WIFO director: Austerity should be complemented with a ‘Social Pact’

Budget consolidation efforts are necessary but should be complemented with a clear promise that better times are lying ahead, says Karl Aiginger, director of the WIFO economic institute in Austria. Otherwise, people will reject it, he argues in an interview with EURACTIV.

Karl Aiginger is director of the Austrian Institute of Economic Research (WIFO). He spoke to EURACTIV's publisher and editor, Frédéric Simon.

Bailout programmes have come at a very high social cost. Yet, at the same time they have allowed passing painful – and sometimes long overdue – structural reforms that would have otherwise been impossible to vote through in national parliaments. With hindsight, can those bailout programmes be considered as a necessary evil?

Yes we think that consolidation is necessary and should go on. But on the other hand the economic consequences depend on how consolidation is made, which has to be fair and employment-friendly.  It has to be made in a way that people know that after consolidation, there are good times lying ahead.  

So it has to start with a vision of where we want to go and why we have to go through hard times. And this vision is in principle missing, specifically on the national level and – if it exists –, it is not taken to the people.

EU governments and the Commission have failed to come out of their weekend talks with a strong message to the people, saying ‘we have a vision for Europe in 2030’ – on economic dynamism, ecological progress, social inclusion, etc. If we would start with such as message then the cutting of expenditures would be put into perspective.

But that message already exists! You’ve just mentioned the goals of the ‘Europe 2020’ strategy, and before that the Lisbon agenda. Does that mean ‘Europe 2020’ is being ignored or that the strategy is not communicated at the national level?

The message is not communicated to the European people. If you ask the Greek or Italian people what the European Commission is doing, they will say Brussels is asking them to consolidate their public finances.

In principle the ‘Europe 2020’ goals exist but they are forgotten. If you look at the European semester, governments are reprimanded if they don’t stick to the consolidation goals but no government is reprimanded for failing to combat poverty or raise spending on research and development, which are part of the Europe 2020 strategy.

And this is both on the European and national levels. Consolidation will not work if there is not an active component.

But the active component of the Europe 2020 agenda is for the member states to deliver. The European Commission cannot force countries to spend more on R&D or fight poverty…

There are a lot of European funds which are available and underused, for example in the regional programmes. And sometimes these funds are being used in the wrong direction – to build highways or airports – but not to restart the production base. In Southern European countries, the share of manufacturing has decreased, they have lost market share to other countries in Asia, for example in the textile sector.

Do you believe regional funds should be made conditional on budgetary targets, like Germany and the European Commission have proposed?

No, they should be targeted on rebuilding the production base and creating jobs, especially for young people. In the past, they were used for building infrastructure like highways which were much more capital-intensive than labour-intensive. And the highways were then often used to bring people to the already congested capital rather than to support local employment and new regional clusters.

In principle there is nothing wrong in setting pre-conditions for EU support programmes. But the unfortunate part is that this is presented as a request from Germany to poor regions. You could formulate things differently and present it as a project of the European Union to support the reform programmes of southern countries, developed by local governments in their own interest.

These EU regional programmes have existed for a long time and although they have been partly successful, they have not filled the economic and competitiveness gap in Southern Europe. And unlike the bailout programmes adopted during the debt crisis, they did not contain the painful structural reforms which would have helped reduce public deficits.

The bailout programmes are necessary but they don’t have a good structure. If you have too much expenditure, you can cut all expenditure or you can change the structure of the expenditure.

We should reduce much more the expenditure for bureaucracy or for the military, and at the same time be able to increase expenditure for innovation, for youth unemployment and so on. So instead of cutting everything by 10%, we should cut some parts by 20% in order to have money to increase other parts by 10%.

The same goes for taxation. You can either tax labour and consumption – and therefore destroy employment –, or you can tax property. And in all these bailout programmes, value added tax was increased, which places the biggest burden on the lowest income.

 Fairness is all important in consolidation periods, we know this from the Swedish and Danish experiment in the 1990s, which was seen to be fair. If the income distribution is already very uneven and you make it even more unfair (cutting low wages and pensions, while keeping privileges of the church and the military), then people will oppose it. The people need to see the benefits and fairness in the long run.

What do you think of the €120-billion European Growth Pact adopted in June last year? Do you consider it as a big step forward?

It was going in the right direction but again the active measures were lacking or had a less stringent time table. The European Investment Bank got more money but I haven’t seen any money flowing inside the countries. So it came very late in the process and active measures were not implemented.

What do you mean by active measures?

Active measures means that EIB money starts flowing quickly into investment and business starts specifically in Southern Europe, that so-called ‘project bonds’ are enacted quickly, that the restructuring of the regional programmes is lead to new investment in deprived regions  quickly, etc.

So all these growth-promoting measures took time while the debt consolidation measures were enacted quickly. And the result was that the deficits in the southern countries were nor really decreased and that the debt increased in the meantime.

On the other hand, there are some countries which could do more on the national level, for example Germany, where domestic demand could be boosted further. Wage share has decreased by 10% over the last ten years and the high wages have increased faster than low wages, which reduces consumer demand. Companies have now more profits but they don’t use it for investment because they are too uncertain of the future. They invest outside Europe but not inside. German firms are net creditors, which means they have less debt than assets. And if one of the leading economies in Europe does not boost domestic demand, consolidation in other countries will not work.

But my point is not that Germany should boost domestic demand because it is good for the Greeks – Germany should do it because it is good for the German population. It is the task of the government to increase the welfare of its people and that will happen if the wages are increased in parallel to productivity, if the difference between high and low income is reduced and if Germany goes for ecological excellence.

If you look at the position of Germany in ecological indicators, you see that it is ranked only 10th among the 27 EU countries, which is not a really good position for a country which wants to be the number one player in new technology. And if you look at the change between 2000 and 2010, Germany is in the 18th position. This means that it is decreasing energy demand or air pollution less than in other countries. And if Germany were to go for excellence in environmental technology, it would maximise the welfare of its own people, if low wages were increased consumption would rise and companies would invest more. So here, it is too much austerity and the export surplus built on reducing the incomes and welfare of Germans.

The wage moderation policies were introduced under Gerhard Schroeder in 2003 with the so-called Hartz reforms. And now, it seems Germany is reaping the benefits of these reforms, although they came at a high social cost. Again, was that not a necessary evil?

At that time I think it was necessary because Germans had wages which were higher than their productivity. And they stuck to that strategy which made sense in the first part of the last decade.

On the positive side Germany is the only country in Europe where unemployment is lower than at the start of the crisis. On the negative side, you now have working poor and there is a shortage of qualified people preventing stronger growth. And currently Germany has a low-wage sector which does not benefit its own people and makes larger transfers to southern Europe necessary in the long run.

Going back to Europe, far-reaching reforms were passed to strengthen European economic integration during the worst days of the sovereign debt crisis –like the six-pack, the two-pack, the European semester, etc. – that would have otherwise been unthinkable before. Reflecting on this process, what would you pick out as the main benefits of these reforms?

When the crisis is over, the European Union will have strengthened its fiscal discipline by ex-ante and ex-post measures thanks to the six-pack and the two-pack and this is good in principle.

What is now missing is other ways to reduce uncertainty and encourage investment into the real economy. For example, the banking union is a very strong must. The banks needed a lot of taxpayers’ money to be saved and this shouldn’t go on –money should be redirected from the financial sector to the real economy. The Financial Transactions Tax is a good step in that direction, I hope it will come to existence very quickly. Its revenues should be used in the first two years to jumpstart investment and growth, afterwards to reduce taxes on labour.

These are tools, but process-wise, did you see much improvement in European economic governance?

The process was too little too late. We now have a fiscal pact but it should be complemented with investment incentives and a social pact. A 12% unemployment rate is not something that Europe can stand for a long time.

How can such as social pact be put together realistically, knowing that Europe has no competence on the matter? Are you thinking about the ‘competitiveness contracts’ that were discussed at the December 2012 summit?

At the heart of this Social Compact should be some goals like for example reducing the spread between the high-income and low-income countries; that youth unemployment should not be higher than average unemployment; and that young people get the best education and skills. Youth unemployment is an imbalance which should be monitored in the ‘imbalance procedure’.

You need money for bringing the young people back to work, but the problems are very different in each country and therefore specific ‘competitiveness contracts’ envisaged by the European Commission could be one part of it.

But I think they should be implemented more quickly, as part of the on-going ‘European semester 2013’, where tackling youth unemployment should receive at least as much attention as debt consolidation, which is not the case currently.

As far as competitiveness contracts are concerned, I think they are a good idea in the long run but, again, as the processes are working today they will take at least two or three years to implement and show results, which will be too late also considering that the European economy is the slowest across the world to recover from the crisis.

I know that it is not easy for any country to make such reforms in a period of budget consolidation. Therefore, I proposed to the Commission and the Council in my talks to start at least with one ‘competiveness contract’ for each Southern European country on a pilot project this year.

For example, a contract of €50 million could be passed with Greece to increase employment in the solar energy sector by 500 people by March next year. It’s a very small project but it could be a game-changer. It’s a project that the Greek government wants to do and which is part of the reform programme so there would be strong ownership.

And so Europe would be paying Greece for an active measure. That would be a game changer because it is totally different from what the Greek people hear on television every day – that Brussels or Germany is forcing them to cut expenditures against their will, which places them on the defensive side.

Maybe this would work with Greece but what about similar contracts with bigger countries, which are not under a European bailout programme, like France for example? Here, it might be more difficult politically…

In other countries, programmes could focus on modernising infrastructure, for example on energy grids which could be financed by project bonds or the European Investment Bank. A lot of these things can be financed in part with European funds.

Project bonds bring to mind the issue of Eurobonds, where France and Germany have opposite views. Paris says they should be introduced quickly as a short term measure to fight the crisis and reduce the borrowing costs of heavily indebted nations. Berlin meanwhile argues that introducing them in the short run will remove incentives for these countries to undertake reforms which have been delayed for too long – so-called ‘moral hazard’. Which view do you support?

First let me explain why I think Eurobonds are necessary in the long run. Europe is currently paying higher interest rates on its debt than the United States, Japan or the United Kingdom despite of lower debt relative to GDP. This is not smart, it is wasting money, so in the long run you need Eurobonds.

I think we can construct Eurobonds in a way which is incentive-compatible, for example by making sure they can be used for only 60% of the debt to GDP. You would therefore pay the national rate of interest only for the margin.

The other possibility is to take the money generated by the Eurobonds and distribute it at different rates of interest. If the interest rate of Eurobonds is 2%, you could for example charge Germany 1% and Greece 3% because Germany has a lower debt-to-GDP ratio and lower annual deficit. It won’t be easy, but you could have groups of countries with different interest rates depending on their economic performance.

What about the moral hazard?

It would be reduced to a large extent. If you are paying only for the debt of the past, then it doesn’t change your forward-looking decisions, where the market rate will apply. So the moral hazard is therefore very much reduced. It still exists in some way but it is part of a solidarity mechanism, which is normal considering that many countries – Germany and Austria in particular – benefitted considerably from the euro and have to pay something. In the United States, it is automatic – if a state is performing badly, it receives an automatic transfer of money, at the same time as the problem is coming up.

Looking ahead to the German elections, Angela Merkel has been an advocate of European federalism, saying solidarity mechanisms like Eurobonds could be introduced only at the end of a broader integration process. Do you see this debate gaining traction in the election campaign? Or will the issue be brushed under the carpet and come back after the election?

I think the question of Europe and its transformation will be part of the election campaign because there are different views on it.

After the election, some proposals will be easier to implement because campaigns usually give way to populist statement and afterwards, politicians think more about the future. So after the elections for example, I very much hope the banking union will come to existence.

Can European issues be used to gain voting intentions in opinion polls, for example in the SPD which has battled against austerity?

Unfortunately, I don’t think so. The debate in Germany is very irrational at the moment. They think that they are going for the best strategy and that Europe has opted for the worst strategy. German people think they already pay a lot and they don’t want to pay more instead of seeing that working together could be a progress. But I’m afraid that being pro-European is not a vote-winner in Germany.

You said Europeans should be given a perspective beyond austerity. Is this not the job of the SPD, which has been relatively silent on European matters so far in the campaign?

All the political parties, not just the SPD, should spell out what vision they have about Europe’s position in the globalised world of 2030. Whether Europe should still be split along national borders and consequently no country will be able to shape rules of globalisation, or whether we want a Europe with the best socio economic model of the world, high incomes, low unemployment and poverty, and acting as a leader in clean technologies. This model is currently developed in a large research programme [www.foreurope.eu] by WIFO and 32 partners as part of the European Commission’s 7th Framework programme.

But I fear the election campaign is not seen as the right place to speak about long term visions, it is dominated by short term problems and prejudices.