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The Problem with Europe ’ s Austerity Debate

The Problem with Europe ’ s Austerity Debate. Anders Åslund Senior Fellow Cato Institute June 5, 2013. What Is Austerity?. Fiscal responsibility! = Money is not free The real questions: 1. Fiscal responsibility: N ow or later? 2. Who is prepared to pay? 3. To frontload or backload?.

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The Problem with Europe ’ s Austerity Debate

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  1. The Problem with Europe’s Austerity Debate Anders Åslund Senior Fellow Cato Institute June 5, 2013

  2. What Is Austerity? • Fiscal responsibility! = Money is not free • The real questions: • 1. Fiscal responsibility: Now or later? • 2. Who is prepared to pay? • 3. To frontload or backload?

  3. Six Reasons why early fiscal adjustment preferable • Early return to growth • Politically easier • Better fiscal adjustment • More structural reform • Financial sustainability • Earlier restoration of confidence

  4. 1. Early Return to Growth & Higher Growth Trajectory

  5. 2. Politically Easier • Rahm Emmanuel: “A crisis is a terrible thing to waste.” • Latvia: One riot in January 2009. PM Valdis Dombrovskis – reelected twice & longest serving PM in Latvia: “In this situation we have only two alternatives – one bad and a worse one. I prefer the bad one.” • Greece: years of riots, strikes & demonstrations; radicalization of electorate; is democracy in danger?

  6. 3. Better Fiscal Adjustment: Get ahead of the curve! • Latvia 2/3 expenditure cuts, 1/3 tax hikes • Greece: Little decline in public expenditures, lingering around 54% of GDP – GDP falls faster than expenditure cuts… • Greece: Little prospect for growth

  7. Latvia: Public Expenditure as % of GDP Normalizing

  8. Latvia Brought Down Budget Deficit, Greece Stuck at Huge Deficit

  9. 4. More Structural Reforms Expenditure cuts drive growth • Vested interest are not mobilized early on • More deregulation • More public sector reform – Latvia sacked 30% of civil servants instantly – Greece just starting

  10. Latvia: Sharply Falling Real Unit Labor Cost, 20%, 2008-12, Greece Less

  11. 5. Financial Sustainability Vital • Public debt in euro area on average 91% of GDP, end 2012 • Nine of 27 EU countries have lost market access and needed assistance • Financial assistance limited • If no financing, little choice

  12. 6. Confidence Restored Early • In Latvia bond yields peaked in June 2009 but in February 2012 in Greece • Much lower yields and market interest rates in Latvia • More domestic and foreign investment

  13. Greatest Mistake:Greece May 2010 Program • Too large credits given caused default • No structural reforms • No reduction of public expenditures as %GDP • Too small fiscal adjustment • No confidence & no growth

  14. Focus on Education! The key problem of Southern Europe: • Little education • Education of poor quality Only 38% of the Portuguese labor force has graduated from high school (US: 88%)

  15. Share of Labor Force That Has Graduated from High School, 2012

  16. Performance on PISA Math Test, 2009

  17. Conclusions • Europe’s fiscally conservative north thrives: Latvia’s GDP growth 5.5% in 2011 and 2012 • The backloaded South suffers: Meanwhile Greece GDP fell about 6% each year • IMF advice seriously flawed • Overestimated fiscal space in Spain, Cyprus & Slovenia • Intentionally delays crisis resolution in the South

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