Across Europe, every time a piece of good economic news emerges, there exists the tendency to proclaim the end of the crisis. José Manuel Barroso is an expert practitioner of this art. But having hit rock bottom is not the same as genuine recovery. Misplaced optimism begets complacency with what is still a miserable state of affairs. The European Commission projects 2014 and 2015 to have two of the highest rates of unemployment since the creation of the Eurozone.
Spain is no exception to premature declarations of victory. For the past six years, the European Commission has predicted that Spain would return to solid growth in two years’ time. They are now forecasting the same recovery in 2014-2015 that they predicted in 2010 for 2011-2012.
Fiscal consolidation hindered recovery then, and now the risk is that the same mistakes will be repeated. The Commission has forecast Spain to have the largest structural budget deficit in the Eurozone in 2015, at 5.8%
This is extremely problematic, because the structural budget balance (also a problematic concept) has been chosen as the main object of fiscal policy, much as monetary policy resolves around the HICP. The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (Fiscal Compact) prescribes a limit of 0.5% of GDP and Spain’s national budgetary rule is even stricter. The Law of Budgetary Stability requires a structural deficit of 0 by 2020.
The structural budget deficit – by definition – is designed to strip out the effects of the business cycle, so not even a return to modest growth is the solution. Taxes must be raised or spending cut in a significant fashion. This cannot be done without hurting growth.
It remains highly unlikely that the ruling Partido Popular will engage in profound tax reform in what remains of its mandate. Meanwhile, further cuts would be a disaster for economic recovery, a disaster for public services, and disaster for social cohesion. Even the IMF recognized that they have been more harmful than expected.
Will Spain Continue Austerity?
Whichever party is elected for the 2015 to 2019 term will be required by law to carry out a fiscal consolidation to match the one carried out from 2009 to 2014. The current fiscal framework is therefore a recipe for perpetual stagnation. And with regards to debt sustainability, the obsession with the structural budget is self-defeating under the current circumstances. The arithmetic is relentless.
The ECB, by carrying out a monetary policy that keeps inflation low – to the point of deflation – rules out a reduction of the real debt burden. Its treaty restriction of the direct purchase of government debt and debt monetization, combined with a political rejection of debt mutualisation, rules out a significant improvement.
But the fiscal compact guarantees a permanent tight fiscal policy, permanently dampening growth. Even in hypothetical boom times surpluses would be dedicated to paying down the debt. So rather than grow its way out of debt, Spain will face an emerging crisis of public debt, with the overall level scheduled to hit 104.3% of GDP by 2015.
The rules of the game need to be changed at the European level to end this slowly unfolding disaster. An intensification of the mistakes that have plunged Europe into crisis threaten to unravel not just the welfare state but also liberal democracy. Time is running out for Europe’s socialists and social democrats. The combination of two five-year plans of austerity will undoubtedly be a lost decade. And when it comes to young people, a lost generation.
This is where the upcoming European elections are so important. Voters will not be deciding the composition of the European Council or the European Central Bank, which are decisive actors. However, the Council will be obliged to take into account the results of the European elections when nominating a President of the European Commission.
It is not the same to elect Martin Schulz as a conservative in terms of setting the agenda. A change in colour in the Commission presidency might not be sufficient, but it is certainly necessary.