For decades the IMF’s best known recipe for troubled economies was loans in return for a fiscal consolidation commitment. It is now refreshing to see that even the IMF is advising that without growth, there is no practical way out of the European debt crisis. It is a simple question of mathematics. There are two main indicators of a country’s fiscal health: the current account balance, and the stock of debt outstanding. Both these quantities are usually then divided by the gross domestic product to produce the yearly budget deficit ratio and the Debt/GDP ratio. Some European nations have a problem with the first ratio, some with the second, and others are developing a double sickness. Spain, for example has a current account problem; Italy, an inherited huge national debt that stands at well over its GDP. Greece, suffering from a combined problem, had to restructure its debt with IMF and EU help. Fiscal restraint works better in case one, where a few years of low budget deficits can cure the economy. Italy has the second problem, which requires a double cure. The budget deficits haven’t been a problem for several years, and in fact there have been a number of primary surplus years, and this year an overall surplus is expected; however, the Debt/GDP ratio will hardly budge as the economy is expected to once again shrink. The only way for the “Italys” to reduce this ratio is to start growing again, having virtually stopped ten years ago.
Greece, the real life laboratory of fiscal consolidation
Driving in the hectic Athens traffic one could be excused for not noticing that Greece has just defaulted on its obligations. Traffic is slow, the taverns are relatively full, and spring is in the air. However, after a few conversations with the likes of guides, taxi drivers and hotel clerks you get a clear idea of what is going on here. For the first time in a generation in Western Europe people are actually seeing their salary and pension cheques go down, significantly, and since prices are still at European level, this hurts a lot. Coupled with the fact that taxes are going up, disposable incomes are going down very significantly, two observations come to mind: First of all people seem to be devoid of hope in the future, and in particular they don’t trust either side of the current parliament. There will probably be a large proportion of abstentions in the forthcoming elections. Secondly, people seem to be accepting the tough medicine with a limited amount of protest. Of course there are sit-ins in front of parliament and the occasional more aggressive act, but there is no Greek Spring at work here.
It is too early to tell if this brutal fiscal consolidation will work. If it does, it will be a test case that people end up accepting to tighten their belts considerably when they see that there is no alternative, but the Greek ruling class has a heavy responsibility to ensure that the suffering it had to inflict on its citizens will not be for nought, and at the same time it must find ways to ensure that the weakest sector of society is not left without the basic needs of life, food and shelter.