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European budget cuts raise recession worries

business Updated: May 30, 2010 09:29 IST

AFP
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As European governments rush to cut budget deficits with draconian austerity measures, experts are warning that the fallout could mean a shutdown in Europe's tentative economic recovery.

They argue that spending cuts and tax increases at a time when many businesses and consumers are still suffering the effects of the global economic crisis could dampen consumption, hampering output across Europe.

And their warnings are beginning to gain credence on international markets, with investors in recent days voicing worries about the combined effect of withdrawing fiscal stimulus and belt-tightening in Europe.

Leading the criticism is Nobel-winning economist Joseph Stiglitz, a former chief economist at the World Bank who now advises several governments and has warned against what he terms the "deficit fetishism" of the cost-cutters.

In an interview with French newspaper Le Monde this month, Stiglitz said that Europe "is facing disaster if it continues along this path."

He advocated instead the establishment of a "solidarity fund for stability" that would aid European countries that find themselves in financial trouble.

"Europe needs solidarity, empathy. Not an austerity that is going to push up unemployment and lead to a depression," he said, adding that Europe should be more like the United States where individual states help each other.

Even the International Monetary Fund -- long seen as a bastion of fiscal conservatism -- has been warning against going overboard with spending cuts.

The IMF's chief economist, Olivier Blanchard, has said there is "a risk... of austerity zeal in some countries under pressure from the markets."

After Greece's near-bankruptcy threatened to engulf world financial markets earlier this year, other European economies have rushed in recent days to put forward often controversial plans for getting their public finances in order.

Governments from left to right have announced draconian austerity action from top to bottom, varying from ministerial pay to unemployment benefits.

Italy, Portugal and Spain have been the main countries to have followed suit and the French government has announced it is planning to raise the official retirement age from 60 -- a move that sparked major public protests this week.

Britain's new coalition government has also announced a first round of 7.2 billion euros (9.0 billion dollars) in cuts.

"The austerity plans are so tough that if they are implemented simultaneously across Europe, the impact on growth not only in Europe but also in the rest of the world could be a major brake on the recovery," said Laurence Boone, an analyst from British bank Barclays Capital.

Governments are clearly beginning to take heed of the warnings, however.

On Friday, trade and finance ministers from the Organisation for Economic Cooperation and Development, a grouping of 35 developed-world countries, said they were committed to cutting their deficits without hurting growth.

"It is important to develop credible and transparent medium-term fiscal consolidation plans," the OECD ministers said after a meeting in Paris.

"We will implement them in ways that do not jeopardise growth," they said.

Elie Cohen, an economic expert at France's Centre for National Scientific Research in France, warned that an even greater danger was for the credibility of governments if they failed to implement the measures they had announced.

"It would be better to have gradual measures that are realistic and achievable instead of outrageous promises that will not be held and will therefore aggravate the crisis," Cohen said.

He also said that countries such as Austria, Germany and the Netherlands "have no reason to enact austerity measures" and should not be pushed.

The risk he said is that the credibility of Europe as a whole could be "stained" by some countries failing to abide by their promises.

Some top experts have insisted, however, that austerity is the way to go.

"It is a complete fallacy to say that fiscal soundness dampens growth. It is exactly the contrary. It is the absence of fiscal credibility which dampens growth," European Central Bank president Jean-Claude Trichet said this month.

"Medium term sound and credible fiscal policies are a major prerequisite for confidence.

"And confidence of the households, confidence of the entrepreneurs and confidence of the investors is what is indispensable for the recovery."

Analysts at Wall Street banking giant Goldman Sachs agreed, saying austerity was "the right medicine."

It added: Europe's "periphery faces exceptional circumstances and, while domestic demand is likely to suffer, the alternative... would have been worse."