Much of the high-level debate surrounding Europe's financial crisis concerns fiscal austerity, how much to impose and whether the periphery should adopt it. German Chancellor Angela Merkel stands as the major proponent and seems at times to promote a single-minded focus on budget restraint and deficit reduction. The German position is clear. Without austerity, rescue monies are a waste and will only facilitate a return to the fiscal profligacy that brought Europe to its current crisis.
On the other side stands French President Francois Hollande. He seems to reject austerity as if nothing were wrong with past patterns. His election campaign resisted budget restraint as if it were too much to ask of the nation. He would place spending restraint, deficit reduction, and debt control low on the national priority list and would, he has said, seek more spending to promote growth.
There are problems with both these positions. In Hollandes's approach, the rescue funds would have little lasting value. They would, as per German fears, simply finance a continuation of profligate budget policies, this time at the expense of German taxpayers. But there are equally severe problems with the German position. Budget cuts and tax hikes alone will only drive already beleaguered economies deeper into recession. The increased demand for social services and the inevitable revenue shortfalls would then increase, rather than reduce, budget deficits. Since the German approach would then only elicit still more austerity, chances are the recession would only get worse. Nations would fall into a vicious downward cycle in which rising deficits prompt more austerity that prompts still worse economic performance and still wider deficits.
But if this binary debate on austerity dominates the headlines and seems to threaten prosperity from either side, it is, fortunately, not all Europe is talking about and, thankfully, doing. Both Mario Monti, the Italian premier, and Mario Draghi, the president of the European Central Bank (ECB), have begun to champion pro-growth structural reforms, as has the International Monetary Fund (IMF), as a way to help the beleaguered nations of the periphery cope with necessary austerity and still create a base for future growth. They have promoted, among other things, the liberalization of labor laws, the softening of regulatory strictures, and the adjustment of government spending priorities with an eye to economic returns. Such efforts would not conflict with austerity, but they would still offer a parallel growth agenda that could ease the strain on these economies of otherwise essential austerity and help avoid the vicious cycle that would emerge from austerity alone. IMF research supports this expectation, indicating that such efforts could add as much as 4.5% to the gross domestic products (GDP) of these countries over the next five years. An annual growth premium of almost 1.0 percentage point a year is not inconsiderable in today's slow-growth, recession-prone environment.
Monti and Draghi could improve their sales pitch with more specifics. To date, they have remained maddeningly vague. The only area where either has offered anything concrete, at least in their summit suggestions, is in the need to upgrade Europe's economic infrastructure. Monti has insisted that such spending, because it has an economic return, should not count in budget deficit calculations. Both Monti and Draghi have recommended greater funding for the European Investment Bank (EIB) as a way to finance such infrastructure spending without burdening national budgets. All this might sound like a gimmick to avoid austerity demands, but the arguments at base are sound and ask, reasonably, that Europe rethink its fiscal priorities to distinguish, in Monti's words, between "virtuous" public investments and less productive state spending.
Still, even as Monti and Draghi have remained coy at European summits, the governments in the periphery have begun to take more concrete structural steps. Following the German reforms, undertaken some years ago under then Chancellor Gerhard Schroeder, all these nations have begun the difficult task of removing rigidities from their labor markets. There seems to be a widespread recognition among them that past restrictive policies have hindered growth. Rules that all but forbid firms from laying off or firing full-time employees, for instance, have discouraged hiring generally or forced firms to rely more on temporary workers with fixed-term contracts. In addition to interfering with business' ability to secure and promote the best workers, these rules have wasted talent generally by denying new, mostly younger workers secure jobs with decent pay. Combined with cumbersome strictures on pensions, hours, the terms of contracts, and collective bargaining, these old policies have made it difficult for firms to adjust to changing economic conditions, impeding overall growth rates and competition.