Global Trends and Politics

Austerity works

The situation looks grim: despite reform policies and drastic savings in many countries, the public debt-to-GDP ratio in the eurozone has risen to an average figure of almost 93% of economic output. Unemployment in some crisis-hit countries is at an intolerably high level; in Greece and Spain it remains over 25%. Nevertheless, the strategy of reforms and consolidation was and remains the right way. The risks that all alternative courses of action entail are simply too big.


One such alternative would be for the crisis-hit countries to leave the monetary union: this is one proposal that will certainly come up again in the event of a renewed escalation. The risk involved here is a domino effect that could destabilise the entire eurozone. And leaving the eurozone would not spare these countries unpopular reforms anyway. The Greek administration would not become more efficient if it were paying its officials in drachmas instead of euros. Currency devaluation after leaving the euro would benefit exports, but important imports such as energy would become more expensive. And whilst the inevitable state bankruptcy would ease the debt burden, the example of Argentina showed how difficult it is to regain the confidence of the markets and economic stability after sovereign default.

© Munich Re
A crisis-hit country leaving the currency union could trigger a domino effect that destabilises the entire eurozone.
Michael Menhart
Head of Economic Research

Another alternative could be for the state to try and spend its way out of trouble, backed by an expansive central bank monetary policy, in the hope that growth would banish the debt problem. Did the USA not show that this was a way out of the crisis? The US growth engine started up much faster than the eurozone's, and the rate of unemployment has fallen to 6.3%. But US sovereign debt has also risen to nearly 105% of GDP. Hardly what one could call budgetary discipline. This model is not transferable and not without its problems. After all, someone has to finance higher public spending.

No joint liability without political integration

The USA can procure money from the capital markets at low interest rates. The financial markets are unlikely to be quite so generous to the crisis-hit countries of the eurozone.  There are good reasons why the countries in Europe are not jointly liable for their debts and why there are no plans to introduce such measures. Only stronger political integration could make this a possibility. But could Germany not sacrifice some of its competitiveness to benefit the peripheral states through stronger wage growth? In fact, this is already happening, as the development of unit labour costs in Germany shows. But it is not only a matter of competitiveness within the eurozone itself. In simple terms, if VW becomes more expensive without Fiat becoming cheaper, it is competitors from overseas such as Hyundai that benefit. Criticism of excessive austerity policy is inappropriate anyway, as it never really existed. Of course, there have been painful reforms. Greece has lowered its unit labour costs by 13% since 2009, while Italy and France have yet to begin their reforms in earnest. Greece, Spain and Portugal were granted more time for consolidation.

Various success stories show that we are on the right track

And there have been some important success stories: in 2013, budget deficits were reduced in nearly all the eurozone countries; the average figure was 3%. Unemployment in Spain and Portugal has fallen noticeably. Portugal has been able to leave the EU bailout programme, not least thanks to the reforms it has carried out. Ireland is another example that shows austerity works. There is therefore no reason to deviate from this course. It will remain painful for some time in the hardest-hit countries such as Greece. But the alternatives are no better, they are much worse.