ROHAC: Eurozone recovery necessitates reform

Day of fiscal reckoning approaches

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The ongoing debt crisis in the eurozone has given rise to a predictable genre of tasteless humor directed at the ailing nations on its periphery. A typical example would go like this: An Italian, a Portuguese and a Greek go into a bar and have a round of drinks. Who pays? The German.

Although it is unfortunate that the crisis fosters ill-advised national stereotypes, such jokes do raise the serious question of why nations in the eurozone’s Mediterranean area seem unable to deal with their fiscal problems. At some level, their problems are simple — they boil down to basic math. Italy, Spain, Portugal and Greece have been living beyond their means for far too long, they have run out of money, and their governments simply need to adjust their spending patterns to economic reality. Their problems are not new or unique — the world is rife with examples of countries that faced similar, if not greater, economic difficulties, and they were able to overcome the adversity through deep and credible reforms.

For a recent example, look at Estonia, Latvia and Lithuania. As economist Anders Aslund writes, the Baltic states were hit in 2008 and 2009 by a nearly complete liquidity freeze, which sank their economies by as much as 24 percent. In response, the government followed strict austerity, with a fiscal adjustment of about 9.5 percent of gross domestic product, accompanied by far-reaching structural reforms. All three returned to their growth trajectories after only two years of recession, and their economies grew at rates higher than 5 percent last year. In short, “the turnaround, driven largely by manufacturing exports, has been one of the most remarkable and promising stories of the crisis,” Mr. Aslund writes.

There is a world of difference between the Baltic states and, say, Greece. Throughout the ongoing “consolidation,” Greek debt-to-GDP ratio has been growing and will reach 179 percent next year — in an optimistic scenario. Recovery is nowhere in sight, and the Greek economy has been in a free fall since 2009. It is also predicted that the GDP will contract by 4.5 percent next year. The unemployment rate is at a historically unprecedented 25.4 percent, with more than 58 percent of young people unemployed. Every attempt to slash public budgets or remove structural rigidities is met with popular resistance.

So what prevents the Mediterranean countries from emulating the Baltic example or those of many other countries, such as New Zealand or Sweden, which have overcome their economic difficulties through serious reforms? The answer is simple: credibility, or the lack of it.

Unlike their Baltic counterparts, it is not clear that the Spanish, Greek or Portuguese politicians are keen reformers. The party of Greek Prime Minister Antonis Samaras was responsible for setting Greece on a path toward economic ruin in the early 2000s. Referring to cuts made in the 2013 budget, Mr. Samaras said those “sacrifices will be the last.”

Even if we see some Mediterranean leaders wishing to follow the example of growth-oriented leaders such as Poland’s Leszek Balcerowicz or Estonia’s Mart Laar, their prospective reforms are unlikely to stick. In Greece, for instance, the extreme left-wing party, Syriza, which rejects austerity and aid from the European Union and the International Monetary Fund, is now the most popular political force in the country.

Reforms that are just imposed, without a buy-in from a critical part of the population, tend to be reversed later or are neutralized by interest groups. When Russia’s Yegor Gaidar first outlined his shock-therapy program in the early 1990s, it did not look very different from reform packages adopted in Poland or Czechoslovakia. Unlike people in the more successful transitional economies, however, Russians never bought into Mr. Gaidar’s radical reform agenda. As a result, the reforms led to drastically different — and much less agreeable — outcomes.

The essence of the debt problem and the fixes that are most likely to work are relatively simple: deep structural reforms and permanent cuts to public spending. Unfortunately, the political reality — including a lack of credible leaders and of public understanding of the nature of the existing problems — has taken most of the good policies off the table.

The debt crisis raging in the Mediterranean is by no means a singular incident. The daunting fact is that with their unsustainable entitlement schemes, faltering demographics and lack of growth, Western Europe at large and the United States are well on their way to follow the Greek example. It remains to be seen whether we are better prepared than the Greeks to face our day of fiscal reckoning. Don’t hold your breath.

Dalibor Rohac is an economist at the Legatum Institute in London.

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