The EU Austerity Policy and Why it Won't Work

By Roberto Marinucci

Italy is going through the second austerity package in 4 months- Greece has had countless of those, France has done some light versions, but ultimately the question is: will it work? Unfortunately, the answer is no. No matter how many austerity moves will be done, there is no way that any of these is going to take the EU out of the crisis. There will be more social unrest, recession and potentially depression in several countries and an acceleration of wealth moving out of EU. There is consensus that ,in fact, these tough measures will only have a positive impact if they are followed by growth stimulus. The conventional wisdom is that EU needs to fix the debt before it tackles growth. For example, Italy is going through a “tears and blood” budget, where the Government is trying to collect some €30bn to be able to use part to cut the public debt and part to fund growth. Unfortunately, the odds are that after some relief to the spread – behind the brief market celebration at the Italian plan—the spread will be back up and the money originally foreseen for the growth will be used to cover higher interest rates. So, a second budget correction will be necessary, and so it goes.

This situation reminds me of the “strategy” of many companies when they are in a bad financial situation: to soften the blow with Wall Street, they announce massive layoffs. For a week Wall Street rewards them with higher stock value, but ultimately the analysts realize that these measures are not sufficient in absence of a credible plan to grow sales profitably. No company has ever become rich only through cost savings, and no country has ever grown out of austerity packages.

The critical issue for EU countries, particularly those at the periphery, is how to create the conditions for growth. Here I just would like to offer a few considerations:

• We need to eliminate the conditions to speculate on EU interest rates. Currently, the swing in interest rates for countries like Italy is similar to the fluctuations of stocks. This cannot be right. A country needs to have stable access to credit, and to have a Central Bank which could use its ability to create liquidity as a way to balance the effect of different forces. So  far, the ECB can only be the defence against inflation. But it can’t intervene to buy countries’ debt, like all the other central banks, like in US, China, Britain etc. This leaves weaker countries totally unprotected from speculation. The first condition for growth is to give the power to the ECB to buy public debt at 1% rate.

• The above will also have the effect of easing liquidity. The lack of growth in peripheral countries is also driven by the credit crunch.

• Countries need to foresee a significant investment in infrastructures. This is a major opportunity to modernize Europe and to increase its competitiveness within the global market.

•  Last but not least, the EU needs to exercise a central drive and control on at least three major areas. The first is to use a central commission to control that the public funds are well spent. Unfortunately, we have witnessed in the past the bad use of money in several countries, and the EU needs to ensure that this won’t happen again. This is particularly important in countries with high level of corruption. The second is to create a pan-EU policy on liberalizations and common ground for competition law. The third is to have the same fiscal policy. The fiscal rules needs to be much simpler than today but need to apply for the whole of the EU.

Unfortunately, right now, Germany and France are trying to exercise their leadership only on the budget deficit, no matter how this is obtained, and are missing the much bigger picture. We are missing an opportunity to turn this crisis into what EU was meant to be:  the drive towards the United States of Europe. 

Italy's window of opportunity

The fall of a democratically elected government and its substitution by a technocratic, unelected one presents a huge opportunity for Italy. True, it was not chosen by the people and true, it is pretty much at the beck and call of the European Central Bank. But this could be a unique opportunity to pass much needed reforms which have failed to go through during the Berlusconi and Prodi governments. But it is also a situation which has an interesting  historical antecedent.

In the 1990's, Italy underwent massive privatization and economic reforms which boosted overall competitiveness, achieved monetary stability and massively reduced corruption following the Mani Pulite Scandal. Inefficient state-owned firms such as Telecom Italia were privatized.
These reforms were not the ingenious idea of some political party. They were pushed through by the European Union so as to ensure Italy met the criteria necessary to join the European Monetary Union. Reforms came to a halt and were in part reversed with Berlusconi because liberalization reforms were seen to undermine his personal business monopoly as well as eliminate a highy profitable source of rent-seeking. Cioffi and Hopner summarize this point exquistly when they claim that "the right-wing Berlusconi government appeared to embrace and embody the incestuous alliances and interrelationships between business and political elites". (http://pas.sagepub.com.gate2.library.lse.ac.uk/content/34/4/463.full.pdf+html)
As a result, Italy has sat stagnant for close to 20 years. Italian GDP growth has averaged around 0.3% over the last 10 years. And patronage, inefficient monopolies and unemployment have run rampant once again.
We now have a unique opportunity to push through much needed reforms because of the external influence of the EU and the bipartisan political climate which has developed in Italy as a result of the crises. This opportunity cannot go wasted and Mr Monti appears to understand this. Of course, even if these reforms are effective, they must be safeguarded against future bastardization. We cannot return to business as usual once the economic situation improves or when Mr Monti's mandate ends in 2013. If history has taught us anything, it is that vigilance on behalf of a citizenry cannot only take place in times of crises. Repeating the mistakes of the past is simply not an option

To conclude, this article does not want to suggest that all the reforms that Monti has proposed will be effective. Some, like the ICI, are dubiously effective at best. But the general climate is moving in the right direction. There is a need to reform the deeply flawed economic system which has proven to not work in the interest of the Italian people. Monti can push forward unpopular pension, trade union and cost cutting reforms using scare tactics. This is obviously not an ideal situation, but in Italy sometimes its the best you can hope for.