Vicious cycle of austerity and unemployment



JEDDAH: ARAB NEWS

Published — Wednesday 5 June 2013

Last update 5 June 2013 2:22 am

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Weak growth and rising unemployment in the euro zone is prompting a change in policy direction away from budget austerity, according to QNB Group. The euro zone economy has now been in recession for the last six quarters, contracting by 1.5 percent in real terms over this period. The contracting economy is providing fewer opportunities for job creation and pushing up unemployment, which reached 12.1 percent of the labour force in March 2013. Amongst under-25s, joblessness is even higher at 24 percent. Both measures of unemployment are now the highest on record.
A primary policy response to the 2008 financial crisis and the European sovereign debt crisis (which reached peak intensity in summer 2012) was to implement budget austerity measures across the euro zone. This involved a sharp drop in public expenditure growth, which fell from an annual average of 4.5 percent in 2007-09 to 1.2 percent in 2010-12. This meant that only 170 billion euros was added to euro zone budgets in 2010-12 compared with 570 billion euros in 2007-09, an overall slowdown of 400 billion euros.
The main areas targeted by governments to slow expenditure growth have been social benefits, public sector jobs and wages, and capital investment. Cutting government jobs and investment has a direct impact on growth and unemployment. Meanwhile, reducing social benefits at a time of hardship is leading to widespread dissatisfaction and protests. The high levels of sovereign debt in Europe have discouraged the counter-cyclical spending that government usually uses to rebalance their economies during recessions. Debt interest and capital repayments, which are not supportive of growth, were the only areas with higher growth in 2010-12 than in 2007-09.
Therefore, euro zone countries policy response has done little to tackle the unprecedented level of unemployment and weak growth, according to QNB Group. Officials increasingly appear to be considering a policy reversal. The target dates for reducing budget deficits below certain thresholds have already been pushed back in France, Spain and the Netherlands. In April, the president of the European Commission, José Barroso, said that Europe might have reached the politically acceptable limits of austerity, although he said he still believed cuts in budget deficits were needed. His comments were more in line with the view of the IMF, which has warned euro zone policy makers against adhering too strictly to budget deficit targets as this risks deepening Europe’s recession.
Budget deficits have fallen from 6.4 percent of GDP in 2009 to 3.7 percent in 2012. Government debt in the Eurozone has now risen from 80 percent of GDP in 2009 to 91 percent in 2012. Although debt levels are rising, there may still be room for manoeuvre. Increased debt-funded spending in growth-supportive areas, such as investment or intermediate consumption could potentially increase revenue and trigger further investment, helping to reduce debt in the longer term.

Heavily-indebted countries have, in the past, increased spending and exhibited strong growth as a means to repaying debt. The US and the UK in the 1950s both had debt in excess of 100 percent but high spending drove strong growth and enabled them to reduce debt to sustainable levels.
Reduced austerity in some of the larger countries could also help tackle unemployment across the region, especially if coupled with reforms to increase labour force mobility around the EU.
However, the overall debt levels in the Eurozone cloud a more nuanced picture among individual countries as both unemployment and debt vary considerably. Unemployment in non-core euro zone countries (Italy, Spain, Greece, Ireland, Portugal Cyprus, Estonia, Slovakia and Slovenia) is 17.7 percent while unemployment in core countries (Germany, France, Austria, Belgium, Finland, Luxembourg, Malta and Netherlands) is 7.6 percent.
Greece, Italy, Portugal and Ireland, each have debt levels of around 120 percent of GDP or greater, leaving them with little room to ease back on austerity. Greece is in the worst position with unemployment at 27 percent and 66 percent for under-25s while debt is 157 percent of GDP (although it is falling). Conversely, Spain, the other country with particularly chronic unemployment (27 percent and 56 percent among under-25s), may have room to borrow more to provide additional government support to the economy.
In addition to more growth focused policies, QNB Group argues that structural labour market reforms are still required. Investment in programs to get people back to work, adjustments in labor costs and greater labor market flexibility should all help. These policies are most needed in countries with high unemployment, such as Greece and Spain.

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