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The Austerity & Reform Programmes of Five Eurozone Countries

Introduction

Since the global financial crisis and the European sovereign debt crisis began, a number of eurozone countries (Greece, Ireland, Portugal and Spain) have adopted special measures to reduce both their government deficits and their level of public debt.  These tough austerity and reform programmes, which involved difficult negotiations with the International Monetary Fund as well as the European Commission (acting on behalf of the eurozone countries) and the European Central Bank, also include structural reforms designed to bring about long-term changes in economic performance as a quid pro quo for the financial assistance offered by these institutions.  Italy has adopted her own programme of austerity and reform.  Austerity and reform programmes are not surprisingly unpopular, as was shown notably by the Greek parliamentary elections in May 2012.

Many of the structural reforms will, if fully implemented, contribute towards the completion of the Single Market and thus be of benefit to all Member States.

This paper is a summary of the measures being taken by these eurozone countries; it is part of a series of papers by the Senior European Experts group examining Europe’s part in the financial crises of recent years.  The key data relating to each eurozone country is set out in the Annex with that for the eurozone as a whole, for the United Kingdom and the USA, so that comparisons can be drawn.

Greece

On 9th March 2012 the IMF released the 101 page Greek Government paper on their economic and financial policies submitted as part of their bid for further, subsequently approved, IMF/EU support. [1]    

The paper identifies Greece’s three key problems:

  • a lack of competitiveness compared with the rest of the eurozone – it estimates the exchange rate overvaluation as amounting to 15-20 per cent;
  • the need to restore fiscal sustainability – Greece’s primary deficit (i.e. the gap between the amount received in tax revenues and public spending before interest payments are added) was still about 2.5 per cent in 2011;
  • there are liquidity and solvency issues in the financial sector because of the sovereign debt issue (i.e. the banks hold bonds issued by the Government which it can no longer fully honour), the falling value of the domestic loan portfolio and the withdrawal of deposits from Greek banks.

Competitiveness

To solve the first of these problems the Greek Government has set out ambitious plans to reduce unit labour costs through wage cuts and labour market reform.  It also wishes to “fundamentally reduce the footprint of the government in the economy” through a large-scale privatisation programme and what it calls “bold structural fiscal reforms”.  The aim here is to facilitate the expansion of the private sector so that new employment can be created, not least by making Greece more attractive to foreign direct investment.  Specific measures to achieve these goals include:

  • reductions in the public sector pay bill [see below];
  • a commitment to reduce unit labour costs by 15 per cent through legislation if negotiations are unsuccessful;
  • various structural changes to reform rigidities, such as within employer-staff relationships and to open up professions;
  • a 20 per cent cut in the minimum wage, even greater for young people;
  • a five per cent reduction in employer’s social security contributions;

Deficit Reduction

The previous Greek Government of Prime Minister Papademos committed itself to achieving a primary budget surplus of 4.5 per cent of GDP by 2014 but slowed the pace slightly with an adjustment to spending in 2012/13 because of the depth of the recession.  The plans recognise that this target will have to be adjusted beyond 2014 if the recession is significantly deeper than anticipated.

The plans set out a large number of measures to bring down Greek public spending, including: 

  • bringing the public sector wage bill into line with “the most efficient OECD countries”, saving 1.5 per cent of GDP through wage cuts and reducing personnel by 150,000 by 2015;
  • a reduction in the projected increase in publicly funded pension costs as a percentage of GDP from the initial prediction of 12.5 per cent to less than 2.5 per cent by 2060 – this will mean reducing some pensions now as well as eliminating structural deficits in supplementary pensions funds;
  • reform to other aspects of social security;
  • reducing the pharmaceutical part of the health budget to bring it closer to the European norm while maintaining health spending at 6 per cent of GDP;
  • fundamental overhaul of the tax collection system to bring Greece’s tax collection up to the standard of other EU countries;
  • a major simplification of the tax system with better systems for resolving disputes and an independent tax authority.

Strengthening the Financial Sector

The plan recognises that the combination of the sovereign debt problem and the recession means that the financial sector can’t recover without significant government assistance.  The aim is to create a viable, independent banking sector that can support growth.  Measures to achieve this include:

  • raising the requirement for capital held by banks to first 9 per cent by end of September 2012 and to 10 per cent in June 2013 but specific deadlines will be set for each bank;
  • following an exhaustive study of the banks by the authorities, banks will be able to borrow from the Greek Government’s financial stability fund through a system of bonds and shares; it is estimated that banks will need €50 billion;
  • there will be a new stress-test for banks in June 2013 to ensure they have enough capital to cope with any sudden shocks.

Delivery

This is undoubtedly a heavy programme of work and given the failure of the Greek Government in the past to live up to its commitments, for example in the field of privatisation, there is scepticism about whether there is the political will to deliver an unpopular package of reforms and further cuts.  

The scale of the problems facing Greece can be seen in the prediction of its Government that while growth is expected to return in 2013, the contraction of the economy in 2012/13 will be 4.5 per cent.  

Greece is being supported by an international team of experts who are both advising it on how the changes can be achieved and monitoring compliance with the agreed plans through quarterly reports.

Ireland

The position of the Republic of Ireland is very different from that of Greece.  In February 2012, when it sent its latest report to the IMF setting out its economic and financial plans, it was able to say that it had met or exceeded every one of the targets given to it by the IMF and the EU. [2]

The Irish economy grew by 0.7 per cent in 2011 and its government expects growth to continue in 2012 despite the problems in the wider eurozone.  The continuing uncertainty about the eurozone economy is a significant risk factor for Ireland.

In December 2010 the Republic of Ireland agreed a funding package worth €85 billion with the IMF, the EU and bilateral lenders (of which the UK was one).  These loans were to enable Ireland to deal with the crisis in its banking system, support restructuring to deal with a sizeable structural deficit while protecting core public services.  The IMF provided €22.5 billion, the various EU funds (EFSM and EFSF with bilateral loans from the UK, Denmark and Sweden) €67.5 billion and €17.5 billion from Ireland’s own resources.  In July 2011 the EU and the IMF agreed that the rate of interest on the loans should be cut and the repayment period extended.

The package of measures the Irish Republic adopted in response to the crisis included:

  • €10 billion of public spending cuts between 2011 and 2014 and €5 billion of tax raising measures, reducing public spending from 49 per cent to 36 per cent of GNP;
  • complete restructuring of Ireland’s banking system, including a reduction in the size of its banks with assets taken over by a national agency and a managed programme of run down;
  • economic reforms to ensure competitiveness and to enable growth. [3]

The spending cuts were particularly steep in Ireland but as the country was spending well above the European average on health (despite its relatively young population) and on housing it arguably had greater scope to make spending reductions.  The Irish Government predicts that the public sector workforce will fall by 37,500 by 2015 and the public sector pay bill will reduce by €3.5 billion in the period 2011-18.

Italy

Italy has not (so far) needed a bail out from the IMF and the EU, although it did benefit from the European Central Bank’s policy of lending to eurozone commercial banks so that the banks could buy sovereign debt.  As the fourth largest economy in Europe and the seventh largest in the world, according to the World Bank and the IMF, Italy is in a different situation from Greece or Ireland.  But it still has significant problems, including a debt to GDP ratio which reached 116 per cent in 2009, making it the second highest in the EU after Greece and a long way above the Growth and Stability Pact’s required 60 per cent. [4]

International markets became concerned about the financial stability of Italy in 2010-11 because of doubts about its ability to repay its sovereign debt and about the ability of the EU and the IMF to rescue it if that became necessary.  This triggered a political crisis in the autumn of 2011 which saw the departure of the Berlusconi Government and its replacement by an all-party supported interim administration headed by Mario Monti.  Mr Monti, a former Single Market and then Competition Commissioner in the European Commission, has embarked on a series of major economic and fiscal policy changes.

Italy had already adopted an austerity programme in July 2011, involving public spending cuts of €70 billion, paid for by increases in healthcare fees, cuts to regional subsidies, to family tax benefits and to the pensions of higher earners.  Mr Monti’s administration has continued the process of reform, cutting public spending by a further €30 billion over three years but also redirecting resources to stimulate growth.  These measures include:

  • higher taxes for the wealthy;
  • increases in pension ages;
  • measures to tackle tax evasion;
  • €3.8 billion for infrastructure projects;
  • a tax break to encourage firms to hire younger workers and women;
  • and labour market reforms.

The labour market reforms, together with the pension rule changes, are likely to be the most significant element in the long-term.  At present an Italian company that employs more than 15 people cannot get rid of employees without legal challenge, even in an economic downturn.  This is widely seen as a major obstacle to foreign direct investment.  It has now been agreed that this law should be modified to introduce redundancy; cases of victimisation or discrimination would be dealt with through the courts. 

There remain considerable obstacles to Italy returning to growth and to achieving a balanced budget, not least widespread corruption and serious organised crime.  The stability of the financial sector, and the country’s continuing membership of the eurozone, depends on it being able to re-finance public debt as it comes up for renewal.  This has eased since the Monti administration took office but it remains vulnerable to market sentiment.  National elections are due in May 2013 and recent local elections showed considerable discontent.

Portugal

Portugal is the third eurozone country to have received a support package from the IMF and the EU.  The €78 billion loan in May 2011 was necessary to stabilise the finances of the country and was part of a series of measures by the incoming Portuguese Government which included an austerity budget.

Portugal’s problems were not as extreme as those of Greece or Ireland.  Its main difficulty was a loss of competitivity and a high level of government spending (public debt was 90 per cent of GDP at the end of 2010), which became more difficult to finance after the global financial crisis.  

The programme adopted with the agreement of the IMF and the EU in May 2011 set deficit targets of 5.9 per cent in 2011, 4.5 per cent in 2012 and 3 per cent of GDP in 2013. [5] These targets reflected the predictions of a lack of growth in 2011 and 2012 and the beginning of a recovery in 2013.  

The Portuguese Government’s programme includes:

  • a five per cent cut in public sector pay and pensions in 2011 and then a freeze in 2012 and 2103 except for the lowest paid;
  • suspension of public private partnerships, including the new Lisbon Airport and the high speed line to Porto;
  • many cuts in administrative spending in all sectors including education;
  • a substantial cut in the Portuguese armed forces budget with a 10 per cent cut in personnel by 2014;
  • taxes on spending will rise while tax allowances and tax exemptions will be reduced;
  • privatisation of major state-owned enterprises including the airline TAP and the national airports company;
  • modernisation of the tax system, including improving administration to increase tax collection with the closure of 20 per cent of local offices;
  • measures to tackle the excessive leveraging of some of Portugal’s banks in order to reduce risks in the financial sector and a reduction in the size of the state-owned CGD group.

Like Greece and Italy, Portugal has brought forward a series of labour market reforms in order to improve its competitiveness.  In this case they include tackling the over-generous provision of termination and unemployment benefits and a “major reduction” in employers’ social security contributions – the latter may require permanent reductions in public spending and/or changes to the VAT regime.

The IMF’s most recent review of Portugal’s progress, in April 2012, highlighted the good progress made in implementing the austerity and reform programme.  It said that progress was being made in key areas such labour market reform and that the easing of the liquidity problems in the banking sector made deleveraging the banks easier.

Spain

With a debt to GDP ratio of 68.5 per cent, better than the UK, France or Germany, Spain 

was regarded as the strongest of the southern Mediterranean countries in the eurozone until market concerns about the weakness of some of its regional savings banks and low growth triggered a rise in the interest on Spanish government bonds in early 2010.  Spain’s difficulties stem from the collapse of a property boom, dependence on energy imports, high levels of unemployment (at 23 per cent the highest in the EU) and the difficulties of constraining public spending in a regionalised system of government.

Spain has not so far needed IMF or EU support, reflecting in part the relative strength of its mainstream banking sector, but fears that it might has led to its Government adopting an austerity and reform programme which has proved unpopular with some voters.

The labour market reforms are designed to make it easier to hire and fire employees by loosening up the very tight rules on permanent contracts (covering about 60 per cent of those in employment) and by allowing firms to opt-out of Spain’s centralised pay negotiations system.

Spending cuts and tax increases are expected to reduce the 2012 budget by €27 billion – a cut of 16.9 per cent in departmental budgets.  It means a public sector wages freeze and far bigger cuts in some departments (the Spanish Foreign Office is having its budget halved) with rises in gas and electricity bills too.  

Despite these measures, it is expected that Spain will struggle to meet its EU target of reducing the deficit from 8.5 per cent to 5.3 per cent in 2012; this is partly a reflection of the economy having slipped back into recession in the first quarter.

Future Developments

The circumstances of each eurozone country are very different.  Broadly, those in the north are in a stronger position as regards growth, the health of their banking sectors and the state of their public finances than countries to the south.  But the situation is volatile; the unexpected fall of the Dutch Government in April 2012 over public resistance to its proposed austerity measures demonstrates that even in countries that have demanded harsh measures in other eurozone states austerity measures are seriously unpopular.  The outcome of the Greek Parliamentary elections in May 2012 was an illustration of the political problems of implementing tough austerity and reform measures.

The ambitious nature of the reform programmes, particularly in Greece and Italy, carry with them the risk that if they are not met market sentiment will become even more hostile, costs of borrowing will rise to unaffordable levels and a fresh sovereign debt crisis will emerge.  

Even if these particular austerity programmes succeed in fending off the debt crises, it is hard to believe that they will on their own restore a sufficient degree of competitivity to permit growth to resume.  The view that more needs to be done to stimulate growth more widely has been gaining ground within the eurozone (and elsewhere in Europe and in the United States) since the autumn of 2011, because of the twin problem of low growth and high unemployment.  It is likely that pressure on the European Council to adopt a bolder and more comprehensive package of growth measures will increase substantially.

May 2012

See annex: key data for the eurozone, UK and USA


[1] Found at: http://www.imf.org/external/np/loi/2012/grc/030912.pdf 

[2] Found at: http://www.imf.org/external/np/loi/2012/irl/021012.pdf 

[3] Details in the The National Recovery Plan, http://www.budget.gov.ie/The%20National%20Recovery%20Plan%202011-2014.pdf

[4] Eurostat figures, published January 2011.

[5] http://www.imf.org/external/np/loi/2011/prt/051711.pdf 

 

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