Nations Can't Forgo Austerity Without Delivering Reforms
For severely indebted countries, there's no viable alternative
May 30, 2013
To address this question in the proper context, it's important to clarify what we mean by "austerity." For some nations austerity is likely unavoidable, while for others it is a poor substitute for structural reforms.
"Europe" is not homogenous, in governments nor economies, notwithstanding a common (for the most part) coin – and neither are the appropriate responses to fiscal pressures. Contrast, for example, Germany with Greece. One is a robust economy that honors its credit obligations and the other is, well, not. It is the unfortunate but inevitable reality of profligacy that bills eventually come due – and that day in whatever manifestation is painful, whether it is in the form of previous fiscal adjustment or immediate "austerity" imposed by foreign creditors.
The former is always the preferred path. However, observers should not labor under the assumption that for severely indebted countries there is a viable alternative.
Debt reduction can often follow two paths – gradual structural reforms, such as to tax systems and transfer programs – or immediate contractions such as new levies under the existing tax regime and reduced discretionary spending. The former is arguably a harder political "lift," as the relevant stakeholders are politically formidable, while in the latter case, forgone services or higher taxes on selected constituencies (i.e. "the rich") are more expedient. But such expedience can have adverse consequences, be it in near-term and longer-term growth. It is this "austerity" that should be avoided, but not in the absence of additional action. A bondholder would likely rest easier lending in the future to a nation with a bloated public pension system if that system is addressed in lieu of near-term tax hikes or immediately reduced services. This scenario, however, assumes that creditors are willing to allow such reforms to take hold.
Where feasible, nations should supplant "austerity" with structural reforms to more meaningfully address fiscal imbalances. But creditors will not and should not look favorably on nations that forgo "austerity" without delivering on reforms.