The Eurocrisis: Austerity is a Prerequisite, not a Solution

The crisis in the Eurozone will only end when politicians start focusing on structural reform.

Imagine that you are a doctor. A patient hobbles to your desk with a twisted ankle. Would you not be at least slightly perturbed if he immediately demanded: ‘Quick! Amputate my arm!’

Such an analogy may be a slightly unfair comparison to the Eurozone crisis. However, it cannot be denied that, in one of the most extraordinary examples of  mismanagement in modern times, politicians have stubbornly focused on demand-side solutions to a calamity caused by catastrophic supply-side weakness.

At its heart, the root of the Eurozone crisis was caused by disparate levels of competitiveness rather than fiscal brinkmanship. Whilst it is true that many countries, most notably Greece, were models of fiscal ineptitude in the years preceding the global recession, others, such as Spain, actually ran surpluses. Yet even Spain is now engulfed in the economic crisis.

OECD figures reveal the vast disparities in productivity between Eurozone states. The main culprits of the Eurozone crisis have – perhaps predictably – low levels of productivity. Whilst the average Eurozone worker generates $50.90 per hour worked, the average Greek generates a mere $32.60. The average Portuguese worker generates $32.40 an hour and the average Spaniard and Italian also score below the Eurozone average. This is in striking contrast to Germany, Belgium, France and the Netherlands – all of which generate more than $55 per hour worked.

Another sure indicator of competitiveness is the Heritage Index of Economic Freedom. The Eurozone itself is not a highly productive economic bloc, with just four countries in the top 20 and no country in the top 10. However, Greece trails at an almost unbelievable 117th, sandwiched between Senegal and Malawi. Italy fares little better at 83rd, lagging behind the likes of Uganda and Ghana. Ireland is, bizarrely, the most economically free member state in the Eurozone, at 11th, though is in crisis for reasons unique to the other periphery members.


Low competitiveness, caused by high labour costs, state-ownership and expensive and plutocratic regulation, contrasted with other Eurozone countries, most notably Germany, where unit labour costs are lower than they were in 1999. The result has been large trade imbalances, with high, persistent surpluses in ‘core’ Eurozone countries mirrored by high, persistent deficits in the ‘periphery’ countries.

Some argue that this is clear evidence that the ‘Mediterranean states’ must leave the Eurozone. Such a policy would decimate the affected member states GDP in the immediate term, though proponents argue, would also argue that it would enable otherwise uncompetitive countries to devalue their exports into the market. Whilst this may ultimately be necessary, like austerity, this would in effect be hiding the symptoms of the crisis rather than curing it.

Uncompetitive countries debasing their currencies may temporarily enable a boost to exports (not that there is any clear evidence that it has worked here in the UK), though they would have to endure similar persistent devaluations in the future. The only long term solution to solving the economic weakness of the PIGS is to improve competitiveness.

Kevin Featherstone criticised successive Greek governments for opaque government statistics, woeful tax and regulation enforcement and cronyism. Greece’s truck regulator did not issue a single license between 1970 and 2010, creating a black market in trucking licenses and some of the most expensive transport costs in Europe. One does not have to be a cynic to suspect that this excessive enforcement is for the benefit of the average Greek truck driver, rather than the average Greek. Liberalising 70 such ‘closed shop’ professions was one of the conditions to Greece’s bailout (as if the predicted 17% boost to GDP was not reason enough).

Whereas there is evidence that the PIGS have regained competitiveness since 2008, Gavyn Davies pointed out that this has been due to lower imports (as a result of austerity) rather than higher exports. The policy recommendations for the Eurozone crisis therefore seem clear. Whereas austerity is inevitable, abolishing state sanctioned monopolies (through privatisation and liberalisation), raising the retirement age and cutting or abolishing employment rights and union privileges ought to be a modest start to the broader goals of modernising Europe’s most bloated and flabby welfare states. Tax reform that emphasises fewer breaks and lower rates could hardly hurt growth and competitiveness as well.

History may look upon the Eurozone crisis as a historical crisis that came to symbolise the West’s broader decline as the economic centre of gravity shifts to the East. Nevertheless, this is not inevitable. The European Commission recently announced that austerity may be eased in exchange for greater structural reforms to labour markets. Whilst higher spending will not be welcome, as fiscal rectitude remains a prerequisite, greater focus on solving the dire competitiveness issues in the periphery economies may be a sign that politicians have finally identified the correct problems. Whether this is translated into legislation depends on the political courage of Europe’s leaders to stand up to vested interests.

Will Archdeacon


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