Portugal cuts to the bone
The Portuguese government’s newly announced cuts of 30,000 government employees designed to replace the cuts in holiday pay and pensions that were disallowed in early April by the Constitutional Tribunal threaten to weaken key services like education, where Portugal is anyway weak, and healthcare, where a relatively well-performing service could be undermined. Portugal like other countries has already endured five years of declining incomes which in the last 12 months have been severely intensified. During this period its long-term external imbalance as measured by the current account deficit has finally been rectified which implies that exports of goods and services now exceed imports of goods and services by a margin sufficient to service the large external debt. But further government cuts threaten to wreak deeper and more permanent damage to the social fabric than has already occurred.
The same is true perhaps even more so with Spain where unemployment has reached a staggering 27% with well over 50% of young people unemployed. If some of these have precarious and low paid jobs in the grey economy such employment hardly provides a basis for their future.
Help out of debt-depression spiral is desperately needed
In both Portugal and Spain governments of the centre-right have been implementing harsh austerity policies prescribed by the European Commission and the creditor countries (Germany and the Netherlands being the largest of such countries) and also striving to put in place the kind of structural reforms to labour and product markets which they are being urged to take. Yet even the beginnings of economic recovery remain elusive. Portugal for example has seen a 20% increase in exports outside the EU but with the majority of exports being to an EU in recession this is insufficient to make a noticeable difference. They have a real need for some complementary action by the creditors and European institutions. This commentary does not believe there is any magic answer to the debt-depression spiral but Germany and others could ease fiscal policy a little and allow wages to rise slightly faster so boosting disposable incomes. They could move a little faster to a banking union which would gradually tackle the divided lending markets where businesses in southern Europe have to pay to banks double or more the interest rates charged by German or Dutch banks in their own countries. Germany and its allies in the ECB could take slightly more risks with the distant danger of excessive inflation.
Estimates of the EU budget required to oil monetary union before the actual plans where drawn up in the Maastricht treaty of 1992 were up to 5% of GDP, the actual budget has been held rigidly within a 1% limit. Loans through the European Stability Mechanism or otherwise are not transfers. They do entail the risk of default but such default could be more rather than less likely if southern economies continue their downward trajectory.
On the other hand the German fear, fed by the country’s own experience of massive transfers since unification to eastern Germany which failed to bring economic convergence, of pouring money into countries which use it to avoid rather than help necessary financial discipline and reform is also understandable. What is being done in Portugal and Spain (and even more so in Greece) should make Germany and its creditor allies see that such fears are now as justified as fearing that an anorexic could become obese by over-eatin.
But Italy sends another message
However the message coming to the creditors from Italy is very different from that from Spain, Portugal or Greece. Although Italy has a massive and chronic government debt its private sector has a low level of debt and huge financial assets so overall it is a wealthy country and not heavily indebted externally. It is less far off eliminating its government deficit than the other countries and its failure to do so is a result of politicians who in an effort to be re-elected have not taken feasible and necessary measures.
In November 2011, the financial markets and Italy’s partners (then President Sarkozy as much as Chancellor Merkel) lost confidence in the government of Silvio Berlusconi and the yields being demanded of Italian debt threatened to bring the country to financial collapse. As a result the head of state, President Napolitano who normally kept aloof from the country’s politics, intervened to appoint the academic economist, Mario Monti, as prime minister of a government of non-politicians to “save” Italy. Its first set of measures entitled “Salva-Italia”) included a tax on first homes (second homes were already taxed). Although similar property taxes are common in other countries, this was highly unpopular in Italy, and from late 2012 Mr Berlusconi staged a spectacular recovery from near political oblivion to almost winning the March election, a central theme of which was his promise to abolish this very property tax which had been necessary to convince external creditors including private bondholders that Italy was financially viable.
In view of such events in Italy, Germans would not be completely mistaken if they concluded that an easing of financial pressures on Italy would make it easier for politicians like Mr Berlusconi to return to power and use that power to entrench their privileges rather than make the reforms needed to allow Italy to perform adequately within the monetary union.
Italy’s problems are not just a result of the economic downturn
It is true that Italy is also suffering from prolonged recession and is offering its young people poor economic prospects but this predicament is more due to deep flaws in Italian politics and society than to the euro zone crisis. The success of Beppe Grillo’s Five Star Movement (M5S) which came from obscurity to 25% of the votes in the March 2013 election reflected a feeling amongst much of the population that Italy’s political class was self-serving. Unfortunately, though, this message was blurred by the simultaneous recovery of Italy’s most self-serving politician Silvio Berlusconi, helped by his control of much of the country’s television. Other flaws include the notorious organized crime clans which though being combatted seriously in Sicily remains rampant in two large southern regions, Calabria and Campania, where their impact on the wider economy is profound. The justice system includes many brave and dedicated public servants but remains appalling slow and is also over-politicised. Most professions remain encumbered by restrictive practices which makes entry even by well qualified young people difficult.
New prime minister Letta has to square the circle
Enrico Letta, deputy leader of the Democratic Party (PD) which just emerged as the largest party in the March election, but performed much less well than seemed likely at the start of the campaign, leads a new grand coalition between the PD and Berlusconi’s People of Liberty (PdL) having failed to persuade Grillo to enter constructive discussions. The government states that it wants to ease austerity but sis committed to maintaining the budget projections of the Monti government including a 2.9% of GDP deficit in 2013, but will have to remove the property tax if it is to retain the support of Berlusconi. It will somehow have to find expenditure cuts or other tax increases to meet this commitment. Neither are likely to be possible without taking on entrenched interest groups linked to one or other of the two parties in the coalition. Hard-nosed German and Dutch policy-makers will be watching.