To listen to some European leaders, especially in France, you would think the era of austerity was over and the euro zone was going full steam ahead to revive economic growth.
In a striking change of tone, European Commission President Jose Manuel Barroso said last month that austerity – the policy of cutting public debt by reducing spending and raising taxes – had reached the limits of public acceptance.
In reality, the shift is more in words than deeds. The rhetoric has changed but there has been no policy U-turn.
To be sure, the European Commission is granting governments more time to reduce their budget deficits to EU limits, chiefly because recession had made those targets unattainable.
Euro zone states have a breathing space because bond markets have ceased to panic since the European Central Bank said last year it would act decisively if necessary to preserve the euro.
The EU emphasis is now on reducing «structural deficits» – an elastic measure meant to take account of the economic cycle – and on reforming labor markets and pension systems, opening up more sectors to competition and easing business regulation to improve countries’ growth potential.
Small initiatives are in the works, amid great political fanfare, to combat the scourge of mass youth unemployment which threatens southern Europe with a lost and alienated generation.
The ECB is exploring ways to ease lending to smaller businesses in the hardest-hit peripheral countries of the euro zone. But while it is keeping the liquidity taps to banks open, it has no intention of following the U.S., British and Japanese central banks into massive money printing to try to spur growth.
“It is not that we are letting austerity policies go,» said Carsten Brzeski, European economist at ING in Brussels. «It’s only about the pace of adjustment and a shift towards structural reforms to avoid ending up in a downward spiral of austerity.”
While the ECB could perhaps do a bit more to increase the supply of credit to business in depressed southern Europe, the main inhibitor to investment there was the lack of demand, for which there was no easy solution, he said.
EU policymakers and central bankers say highly indebted countries will have no alternative for several years to curbing public spending and shrinking the state, however politically unpalatable that may be.
“Growth is the key to getting out of the crisis, we all agree on that,» German Bundesbank chief Jens Weidmann, the ECB’s leading hawk, said in a speech to French businessmen last week. «But renouncing budget consolidation will not bring us closer to that objective.”
Barroso’s April 22 recognition of the political limits of austerity recalled his predecessor Romano Prodi’s 2002 comment that the EU’s budget rules were «stupid» because they were too rigid.
“While I think this policy is fundamentally right, I think it has reached its limits,» Barroso said. «A policy to be successful not only has to be properly designed, it has to have the minimum of political and social support.”
To some, that sounded a bit like the pope questioning the existence of God. It prompted gleeful «austerity is over» headlines in countries such as Ireland that have endured harsh cuts, and irritated several European governments.
In Brussels, a senior official in regular contact with national leaders said Barroso had «miscommunicated» and there was no alternative to austerity, even if the word was avoided.
“The idea that there will now be deficit spending, that the age of austerity is finished, is misleading,» the official said, speaking on condition of anonymity because of the sensitivity of his position.
“On the margins, we can postpone budget consolidation by a year, or by two years, but it’s not really the answer. The answer is growth, and that is only going to come through structural reform and improved productivity.”
German Chancellor Angela Merkel, who has used Berlin’s financial clout since the start of the crisis to press for fiscal discipline, made clear that austerity and growth were not opposites and that budget savings must continue.
In a veiled criticism of close ally France, which has so far raised revenue rather than cut public spending to narrow its budget gap, Berlin says governments should avoid increasing the tax burden because that harms growth.
Two events in the economics profession have sapped the theoretical case for so-called front-loaded austerity – making drastic public spending cuts at the start of an economic adjustment program.
First IMF chief economist Olivier Blanchard acknowledged that cutting government spending may have had a bigger impact than previously calculated on reducing economic output. Then U.S. economists found flaws in data underpinning the influential theory of Harvard economists Kenneth Rogoff and Carmen Reinhardt that public debt above 90 percent of GDP stunts growth.
That leaves the economics of austerity murkier today than when the euro zone debt crisis struck in 2010, while the politics just keep getting harder.
Governments in Greece, Ireland, Portugal, Spain and Italy that implemented austerity measures such as civil service pay and job cuts, pension freezes, raising the retirement age and easing hire-and-fire rules have been turfed out by voters.
Their successors have faced mass protests, rising anti-austerity populist movements and a steep decline in public support for the European Union.
EU policymakers were chilled to watch former Italian Prime Minister Mario Monti, a liberal technocrat revered in Brussels, crash and burn in a general election in February in which anti-austerity populists made stunning gains.
The lesson that leaders such as French President Francois Hollande and new Italian Prime Minister Enrico Letta seem to have drawn is that they must pursue fiscal discipline by stealth while constantly talking up growth.
The question is whether they will be willing to pursue bold economic reforms that loosen job protection, cut labor costs, break open closed professions and change the incentives to work.
The political price of such measures may be high since they disturb vested interests, and the economic payoff in higher growth rates and more job-creation may take years to be felt.