Time to slay the austerity myth

There was more evidence overnight that budget or fiscal austerity is economic snake oil when it comes to the objective of reducing government debt in a climate of economic weakness or recession.

According to Eurostat, government debt in the 17 countries that make up the Eurozone exploded to 92.2 per cent of GDP in the March quarter 2013 from 88.2 per cent of GDP a year ago and 66 per cent of GDP in 2007. In other words, Eurozone government debt is 8.75 trillion euros or approximately 12.5 trillion Australian dollars.

In many respects, the news of the debt explosion was not unexpected. The on-going recession which has seen GDP fall for six straight quarters and the record high unemployment rate are keeping a lid on government revenue, thereby limiting any narrowing in budget deficits and adding to the level of debt. Indeed, the Euro was firmer against the US dollar at just under 1.32 while stock markets in the region were generally little changed.

That said, the updated news on government debt in the Eurozone was an unfriendly reminder of  some of the problems that fiscal austerity and the repair of the budget is creating, especially for countries already with high debt and which still are in recession.

Massive cuts in government spending, tax hikes, public sector job cuts and privatisations have clearly not reduced government debt. If fiscal austerity worked as per the textbook, debt levels would obviously be lower by now. But budget austerity when the private sector is weak or already shrinking knee-caps economic growth, pushes the unemployment rate higher and undermines the fiscal position of the government which in turn sees debt levels rise.  

Within the Eurozone, the countries with the highest government debt to GDP ratios are Greece at 160.5 per cent, Italy 130.3 per cent, Portugal 127.2 per cent and Ireland 125.1 per cent. Those countries with the lowest debt to GDP ratios are Luxembourg at 22.4 per cent, Bulgaria 18.0 per cent with Estonia having the lowest government debt to GDP ratio at 10.0 per cent.

Perhaps most disconcerting is the revelation that 24 out of 27 member countries of the European Union saw their debt to GDP ratios increase over the past year with only Latvia, Lithuania and Denmark registering a lower debt level than a year ago.

There is no hint in the recent data that the overall debt to GDP ratio has peaked or will peak soon. Only when the Eurozone locks in an economic pick-up that is strong enough to lower the unemployment rate will there likely be a meaningful reduction in government debt. Economic growth, not austerity, is the medicine for fiscal repair.

In terms of reducing government debt this may not be evident until 2015, given that the consensus view for Eurozone GDP growth in 2014 is just 0.5 per cent which is still too weak to see the unemployment rate fall and government revenue rise.

For the record and by way of comparison, Australia’s government debt is 11 per cent of GDP having risen by 15 per cent of GDP from the low point in 2007 prior to the global banking crisis when there was negative net debt of 3.8 per cent of GDP. Over that time, the debt to GDP ratio rose by 27 per cent in the Eurozone, confirming the fact that the debt widening in Australia was relatively minor.

Furthermore, Australia’s government debt is forecast to peak at 11.4 per cent in 2014-15 before falling as the budget returns to surplus and on current conservative projections net debt will be eliminated around 2020.

With these facts in mind and when compared with most countries in the Eurozone (and the rest of the world for that matter), it is little wonder Australia has a triple-A credit rating with a steady outlook. Our debt levels are chicken feed in absolute terms and certainly when compared with the debt mountain in the Eurozone.