ECONOMICS:TWO VIEWS put forward this week illustrate just how polarised the debate on fiscal policy has become.
“I put austerity first. Only austerity can give back growth.” So said Alex Stubb, Finland’s minister for European affairs.
Nobel prize-winning economist Paul Krugman stated with similar assuredness that staying the austerity course in Europe was akin to economic suicide.
The evidence simply does not support either position.
A voice of reason on the huge uncertainties involved has come from a source usually very definite in its pro-austerity views: the Bundesbank. On Tuesday, Manfred Neumann, a research professor at the German central bank, wrote that austerity “may” have gone too far in Greece and Portugal but concluded that, on the basis of what has happened to date, it is just “too early to sound the alarm”*.
One may agree or disagree with the views put forward by Neumann in the article, but his acceptance of the uncertainty surrounding the issues is fully warranted by the evidence from economies that have experienced and/or continue to experience extreme austerity.
Consider the countries among the worst affected by financial/economic crisis: Ireland, Greece, Portugal and Spain in the euro zone; and the EU’s Baltic states – Estonia, Latvia and Lithuania.
Since early 2008 they have experienced some of the biggest shocks suffered by developed economies. When measured by domestic demand, they have all suffered double-digit declines. (Domestic demand is arguably a better indicator of economic conditions on the ground than GDP but the trends in other indicators of output and employment reflect the trends in domestic demand in all countries discussed.)
Ireland’s position is grim, as the chart (left) shows. No other country has suffered such a persistent contraction in domestic demand. In the three years to the end of 2011, it has fallen by a massive one-quarter.
How much of this is the result of austerity? Some, certainly, but it is hard to conclude that it was the determining factor. In early 2008, domestic demand began to plummet. That happened when the Government was only just waking up to the scale of the crisis. By late summer of that year €440 million in adjustment measures were introduced.
The freefall in the economy began to slow in the first half of 2009, just as multiple austerity packages were introduced amounting to a massive €8 billion combined.
A smaller €4 billion budget package was introduced in 2010. The pace of decline slowed. A bigger €6 billion package was implemented in 2011. Domestic demand stabilised in the first half of the year, before falling quite sharply in the second. The relationship between the size of austerity packages and the pace of economic decline is not strongly correlated.
Now consider the Baltics. They underwent even more severe austerity than Ireland when their crises erupted. That undoubtedly made the loss in output and employment worse than it otherwise would have been, but to suggest that the medicine “killed the patient” is simply not the case. All three countries have rebounded strongly since they hit bottom in 2009, as illustrated clearly in the chart.
This pattern of recovery is mirrored in GDP and employment. Between their low points and the final quarter of 2011, GDP grew by 19 per cent in Estonia, 17 per cent in Latvia and 12 per cent in Lithuania (all figures here and below are sourced from Eurostat and are seasonally adjusted). Employment, which lags output on both the way down and up, is also growing. From low points in numbers at work (in 2009/2010) to the final quarter of 2011, Estonia had employment growth of 13 per cent, Latvia 8 per cent and Lithuania 4 per cent.
The argument linking austerity to slump is stronger for the southern European countries, but that may be because, as Neumann suggests, it is too early for a full evaluation. In Greece and Portugal, the rate of contraction has become more marked since their bailouts and additional fiscal tightening packages. Nobody doubts that tightening has negative effects, but whether all of both declines are associated with the fiscal measures or whether, for instance, confidence factors played a role cannot be fully disentangled.
Austerity may fail in southern Europe and Ireland, but sweeping statements either for or against are just not warranted.
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