Many EU nations have disclosed plans for budget cuts as part of the trend toward austerity that has swept the region. The frugality is understandable. In the eyes of the world, Europe has gone from a period of prosperity a few years ago to being close to broke. It seems the trouble was not apparent to bond traders and most Europeans until just a few weeks ago. Now nearly every public employee and pensioner in the region is about to experience a painful cut in benefits.
Austerity has been forced on the region and the force has had to be profound. Europeans have spent years sitting in cafes smoking and drinking strong coffee. The UK government has moved in toward socialism and the real estate bubble got particularly big in some parts of the country.
The new perception of the financial problems in Europe should not be new. Moody’s and S&P may have been late to catch up with them, but the agencies are only following their normal course of being perpetually late. It is more surprising that some much of the smart money from banks and hedge funds bet on positive economic news out of the region and the ongoing strength of the euro and pound.
An analysis of budget cuts in the EU is nearly impossible, at least if it is to be precise. Unlike cuts in the US which can be calculated on one scale, a $10 billion budget cut in Portugal is quite different from a $10 billion budget cut in Germany. The German number is modest. The CIA Factbook reports that Germany had a $3.8 trillion GDP last year. Greece’s was only $342 billion, barely larger than Ukraine.
The total of the budget cuts announced by the UK, Spain, Germany, and Greece in the last few weeks is only about $50 billion. And, sometimes, the figure measures cuts over more than one year. The cuts will be painful nonetheless. For instance, UK deficit reduction may put 300,000 public employees out of work. Many government workers will have their compensation cut. Taxes will be raised in almost every nation among those that are in the process of huge financial adjustments. It would be reasonable to ask the extent to which these actions are regressive. In some countries they probably are. GDP growth depends on business expansion and consumer spending more than anything else. High taxes and low pay restrict economic improvement at some point, and there is no way to predict that tipping point although nearly every expert is willing to offer an opinion.
The catastrophe in the EU is beyond the point where it is worth debating regression. The countries have too much debt to continue to raise large sums to cover their deficits. The capital markets have lost faith as the cost of sovereign borrowing is rising rapidly. Greek borrowing costs triggered the bailout of its economy. The loss of confidence in the euro and other national budgets made the trouble regional and forced the raising of a credit facility of close to $1 trillion.
The causes of the deficits that have led to the austerity are generally said to be two-fold. Years of spending on social services have not been matched with tax receipts and as the population ages the trouble becomes more acute. In addition, the recession has cut tax revenue to the quick by bankrupting businesses and putting millions of people out of work in the EU. Budget cuts are necessary even if they risk a second recession. It is a gamble without an alternative.
The trouble with the budget cuts in the region is that they are extremely modest no matter how large they seem to be nation-by-nation. The GDP of the EU was $14.5 trillion in 2009, slightly larger than the US. In other words, the GDP for the region is more than 15% larger than that of America.
The American budget problem is measured in hundreds of billions of dollars. Europe’s, it seems, is measured in tens of billions. GDP growth in the old world is expected to be little better than 2% this year, if the World Bank and IMF are reasonable judges. The growth rate in the US is expected to be closer to 3% or even 4%. If these things are true, the budgets cuts in the EU are far too modest to take away most of their deficit and sovereign debt problems, which means that short sellers and predatory speculators will begin to work against their currencies and bonds again and very soon. In some cases, the process has already begun, if the value of the euro is an indication.
It may be unimaginable to the people and politicians in the EU that they will be taking only a modest part out of their budgets compared to what it would have to be eventually. That means more cuts will have to come later, and, as hard as it may be to imagine, they will have to come under more dire circumstances
Douglas A. McIntyre