THIS TIME, it is for real. For months, the eurozone has been teetering on the brink of collapse but, at the last minute, it has regularly been pulled back from the edge. Any respite proved short-lived and the turmoil always returned, with renewed intensity. Now, having ‘kicked the can down the street’ with a series of temporary measures, the authorities have run out of street. Elections in France and Greece, uncertainty in the Netherlands, and tension in Spain and Italy leave no place for the policymakers to hide. Economic and financial issues are the major political and social questions that have to be addressed in Europe, and while the answers seem as remote as ever, the choices are crystallising.
While debate rages about contagion, eurobonds, fiscal rules and bank solvencies, the heart of the problem is simply debt and how it should be repaid. At one extreme, there is the ‘can’t pay, won’t pay’ school, which implies default and eurozone exit for a country. At the other end of the spectrum, we find those who believe (as president Coolidge did of World War One reparations) that ‘they hired the money, didn’t they?’ So, this group argues, the debt must be repaid, even if it means driving a country into recession/depression. In between are several positions which may take longer, and involve some debt forgiveness and/or support from richer to poorer countries.
The election of a new French president has been seen as a watershed moment for the eurozone. His emphasis on growth rather than austerity seems to break with the attitudes of the recent past. Although the choice is not as straightforward, it is easy to understand the dividing line between the major players.
As all households and businesses appreciate, there are two ways of reducing debt: reducing spending and increasing income. The austerity route argues for spending cuts and tax rises to tackle deficits and debts, but such a policy has built-in contradictions. Both higher taxes and a squeeze on public spending will slow growth, thus pushing up spending on unemployment and reducing tax revenues. Such an outcome, aside from increasing social tensions, would make achieving the fiscal targets more difficult and would be counter-productive.
Encouraging growth and using the ‘growth dividend’ to repay debt, on the other hand, seems a logical approach but has huge risks. Any support for growth implies a loosening of the current policy stance – resulting in spending increases or tax cuts – which would worsen the situation in the short term. Support for the weaker countries would have to come from the stronger, which have already seen vast sums spent on bailouts with little evidence of reform and restructuring of the struggling economies. To the strong, it would be pouring good money after bad with little prospect of improving economic performance.
The UK is not a disinterested spectator as the same points have been made to the chancellor. With the economy technically in recession, his adherence to his fiscal Plan A has come in for criticism. But it is different here. The UK can borrow at low rates if it wants to step up spending. As sterling can adjust to encourage competitiveness (which cannot happen in Greece, Spain, etc.), it gives Mr Osborne more flexibility than most eurozone governments.
And there is no contradiction between debt and growth. The UK’s fastest post-1945 decade of growth was the 1950s, when our national debt was 200% of GDP (it is 66% today). The benefits of growth were used to reduce debt rather than cut taxes or increase spending. Infrastructure spending (investment rather than consumption) could be funded cheaply and kickstart activity. Call it Plan A+ rather than Plan B, and it might be acceptable. ?