
Donal Donovan is a former deputy director of the International Monetary Fund and a member of the Fiscal Advisory Council. He is co-author with Antoin Murphy of The Fall of the Celtic Tiger: Ireland and the Euro Debt Crisis , to be published next month. This article was written in a personal capacity