Tuesday, June 29, 2010

The high costs of austerity

But rather than being rewarded for their actions, these countries are being penalised with a rise in bond yields. The economic downturn has been even sharper than if the governments would have spent on stimulus to keep people in their jobs. As a result, the economies of these countries shrunk dramatically ( more than 20% of GDP loss in Latvia and Lithuania) and remain in recession. Wages in the public sector have fallen by 20-30% in several countries. In the meantime, joblessness has risen to two digit reaching almost 20% in Spain!

Austerity prompts strikes and slowdowns which in turn shrink the domestic market, investment and tax revenues. As unemployment spreads and wages fall, mortgage arrears and defaults soar. Property prices have plunged in some countries. Some business owners are even escaping their debts and emigrate.

For States in crisis, austerity is not the only option. It has huge economic and social costs. It does not make countries more competitive: it uses unemployment to lower wages and imports and therefore depresses domestic demand. There is a second option for non euro-area countries which is currency devaluation but it is not pursued as it would delay their planned integration into the euro area as their currencies are pegged to the euro. It would also raise the price of energy and other essential imports, aggravating the trade deficit.

But there is another option which is worth being pursued and would yield better results. In some of these States in (fiscal) crisis, there is high taxation on labour and capital and land are under-taxed. Lowering taxes on wages would reduce the cost of unemployment and increase demand.

The main issue in European countries, notably in the eastern part, over the coming years will be whether economies can cope with heavily taxed wages and inflated housing prices while avoiding an overdose of needless austerity.

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