Note from Ben: I typically receive about one guest post submission via email each week. For a variety of reasons, the majority end up not being posted. None of those reasons include me disagreeing with the author’s perspective. This guest post was submitted to me earlier in the week. I strongly debated whether or not to post it. This is a case where I fundamentally disagree with the author’s perspective, but it captures a debate that I believe will soon encompass much of the Western world and therefore I believe that it is worth posting. However, accepting a guest post submission in no way binds me from analyzing the content of the post and suggesting an alternate way of seeing the data. That’s exactly what I intend to do here. I’ll discuss my thoughts at the end of this post.
Marc Brown is an Associate Editor with Oak View Law Group. He has been writing on financial topics over the years with special focus on European economy. Marc also takes interest in debt related issues and contributes articles on debt relief to personal finance blogs.
Social Issues Surface as Europe Considers Fiscal Austerity to Solve Debt Crisis
Some economists opine that a strict fiscal policy is the best strategy to pull the battered U.S economy back to its feet. They argue that the fiscal austerity of Latvia can be a perfect model to follow for economic resurrection. They also point out that the ruling party won election in Latvia yet again even after imposing harsh taxes and emphasizing on the need to have a tightened economy. Credit is given to the Latvian people for being responsible voters and taking the right decision. Advocates of this theory claim that Latvia is on its way to recover from a deep economic crisis.
However, things are not what they look apparently. Actually, the Latvian people cast their vote largely on the basis of ethnic issues. The ethnic Latvians (the majority) usually lend their support to ethnic parties which are inclined on taking strict measures. Contrary to what the press says, the Latvians are not happy with the austere policies of the government. Unless the political parties in the U.S can divide the audience on ethnic matters (which is quite unlikely), any attempt to attract votes on the basis of austerity in economy will result in utter disappointment.
The current situation in Latvia is not really enviable. There are serious unemployment issues and on top of that the government has cut down its expenditure on education as well as health care. As a result, a lot of people are emigrating to other countries. Do you know that about 12% of the Latvian population is working abroad currently?
It is predicted that the economic growth of Latvia will be 3.3% this year. However, with a 25% decline in GDP, this will not be enough to restore Latvian economy to the pre-financial depression state. Even the IMF has expressed concerns over the policies of Latvia’s Central Bank because the strict monetary policies are causing significant troubles to the common people. Despite its social and economic debacles, the Latvian fiscal policy (which is based on foreign currency loans) is idealized by a part of the press and the neo-liberal politicians.
The advocates of financial austerity fail to understand that strict measures are being applied on top of a pretty bad debt crisis in euro zone. It is not possible to achieve long time economic growth by cutting the wages of debt-stricken people. Moreover, it is also not beneficial to impose lower living standard on people to cut down debt. Fiscal austerity can actually be devastating and push the euro zone towards a deeper economic crisis.
Will Europe start treading on the path shown by Latvia? A number of countries like Greece, Ireland and Spain are already following Latvia’s footsteps. Jacques Delors’ dreamt of a social Europe but this kind of fiscal philosophy was not what he envisioned. We really do not want to lower our purchasing power to pay the creditors, do we?
I thank Marc for highlighting an important issue that will increasingly move to the forefront over the next few years as governments all over the world seek to reduce their swollen deficits. For a refresher, I suggest you read the following post:
There are two main statements in the article that I would take issue with. Here’s the first:
“The advocates of financial austerity fail to understand that strict measures are being applied on top of a pretty bad debt crisis in euro zone. It is not possible to achieve long time economic growth by cutting the wages of debt-stricken people.”
As I see it, this type of analysis misses a massive point: Austerity can be involuntarily imposed by the bond market. No elected government would ever willingly choose to embrace such an exceptionally unpopular move without being fully backed into a corner.
I would argue that this article has put the cart before the horse. The debt crises we’re seeing all over the world are the result of the bond markets doubting the ability of sovereign nations to repay their debts (and rightfully so). It’s the bad debt crisis that is forcing the austerity. And contrary to the author’s position, savings and productive investment are exactly how you build a productive economy, though the temporary pain involved in a move from consumption and borrowing to saving and producing is certainly acute.
Ultimately, those who advocate non-austere approaches must answer the following questions:
- How would they advise a country to proceed when financing their existing debt is becoming exceptionally expensive in the bond market? Once bond holders sense that debt levels are becoming too onerous, in a cruel twist of fate they demand an increased risk premium at renewal. Hence the spreads on PIIGS bonds have exploded to generational highs at a time when their ability to repay such debt is the most strained to begin with.
- With more tax revenue eaten up via interest payments, where do the funds come from to maintain former spending levels? In some cases governments find that rising borrowing costs for them and their citizens squeeze the economy just as significantly as spending cuts…..but with more long-term repercussions.
- In the US, what is the logical course of action when QE2 has failed in its primary task of lowering the long end of the yield curve? QE has been successful only in its capacity to induce speculation on commodity markets and buoy risk assets. Mortgage rates have moved progressively higher begging the question of just what a credible QE exit plan looks like.
The second quote I particularly disagree with is the following:
“Moreover, it is also not beneficial to impose lower living standard on people to cut down debt.”
This assertion also misses a key point: The government debt has accumulated primarily in the process of providing an artificially high living standard to its citizens. Austerity does not represent a challenge to fundamental human rights, rather it is the realignment of our expectations with our economic realities. That governments have allowed our expectations to massively diverge from their ability to meet them should have no moral bearing on the necessary outcome.
In short, there is no easy one. Many nations are finding themselves stuck between a rock and a hard place. Many debt-stricken nations may be well advised to force bond holder haircuts in debt restructuring. Of course that creates banking crises as the banks are the holders of much of that sovereign debt and are leveraged to the max. This has been the ultimate motivation for all EU bailouts so far. The citizens are getting screwed in the process.
While Canada’s credit standing in the eyes of the global bond market is still pristine, we would be wise to learn from the stories of other less fortunate nations who have found themselves humbled and bowed at the incredible mightiness of the bond market: We need to get our financial house in order. That means realigning our expectations with our economic realities. A measure of austerity is in the cards…..and rightfully so.