To keep its debt crisis from mushrooming out of control, the European Union is imposing harsh cutbacks on millions of ordinary people in debt-plagued countries like Greece, Ireland and Portugal.
But some economists think cutbacks right now are a mistake that might
tip Europe into a dreaded double-dip recession.
How, sceptics ask, will Europe’s barely-there recovery withstand the loss of stimulus from sudden, steep austerity measures demanded by the EU? So far the pain includes cutbacks and freezes in teachers’ and nurses’ salaries, higher retirement ages and heavier taxes on everything from incomes to cigarettes and fuel.
Europe is barely expanding, with only 0.1 per cent growth in the fourth quarter in the 16 countries that use the euro, leaving a renewed slide into recession impossible to rule out. And the recession is still on in several countries facing the cuts such as Greece, Ireland and Spain.
“This premature fiscal tightening is the route to the Second Great Depression, or at the very least, a long period of economic stagnation,” warned Simon Johnson, a professor at MIT’s Sloan School of Management and a former chief economist at the International Monetary Fund.
Yet markets are leaving EU leaders with little room to manoeuvre.
Robbie Cullen can see both sides of the coin. As a tax collector, he’s in the front line of Ireland’s battle to bring its runaway deficit under control. But as a divorced dad working two jobs, his own wallet is already at breaking point.
“The debt we have run up as a nation is just unbelievable. A tsunami could hit Ireland and cause less damage,” said a red-eyed Cullen, who shifts every day from his civil servant job to moonlighting as a taxi driver in Dublin.
It is a choice he could not have imagined a few years ago – before the government’s emergency budgets cut his overtime, froze his salary, raised his income taxes and boosted his workload as departing colleagues were not replaced.
“I cannot even keep up with my own debts, never mind the nation’s,” Cullen said, shopping for cut-rate sausage at a discount supermarket he disdained to visit in better times. “I have got to spend 30 hours a week taxiing just to break even. Something else has got to give. I cannot give any more.”
Despite the pain its cutbacks are imposing on ordinary people, the conservative Irish government of Prime Minister, Brian Cowen, has won praise from the European Union and the bond markets for its efforts to cut debt, prices and salaries.
The European Union is demanding austerity in defence of its common currency, which can be undermined by big deficits and would be devastated by a Greek default. The strategy, led by Economic and Monetary Affairs Commissioner Olli Rehn, seeks to reverse deficits spiralling far beyond the euro zone’s rule of three per cent of gross domestic product – Greece’s is expected to hit 12.7 per cent, Ireland’s 12.5 per cent, Spain’s 11.2 per cent and Portugal’s 9.3 per cent.
The austerity is supposed to deter bond markets from demanding higher interest rates and ultimately sinking state finances.
The cuts are based on a hard fact of economics: the usual path for a country in trouble is to see its currency fall relative to other currencies. That quickly makes it a lower-cost location for business investment and makes its exports cheaper and more competitive, an automatic if painful boost.
But Europe’s highly indebted governments such as Ireland, Greece, and Portugal, cannot devalue because they belong to the euro and no longer have their own currency. Latvia is in the same boat, since it has pegged its currency to the euro, which it hopes to join in the next several years.
Without the safety valve of devaluation, countries must instead force down wages and prices to restore competitiveness and get deficits under control. And that is what they are doing, starting with government workers.
Economist, Paul de Grauwe, of the Catholic University of Leuven in Belgium thinks that panicking markets have the clear upper hand and are forcing governments into slash and burn policies prematurely, before the recovery is self-sustaining enough to endure them. “It is all a question of timing,” said Mr de Grauwe.
The EU, said MIT economist Johnson, has to set up creating a crisis management institution, so long as it will not let the Washington, DC-based International Monetary Fund help with crisis lending.
“If you do not want them, fine, but get a move on and do something else,” said Johnson.
Cuts have been the hardest in tiny Latvia, where a European Union-sponsored bailout has led to 30 per cent salary cuts for police officers and teachers.
Ireland’s cutback strategy so far seems to be appeasing bond investors. Ireland has imposed income-tax hikes ranging from one per cent to three per cent and slapped a seven per cent charge on the wages of more than 700,000 State-paid workers – including nurses, teachers and taxmen like Cullen – to fund their
pensions.
“I lost near 10 per cent off my wages just like that,” he said, snapping his fingers. “But they also took away overtime pay, bonuses, all these supposed ‘extras’ that you actually relied on to get you through Christmas. I’m easily 30 per cent worse off. But my maintenance (alimony) to the ex-wife has not dropped a cent.”
Like Ireland’s economy as a whole, Cullen is still struggling to “deleverage” – or cut his own debt levels from the boom years. He says he is struggling himself to maintain payments on his own suburban home – unsellable in a market that has a glut of property and trapped a fifth of households in negative equity.
Some politicians in the affected countries are warning of the dangers of cutting too far too quickly. The Socialist leaders of Greece and Portugal are trying to hold the line at hiring and pay freezes, while avoiding outright pay cuts. Greek unions held wide-ranging protest strikes yesterday, shutting down flights, schools and curtailing medical services.
In Spain, shoppers are bracing for a planned two-point hike in national sales tax to 18 per cent and a two-year increase in the retirement age to 67. Pro-austerity economists say this is not nearly enough.
Neighbouring Portugal plans to freeze the pay of its 675,000 civil servants this year and prune payroll by at least 7.5 per cent within four years. Freezing salaries means an effective pay cut as Portugal’s prices, particularly for utilities, keep
rising.
“Luxury goods, travel, treats, vanity items will all have to go,” said Helena Ferreira, a 46-year-old single mother of two teenage sons who works in the immigration service in Lisbon.
“I will have to buy clothes in the sales and avoid buying the brand names the kids want. Even with food – those little things we spoil ourselves with – I will have to cut back.”
