Rescue 2.0: Back to Austerity?

September has come and Europe’s politicians are finally in their offices, back from the annual August recess. Back to the rescue. We’re only half way through the month, but so much has been done and said over the past few days. True, European leaders still disagree over what the eurozone banking union should look like. But I think Europe has sent out one of the strongest signals in its commitment to save the eurozone. European Central Bank (ECB) declared that it would basically act as a lender of last resort for failing state governments; previously, the ECB’s primary—and essentially the only—mandate had been to keep inflation below 2 percent. Now it can start doing other things, like buying short term bonds of those troubled countries and contribute to the rescue. Six days later, the German Constitutional Court backed the new permant eurozone bailout fund, the European Stability Mechanism. Can we, though, really hail these movements as good news?

I am not so sure. It seems too good to be true. Look more carefully into ECB statements; what seems to be a radical decision comes with strings attached. The Bank will only buy short-term bonds of these countries on the strict condition that these countries adhere to reform programs and formally request help.

It seems to me we are back to where we started off with: austerity. Simply put, austerity politics is a way of reducing massive government debt through a mix of huge spending cuts and tax increases. If we look back at the policies passed in the EU with respect to the financial crisis, austerity had been the undisputed paradigm over the past few years. The idea behind this policy prescription was that the lack of economic activity came from uncertainties about large government debts, and that the only way to re-instill confidence in the economy was to drastically cut the debt burden off of government balance sheets.

Governments thus cinched their waist belts to those last inches, hoping that attempts at debt reduction would ease market fears of a sovereign default and stimulate economic activity. To give one drastic example, public spending was slashed by more than 6 percent in Greece; wages and pensions fell by as much as 35 percent. Of course, austerity wasn’t so voluntary in Greece. But in January, twenty-five EU countries agreed to write a cap on future deficits into national law or into their constitutions. Austerity economics was clearly German-inspired, but it enjoyed a certain degree of political support in the UK, Spain, Ireland, and Italy, where new administrations placed deficit reduction at the center of their economic strategy.

But austerity didn’t seem to work. Even though huge chunks of government budgets had been slashed, government bond yields—a major indicator of economic confidence—remained high. Spainish yields, for instance, hit 6 percent in April. Austerity programs were also greatly unpopular. Former French president Nicholas Sarkozy was the eighth leader of a eurozone country to have been swept from office the past year.

Moreover, unconditional austerity programs blinded politicians from the real problem. Many scholars and politicians had viewed the crisis as a problem of Mediterranean profligacy. The Greek government lied about its financial situation and Spanish households and firms lived above their means. “The German word for debt, Schulden,” as the Economist pointed out early this year, “is the plural Schuld, meaning guilt or fault.” Countries in the periphery, which also includes Portugal, Ireland and Italy, must pay their price and immediately restore budget discipline. But these countries are not entirely profligate. Before the crisis, the governments of both Irelands and Spain were in constant surplus. Ireland ran budget surpluses between 2001 and 2007 and Spain between 2005 and 2007. Unlike Germany, who failed to meet the limits for deficit and debt set out in the Stability and Growth Pact and evaded punishment, these countries fulfilled their obligations. Aside from the Greeks whose debt level surpassed 100% since long, the outbreak of the crisis preceded the accumulation of debt in many Mediterranean countries. It seems unreasonable to criticize the Irish and the Spanish as prodigal when their level of debt has been among the lowest of the eurozone before the crisis.

I thought Europe’s politicians had finally understood—through the pain of losing office—that austerity cannot be the primary way out of the crisis. But they seem to have come back to where it all started. I am not denying the importance of debt reduction, but before going back to what involves large reforms to cut debt, I wish Europe’s leaders would put a pause to the swift and courageous rescue movement to think about how Europe got into this unfortunate mess. After all, the single currency and the European Union was a brave new experiment of the 50s, conceived as a means of establishing peace within the continent.