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5 July 2023

Austerity is about to return to Europe

The political fallout from the reimposition of the EU’s fiscal rules will be toxic.

By Wolfgang Münchau

I called it the worst policy mistake of my lifetime: the austerity imposed in Europe after the onset of the eurozone crisis. It permanently damaged the zone’s economic resilience, fuelled the rise of the far right and drove wedges between eurozone countries. This mistake is about to be repeated.

Austerity is not a trade-off between short-term pain and long-term gain. It makes people worse off in the long run too. The New Economics Foundation recently came up with an estimate of austerity’s total cost since 2009: a shortfall of €533bn in investment in infrastructure, including renewable energy. You can see its results everywhere – in the form of underfunded police and armed forces, deteriorating railways and closed motorways.

The current suspension of the EU’s fiscal rules – a measure introduced in 2020 to help member states cope with the pandemic – ends this year. The European Commission, to its credit, has proposed changes in the way the rules are applied, introducing more flexibility and tailoring them to countries’ economic conditions. But there is, as yet, no deal among member states on these reforms. If there is no deal, the old rules will kick back in automatically.

[See also: A rising backlash against green policies is energising Europe’s far right]

Meanwhile, Germany’s finance minister, Christian Lindner, who distrusts the Commission and many of his European colleagues, wants a return to the old regime, with only a few changes. Most likely, there will be a deal, something half-way between Lindner and the Commission. But even that would mean a lot more austerity to come.

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Because of where we are starting from, it is going to be worse than last time. Italy had a deficit of 8 per cent of its economic output last year. This is projected to go down to 3.7 per cent next year. This constitutes an unbelievable fiscal squeeze. France, which currently has more than its fair share of civil unrest, needs to make fiscal cuts of a similar magnitude.

Now consider the politics. The EU’s climate change agenda is moving into a phase where it starts to cost real money. The German government is just about to pass a domestic heating bill which will force homeowners to replace cheap gas heaters with expensive heat pumps – and further costly environmental legislation is on the way from Brussels. The EU’s plan to phase out fossil-fuel cars will impose burdens on drivers. Opposition to green policies is one of the causes for the surge in far-right support in Germany.

Now add austerity to the mix. With the return of the fiscal rules comes the return of the hard budget constraint. The Green agenda is the costliest project in the EU’s entire history. It will affect people unevenly. Homeowners, commuters and farmers will be much worse off than urban dwellers who are renting apartments. Austerity makes it harder for governments to compensate the losers. Brexit-style country-vs-town divisions are opening up.

There are quite a few similarities to the pre-Brexit political economy. On average, the UK performed reasonably well in the EU but the spoils were unevenly distributed –and those who lost out were able to register their discontent at the ballot box.

[See also: Labour’s Remainers are getting organised]

Austerity will also constrain other large commitments, such as aid to Ukraine. With the return of the fiscal rules, this will have to compete with domestic spending. In March, just after the anniversary of the invasion, a number of bodies including the World Bank and the UN put the cost of reconstruction in Ukraine at around $400bn. This could easily double as the war goes on. 

Beyond the war effort, if Ukraine were to join the EU it would need a great deal of financial support; it’s likely Kyiv would become the largest recipient of EU funds, eclipsing other beneficiaries, mostly from eastern and southern Europe. Germany’s net contributions to the EU’s budget, already the largest, would rise significantly. I struggle to see how any of this is possible once fiscal constraints are being enforced.

The EU could resort to financial wizardry. It is a master of fiscal smoke and mirrors. But there are limits to that too. It could launch a Ukraine reconstruction facility on lines similar to the recovery fund it created at the start of the pandemic. But this mechanism was sold as a one-off, and is not supported by everyone.

The EU could try to co-opt international institutions and the private sector. It could divert frozen Russian assets – some €200bn in central bank reserves. But this is legally problematic, and might lead international investors to shun the eurozone. There are no easy choices. The bulk of funding for the reconstruction will have to be guaranteed by national governments, and everything will need unanimity. That’s the bottleneck.

The combination of fiscal austerity and competing funding needs makes me sceptical about any big uncosted proposals – such as large-scale financing for Ukraine or a European army. The big question is not whether these are good ideas. I believe they are. I just cannot see how you could organise a political majority in favour of them and still do all the things necessary for the EU to function – and then some.

Austerity has many economic consequences, but the political side effects are utterly toxic. Our deficits are much higher now than they were in 2009; we have high inflation; the extreme right is much stronger; and the EU has pre-committed itself to an expensive green agenda. All this constrains the EU’s foreign policy choices just at a time when it is starting to discover its geopolitical role.

The maths of austerity does not add up. We are reaching the limits of what a decentralised, rules-based EU can do.  

[See also: Why the far right is surging in Germany]

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This article appears in the 05 Jul 2023 issue of the New Statesman, Broke Britannia