Thursday, May 30, 2013

A bit of breathing space in Europe

The pace of austerity in the Euro zone is being allowed to slow in return for a stepping up of structural reform.  That’s a good thing.  Regular readers will know we have long been of the opinion that the recipe for repair of the euro zone was too unbalanced, favouring austerity over more fundamental structural reform.  The reality is that both are required, but when a country is in deep austerity-induced recession structural reform becomes academic with no political, let alone public, appetite for implementation. 

To be fair, considerable progress has been made on deficit reduction.  For the euro zone as a whole, the budget deficit reduced from 3.6% of GDP in 2011 to 2.0% in 2012.  But the cost of that adjustment has been high in terms of lost output and high unemployment, especially youth unemployment.

The more recent calm in financial markets, driven off the back of ECB commitments to do whatever it takes to save the Euro and the establishment of the Outright Monetary Transactions (OMT) program, which is still yet to be activated, have created a window of opportunity for some rebalancing.  To that end the European Commission has granted Spain and France an extra two years to meet the 3% deficit target while the Netherlands and Belgium were both granted another year.  The extra time for Belgium is despite the fact that they were ruled to be in violation of EU rules by missing its deficit target last year.

The extra time is a quid pro quo for a stepping up of structural reform.  The Commission has made a number of recommendations for structural across member states in areas of taxation, pensions, public administration, services and the labour market.   All of these are essential if Europe is to return to sustained economic growth. 

The next step is in the hands of politicians.  Whenever I say that, it’s with a sense of trepidation!  But there is reason to be optimistic.    Both President Hollande in France and Prime Minister Rajoy in Spain have been vocal about the need for a relaxation of austerity to create room for growth enhancing reform.  Now is their opportunity.