Austerity Measures

38.1.4: Austerity Measures

The austerity measures introduced as a response to the European debt crisis under the pressure of EU leadership had mixed results in terms of stabilizing European economies and a largely negative impact on ordinary Europeans, many of whom faced unemployment, lower wages, and higher taxes.

Learning Objective

Evaluate the effectiveness of the austerity measures advocated by the European Union’s leadership

Key Points

  • Austerity is a set of economic policies that aim to demonstrate the government’s fiscal discipline by bringing revenues closer to expenditures. Policies grouped under the term austerity measures generally include cutting state spending and increasing taxes to stabilize public finances, restore competitiveness, and create a better investment environment. Under the pressure of European Union leadership, many European countries embarked on austerity programs in response to their debt crisis.
  • In 2010 and 2011, the Greek government announced a series of austerity measures to secure loans from the Troika. All the implemented measures have helped Greece bring down its primary deficit, but also worsened its recession. The Greek GDP had its worst decline in 2011. Greeks lost much of their purchasing power, spent less on goods and services, and saw a record high seasonal adjusted unemployment rate of 27.9% in 2013.
  • The Irish sovereign debt crisis arose not from government over-spending, but from the state guaranteeing the six main Irish-based banks who financed a property bubble. Ireland initially benefited from austerity measures but subsequent research demonstrated that its economy suffered from austerity. Unemployment rose from 4% in 2006 to 14% by 2010, while the national budget went from a surplus in 2007 to a deficit of 32% GDP in 2010, the highest in the history of the eurozone.
  • In 2010, the Portuguese government announced a fresh austerity package through a series of tax hikes and salary cuts for public servants. Also in 2010, the country reached a record high unemployment rate of nearly 11%. In the first half of 2011, Portugal requested a €78 billion IMF-EU bailout package in a bid to stabilize its public finances, affected greatly by decades-long government overspending and bureaucratized civil service. After the bailout was announced, the state’s finances improved but unemployment increased to over 15% in 2012. The bail-out conditions of austerity also created a political crisis.
  • Spain initiated an austerity program consisting primarily of tax increases. Prime Minister Mariano Rajoy announced on in 2012 €65 billion of austerity, including cuts in wages and benefits and a VAT increase from 18% to 21%. The government eventually reduced its budget deficit from 11.2% of GDP in 2009 to 8.5% in 2011. Due to reforms already instituted by Spain’s conservative government, less stringent austerity requirements were included.
  • There has been substantial criticism of the austerity measures implemented by most European nations to counter the debt crisis, with economists predicting that the timing and level of austerity would only worsen the recession. As ordinary citizens paid the highest cost for the measures, including high unemployment, lower wages, and higher taxes, protests against austerity broke out across Europe.

Key Terms

European debt crisis
A multi-year debt crisis in the European Union since the end of 2009. Several eurozone member states (Greece, Portugal, Ireland, Spain, and Cyprus) were unable to repay or refinance their government debt or bail out over-indebted banks under their national supervision without the assistance of third parties like other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).
Troika
The designation of the triumvirate representing the European Union in its foreign relations, in particular concerning its common foreign and security policy (CFSP). Currently, the term is used to refer to a decision group formed by the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF).
austerity
A set of economic policies that aim to demonstrate the government’s fiscal discipline, usually to creditors and credit rating agencies, by bringing revenues closer to expenditures. Policies grouped under the term generally include cutting the state’s spending and increasing taxes to stabilize public finances, restore competitiveness, and create better investment expectation.

 

Austerity is a set of economic policies that aim to demonstrate the government’s fiscal discipline, usually to creditors and credit rating agencies, by bringing revenues closer to expenditures. Policies considered austerity measures generally include cutting the state’s spending and increasing taxes to stabilize public finances, restore competitiveness, and create a better investment environment. A typical goal of austerity is to reduce the annual budget deficit without sacrificing growth. Over time, this may reduce the overall debt burden, often measured as the ratio of public debt to GDP.

Under the pressure of the European Union leadership, many European countries embarked on austerity programs in response to the European debt crisis, despite evidence that overspending was only to a certain extent in some cases responsible for the unfolding economic disaster. However, austerity measures became the main condition under which the eurozone countries in the most dramatic economic situation, most notably Greece, Ireland, Portugal, and Spain, would receive financial support from the Troika, a tripartite committee formed by the European Commission, the European Central Bank, and the International Monetary Fund (EC, ECB and IMF).

 

Response to European Debt Crisis

On May 1, 2010, the Greek government announced a series of austerity measures to secure a three-year €110 billion loan. The Troika offered Greece a second bailout loan worth €130 billion in October 2011, but with activation conditional on implementation of further austerity measures and a debt restructuring agreement. All the implemented measures have helped Greece bring down its primary deficit but contributed to a worsening of its recession. The Greek GDP had its worst decline in 2011, when 111,000 Greek companies went bankrupt (27% higher than in 2010). As a result, Greeks lost about 40% of their purchasing power since the start of the crisis, spent 40% less on goods and services, and experienced a record high seasonal adjusted unemployment rate that grew from 7.5% in September 2008 to a record high of 27.9% in June 2013. The youth unemployment rate rose from 22% to as high as 62%. In February 2012, an IMF official negotiating Greek austerity measures admitted that excessive spending cuts were harming Greece. The IMF predicted the Greek economy to contract by 5.5 % by 2014. Harsh austerity measures led to an actual contraction after six years of recession of 17%.

The Irish sovereign debt crisis arose not from government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. Irish banks had lost an estimated 100 billion euros, much of it related to defaulted loans to property developers and homeowners made in the midst of the bubble, which burst around 2007. The economy subsequently collapsed in 2008. Ireland was one country that initially benefited from austerity measures but subsequent research demonstrated that its economy suffered from austerity. Unemployment rose from 4% in 2006 to 14% by 2010, while the national budget went from a surplus in 2007 to a deficit of 32% GDP in 2010, the highest in the history of the eurozone.

In 2009, the Portuguese deficit was 9.4%, one of the highest in the eurozone.In 2010, the Portuguese government announced a fresh austerity package through a series of tax hikes and salary cuts for public servants. Also in 2010, the country reached a record high unemployment rate of nearly 11%, a figure not seen for over two decades, while the number of public servants remained very high. In the first half of 2011, Portugal requested a €78 billion IMF-EU bailout package in a bid to stabilize its public finances, affected greatly by decades-long governmental overspending and an over-bureaucratized civil service. After the bailout was announced, the government managed to implement measures to improve the state’s financial situation and seemed to be on the right track. This, however, led to a strong increase of the unemployment rate to over 15% in 2012. The bail-out conditions of austerity also created a political crisis in the country, resolved in 2015 with the anti-austerity left-wing coalition leading the country.

Spain entered the crisis period with a relatively modest public debt of 36.2% of GDP. This was largely due to ballooning tax revenue from the housing bubble, which helped accommodate a decade of increased government spending without debt accumulation. In response to the crisis, Spain initiated an austerity program consisting primarily of tax increases. Prime Minister Mariano Rajoy announced in 2012 €65 billion of austerity, including cuts in wages and benefits and a VAT increase from 18% to 21%. The government eventually reduced its budget deficit from 11.2% of GDP in 2009 to 8.5% in 2011. A larger economy than other countries that received bailout packages, Spain had considerable bargaining power regarding the terms of a bailout. Due to reforms already instituted by Spain’s conservative government, less stringent austerity requirements were included than in earlier bailout packages for Ireland, Portugal, and Greece.

The text of the poster reads, "Education not emigration. Can you afford a £3,999 reg fee in September? No...then march!"

“Education not Emigration” – a poster for the national student march in 2010 in Ireland. A student demonstration took place in Dublin on November 3, 2010, in opposition to a proposed increase in university registration fees, further cuts to the student maintenance grant, and increasing graduate unemployment and emigration levels. Organized by the Union of Students in Ireland (USI) and student unions nationwide, it saw between 25,000 and 40,000 protesters on the streets of central Dublin during what “the largest student protest for a generation.”

Economic Debates on Austerity

There has been substantial criticism over the austerity measures implemented by most European nations to counter this debt crisis. U.S. economist and Nobel laureate Paul Krugman argued that the deflationary policies imposed on countries such as Greece and Spain would prolong and deepen their recessions. Together with over 9,000 signatories of A Manifesto for Economic Sense, Krugman also dismissed the belief of austerity-focusing policy makers that “budget consolidation” revives confidence in financial markets over the longer haul.

According to some economists, “growth-friendly austerity” relies on the false argument that public cuts would be compensated for by more spending from consumers and businesses, a theoretical claim that has not materialized. The case of Greece shows that excessive levels of private indebtedness and a collapse of public confidence (over 90% of Greeks fear unemployment, poverty, and the closure of businesses) led the private sector to decrease spending in an attempt to save up for rainy days ahead. This led to even lower demand for both products and labor, which further deepened the recession and made it even more difficult to generate tax revenues and fight public indebtedness.

Some economists also criticized the timing and amount of austerity measures in the bailout programs, arguing that such extensive measures should not be implemented during the crisis years with an ongoing recession, but delayed until after some positive real GDP growth returns. In 2012, a report published by the IMF also found that tax hikes and spending cuts during the most recent decade indeed damaged the GDP growth more severely compared to forecasts.

 

Social Impact of Austerity Measures

Opponents of austerity measures argue that they depress economic growth and ultimately cause reduced tax revenues that outweigh the benefits of reduced public spending. Moreover, in countries with already anemic economic growth, austerity can engender deflation, which inflates existing debt. Such austerity packages can also cause the country to fall into a liquidity trap, causing credit markets to freeze up and unemployment to increase. Supporting the conclusions of these macroeconomic models, austerity measures applied during the European debt crisis negatively affected ordinary citizens. The outcomes of introducing harsh austerity measures included the rapid increase of unemployment as government spending fell, reducing jobs in the public and/or private sector; the reduction of household disposable income through tax increases, which in turn reduced spending and consumption; and the bankruptcy of many small businesses, which contributed to even more unemployment and lowered already low productivity.

Apart from arguments over whether or not austerity, rather than increased or frozen spending, is a macroeconomic solution, union leaders argued that the working population was unjustly held responsible for the economic mismanagement errors of economists, investors, and bankers. Over 23 million EU workers became unemployed as a consequence of the global economic crisis of 2007-2010, leading many to call for additional regulation of the banking sector across not only Europe, but the entire world.

The photograph on the left shows a violent protest in 2010. The photograph on the right shows a peaceful protest in 2011.

The anti-austerity protests in Greece in 2010 and 2011. Anti-austerity activists demonstrated in major cities across Greece. Some of the events later turned violent, particularly in the capital city of Athens. Inspired by the anti-austerity protests in Spain, these demonstrations were organized entirely using social networking sites, which earned it the nickname “May of Facebook.”

Following the announcement of plans to introduce austerity measures in Greece, massive demonstrations occurred throughout the country aimed at pressing parliamentarians to vote against the austerity package. In Athens alone, 19 arrests were made, while 46 civilians and 38 policemen were injured by the end of June 2011. The third round of austerity was approved by the Greek parliament in 2012 and met strong opposition, especially in Athens and Thessaloniki, where police clashed with demonstrators. Similar protests took place in Spain and Ireland, led by student communities. The ethics of austerity have been questioned in recent years outside of the European states hit by the harshest measures as a result of the bail-out conditions. For example, the Royal Society of Medicine revealed that the United Kingdom’s austerity measures in healthcare may have resulted in 30,000 deaths in England and Wales in 2015.

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