Fisher Investments Editorial Staff
Developed Markets, Market Risks

Dear Prudence

By, 07/21/2010

Story Highlights:

  • Many are questioning the merits of recent European austerity measures.
  • Austerity can present risks to growth, especially if done excessively.
  • But in PIIGS countries, austerity is necessary now for longer-term budget sustainability.
  • The measures have some beneficial features, including streamlining bloated governments.


In the wake of extreme fiscal housekeeping among the PIIGS (Portugal, Italy, Ireland, Greece, Spain) nations, many EU countries looked inward at their own fiscal houses. Faced with big budget deficits and rising debt levels—the result of recession and stimulus spending—the latest catchphrase became "austerity." The recent UK budget contained some austerity measures—spending cuts and tax hikes—while Germany's plans await legislative approval and France has floated some proposals. Suddenly, instead of (or in some cases, in addition to) fears that some nations had "too much" debt, which could drag on growth, investors started fearing austerity plans would starve the recovery. In other words—debt is bad, but the solution to the debt is equally bad or worse. Tough audience!

Yes, austerity has risks. Less government spending without an offsetting increase from the private sector means less economic growth overall. Higher taxes sap growth as well. Ideally, private sector growth would rebound organically, bringing higher government revenues (thanks to a larger tax base) and naturally lower bloated budget deficits. But that can take time, particularly in those nations most in need of austerity. In the meantime, aggressive austerity can be a drag on economic growth, particularly early in an economic cycle. But a balanced perspective shows some of the austerity measures were a necessary evil, and, longer-term, may result in much-needed structural reforms and increased productivity down the road.

Greece clearly needed some fiscal reordering. The country spent unwisely in the  boom years leading up to 2008 and are paying dearly now—their problems exacerbated by the recession. Ditto for Ireland and Spain, which, while far more fiscally responsible in prior years, were nevertheless victimized by the housing bust. All need a more sustainable budgetary path, and austerity seems one sensible way to get there. Even Germany, where austerity is hardly urgent, is shoring up spending now, anticipating their aging demographic will lead to lower growth rates—and, by extension, lower revenue—in time.

In the longer term, it's hard to find the silver lining in tax hikes, but some austerity measures should have some structural positives. Greece and Portugal are selling state-owned assets, which almost certainly will be more productive in the private sector. Greece went one step further in shrinking government, closing over 800 outdated state agencies. That's a lot of bloat. There are also efforts to tackle corruption and tax evasion, with Greece cleaning house on tax collectors and going after known tax evaders and Italy targeting its large and untaxed "shadow economy." Finally, some bloated social programs are being reformed. Countries like Greece and France are increasing the retirement ages from 60 or 62 to a more reasonable 65, which seems prudent given today's longer life expectancies. Greece also cancelled the 13th and 14th month salaries paid to civil servants—essentially bonuses for public sector workers outside government control. (Civil servants weren't happy—but other nations seem to survive fine with just 12 months.) Together, these measures should help improve fiscal efficiency in these countries over time.

Most importantly, these measures improve the European debt outlook. We've covered repeatedly here why the fear of PIIGS debt is likely much larger than economic reality, and the bazooka of a bailout provided by the EU/ECB/IMF seriously alleviates the risk of PIIGS default. Lower deficits further reduce default risk, increasing longer-term stability for the European Monetary Union and the euro. This should also bring better yields and cheaper funding costs—which support future growth.

Austerity isn't a magical panacea, but overall, we see little risk from austerity in larger developed nations. The measures are drawn out over several years, and political will for austerity likely wanes as the global economy continues improving. But those nations more aggressively pursuing austerity (namely the PIIGS) likely overall benefit from the measures, and any growth risks are limited to a small percentage of global GDP. 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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