The Politics of the Politics of European Austerity

German Chancellor Angela Merkel and European Commission President Jean-Claude Juncker in May 2014. Has the advent of the latter's European investment plan indicated a shift in the balance of power in Europe away from German austerity?German Chancellor Angela Merkel and European Commission President Jean-Claude Juncker in May 2014. Has the advent of the latter's European investment plan indicated a shift in the balance of power in Europe away from German austerity? (Source: European People's Party)

The situation in Greece is at breaking point. Local councils have no money and Orthodox churches are having to feed people that authorities cannot cope with. Meanwhile in Athens, the newly elected Syriza party are in a standoff with the European Central Bank as they try to restructure their debt. They promised Greek voters they would ditch the austerity measures forced on them by the rest of Europe after 2009, and renegotiate the country’s €240bn (£180bn) debt. However the ECB has been unwilling to acquiesce to their demands and Greece must either pay back its debts, or leave the Eurozone.

The Politics of Austerity in 2009

This is a dark situation for the Greeks, who hoped they had seen the worst of their financial troubles. When the extent of Greece’s sovereign debt became apparent in 2009, after the global ‘credit crunch’, Greece was faced with a similar dilemma to the situation they face currently – commit to externally created economic measures, or leave the Eurozone. Austerity measures were, and still are, a hugely controversial tactic for a country in debt. It has been described as “zombie economics” by the political economist Mark Blyth, because, as he puts it in his 2010 book Austerity: The History of a Dangerous Idea, “it has been disproved time and again, but it just keeps coming”. The Oxford Professor Simon Wren-Lewis on his ‘mainly macro’ blog is also highly critical of austerity because of the immense harm it does to economies.

Austerity promotes the idea that governments cannot continue with large deficits, and so encourages spending cuts and tax hikes to get the deficit under control. While this may sound logical, it has historically been shown to be detrimental to the recovery process. Countries are not run like households, and while it is often undesirable for a government to be running a large deficit, it is possible. In some cases, it is better in the long run to increase the national debt by plugging more money into the economy, with the aim of creating growth in the short term and reducing debt through growth. Authorities in the USA were well aware of this when the sub-prime mortgage crisis first came to light in 2008. After Lehman Brothers collapsed, the newly elected President Obama signed an $831 billion stimulus package, worth a staggering 6% of the country’s GDP in 2009. He made it compulsory for US banks to accept the stimulus, arguing that bolstering consumer confidence and investment was more important in the short run than reducing the size of the deficit.

However, the rhetoric across Europe was different: that high levels of debt were unsustainable and must be reduced. The economic situations of the ‘PIIGS’ – Portugal, Ireland, Italy, Greece and Spain – had spurred this political mantra. The Maastricht Treaty, signed in 1992, dictated that the countries joining the Eurozone must keep their budget deficit below 3% of Gross Domestic Product (GDP) and national debt levels at less than 60%. When sovereign debt levels were scrutinised after the global financial crisis of 2008, it became clear that these countries were well over this limit, having enjoyed years of the low interest rates bestowed on all Eurozone countries. Ireland invested heavily in a property bubble and Portugal ran an unsustainable balance of trade deficit. Cheap lending was both a benefit (and now it seems a flaw) of the single currency, because it was assumed that the European Central Bank would step in in the event of any problems.

European government deficits as a percentage of GDP

European government deficits as a percentage of GDP (Source: Eurostat, created by author)


The situation created a power split through Europe, and subsequent economic policies revealed large ideological divisions between Eurozone countries. As the PIIGS risked faltering on their debts, on the other side of the spectrum was economically-stable Germany, and, to a smaller extent, France under President Nicolas Sarkozy. Germany – long advocates of keeping small debts since the Weimer hyperinflation crisis of 1922-3 – was highly resistant to the idea of bailouts, concerned that it would simply refuel credit-led growth. After the collapse of Lehman Brothers in 2008, Merkel berated the Americans, arguing that that common sense lay with the “Swabian housewife, here in Stuttgart… She would have provided us with a short, simple, and entirely correct piece of life-wisdom: that we cannot live beyond our means”.  France and the Netherlands were also reluctant to create a bailout package. Germany’s staunchest ally was probably the European Central Bank’s president, Jean-Claude Trichet, who had publicly berated the PIIGS over their irresponsible spending.

However, should any of the ‘PIIGS’ default and have to leave the Eurozone, all the other Eurozone countries would see confidence in the currency plummet. Thus the most realistic option was for the ECB, together with the International Monetary Fund and EU, (known as the Troika), to create a bailout package, albeit with gritted teeth. The trade-off for any recipient country was severe economic restructuring.  Thus the PIIGS were forced between a rock and a hard place – either to receive the desperately-needed bailout packages or agree to severe austerity measures. These included welfare reforms, privatisation measures and tax increases. At the time, many argued that austerity was not in the economic interests of these countries, but instead was a form of punishment. With rising unemployment and reduced welfare spending on the horizon, there were huge public protests in Spain and Greece, where over 300,000 Greek indignados gathered in front of Parliament in June 2011, as John McAuliffe has outlined. In Portugal, Prime Minister Jose Socrates resigned after his austerity bill was rejected. The loss of economic sovereignty has had harsh political repercussions.

This has exposed a key structural weakness in the Eurozone. All countries joining the euro were endowed with Germany’s stable credit rating, but not all of them exercised the same strict policies as the German spending regime. Wages and welfare spending in the PIIGS climbed exponentially from the start of this century, whereas German increases have been much more restrained. However it has been a bitter irony that by insisting on austerity measures for the PIIGS, Germany and the other supposedly cautious economies have been forced into undertaking austerity measures too. A number of big German banks had been put at risk through their loans to Austria, which in turn had financed the now flagging Eastern European housing markets. Since signing off rescue measures it has become apparent that in order for austerity to work in peripheral countries, “all of Europe needs to be austere – because each national state’s balance sheet has to act as a shock absorber for the entire system,” as Blyth argues. Germany promised to cut €80 billion from its budget starting in 2011 and France too announced an austerity plan to slash state spending by 45 billion euros over three years.

Austerity measures even took root in British soil, despite being outside of the Eurozone, although unlike Greece and the others, this was a domestic decision, as Neil Gandhi has outlined. The Greek bailout occurred just weeks before the 2010 general election, and politicians and the media stoked the idea that the Greek crisis could be contagious (despite this being “economic nonsense”). Incumbent Prime Minister Gordon Brown insisted that financial stimulation was necessary before austerity, whereas the Conservatives argued that austerity needed to happen hard and fast. And the Conservative-Liberal Democrat coalition, once in power, essentially ‘jumped’ into austerity, where the PIIGS in Europe had been ‘pushed’. The political strategy here cannot be ignored: Chancellor George Osborne was able to emphasise the profligacy of the Labour party, citing the ‘thrifty housewife’ metaphor for the UK, and appear in charge of the economy, promising to eliminate Britain’s budget deficit by 2015 through spending cuts and tax increases at a ratio of 75:25 percent. As well as cutting the deficit, there is a great deal of political speculation of an underlying Conservative agenda to roll back the welfare state in the longer term. David Cameron has pledged that, should the Conservatives win in May 2015, absolute government spending (including spending on capital infrastructure projects) will be reduced to zero by 2019-20, without resorting to tax increases.

Why is austerity no longer in vogue?

In Europe, the situation is much the same as five years ago.  Austerity still has not worked as a sustainable way to cut debts but maintain economic growth, and 2014 finished with sluggish economic growth and stubbornly high unemployment rates; in Greece it is 25%, in Spain it is 23%, with the rate of youth unemployment particularly worrying. Deep domestic discontent was expressed throughout the European elections in May 2014. As well as SYRIZA France’s Front National, Italy’s Five Star Movement and Spain’s Podemos! (We Can!) have both showed alarming gains in popularity. The Front National, a far right-wing party advocating economic protectionism, and Podemos, a left-wing party seeking to address economic inequality, both express Eurosceptic views, and are trying to regain economic sovereignty in their respective countries. Even in Germany, often seen as the most politically and economically stable country in the Eurozone, a new anti-euro party, Alternative für Deutschland, has been creeping onto the political scene. The economic decisions spearheaded by German Chancellor Angela Merkel have sown the seeds for a potentially dangerous political challenge.

At the supranational level, the European Commission has also seemed to acknowledge that austerity is no longer the best policy for Europe. Jean-Claude Juncker, its current President, has tried to take the burden off national governments; at the end of 2014  he promised a second round of cheap, four year loans, aimed at boosting the Eurozone’s struggling economy and powering up inflation in Europe from its paltry 0.4% rate. Juncker set out a €315 billion (£250 billion) investment plan, hoping most of it would be funded by private backers, to help the continent invest in jobs in broadband, energy networks and transport infrastructure, as well as education and research. The aim, he said, was “getting some new winds blowing through Europe”. However, these funds have not been taken up as enthusiastically as was hoped. Even when combined with the first round of loans in September 2014, when just over €82 billion was given to 250 banks, take-up has been sluggish.

The private sector is still cautious, and many governments who might otherwise contribute to the fund are themselves worried that anything they invest in the project will be added to their national deficits. Germany, in particular, the champion of austerity measures, is reluctant to invest any more than €10 billion in the plan. It is worried that this contribution would be added to its government deficit, which, as mentioned earlier, they try to keep low. The German economy only narrowly avoided going into recession at the end of 2014, and predicts just a 1% growth rate for 2015 as confidence in German business remains wobbly as a result of slowing exports and apprehension about the situation in Ukraine.

Europe’s Future

Amidst fears that Europe is heading for its own Japanese ‘Lost Decade’, a Juncker-style investment plan might just be what Europe needs to get its export markets growing again. However, while he waits for committed investors, in the meantime, European citizens are using their vote to try to claw back economic sovereignty. The balance of power in Europe is shifting again as Germany’s position as Europe’s economic powerhouse looks increasingly insecure. The Centre for Economic and Business Research (CEBR) has predicted that the UK will be in a position to overtake Germany as Europe’s largest economy by 2030, because of its high population growth relative to Germany’s ageing population, and the German reliance on export-based growth. And having exercised a disproportionate amount of power across the Eurozone five years ago, Germany is now looking increasingly isolated. Whereas Germany once dictated the terms for Greece’s survival, now the ECB has the power of life or death over Greece, with the ability to pull its cash flow and almost certainly force Greece to leave the Eurozone, in a political climate where increasingly the Troika, rather than Germany, is calling the shots in Greece, as Auriane Terki-Mignot has analysed. However, this would bring the Eurozone back round to the situation they faced in 2010, where losing one country would jeopardise all countries. The Greece-ECB standoff will soon need a compromise, but it is unlikely to come from the latter.