Hard to swallow Merkel's sweetener

Under the threat of some countries refusing to accept bitter new austerity measures, Angela Merkel may agree to boost Europe's rescue fund. But will this be enough?

German Chancellor Angela Merkel appears to have reluctantly decided to sugar-coat the bitter medicine she’s forcing debt-laden countries to swallow by offering to increase the size of the eurozone’s emergency rescue fund.

Last month, all 17 eurozone countries signed up for tough new budget rules dictated by Berlin which for most countries will require major cuts in government spending along with tax hikes if they are to meet the new deficit and debt limits.

But Merkel is well aware that these tough new austerity rules will likely meet with howls of protest from voters when they’re actually introduced. The opposition could be so ferocious that some national parliaments may actually refuse to endorse the new rules.

So Merkel now appears to have grudgingly agreed to make the deal more palatable. She’s decided that if debt-strapped eurozone countries sign up to the new Berlin rules, she may be willing to reward them by agreeing to boost the eurozone’s rescue fund to €750 billion ($US977 billion) by adding the €250 billion of unused funds from the existing rescue fund to the new €500 billion rescue fund that will be launched this July.

Any concession by Merkel’s will be welcomed by IMF boss Christine Lagarde, who has been urging Berlin to boost the size of the rescue fund.

In a speech in Berlin overnight, Lagarde again underlined her point, warning that unless the size of the rescue fund was boosted, countries like Italy and Spain could face a financing crisis. "This would have disastrous implications for systemic stability,” she warned.

But Merkel is not only insisting that financially embattled eurozone countries cut their debt levels and commit to balanced budgets. She’s also pushing them to enact painful policies that will liberalise their economies and to make their labour markets more flexible. Berlin is hoping that the debt-stressed eurozone countries will boost their competitiveness by enacting the type of flexible labour market policies that Germany itself adopted in the early 2000s.

Last Friday, Italy’s caretaker leader, Mario Monti, announced new competition rules that would apply to a wide range of industries such as taxis, pharmacies, banking and insurance. He’s also working on new measures to free up the Italian labour market and to change the way that unemployment benefits are calculated.

Last Wednesday, Portugal announced its labour market reforms, which were designed to make it easier for employers to hire and fire workers.

And Greece is under pressure to abolish its minimum wage and to get rid of the two special annual payments that private sector employees enjoy.

The big question is any dusting of sugar from Merkel will make the bitter pill of austerity and labour market reforms any more palatable for the debt-laden eurozone countries.

Or will national parliaments, faced with the invidious task of cutting budgets and introducing painful labour market reforms at a time when their economies are already mired in a deep recession, decide they’ve had enough of the Merkel remedy?