Economists say some European countries will follow the UK’s example of making tough choices on public spending sooner or later.
UK Prime Minister Gordon Brown surprised an annual conference of labour unions this week by taking what is widely considered the Tory approach and announcing sweeping cuts to public spending in order to sustain Britain’s nascent recovery.
“This isn’t some abstract debate about political ideology. It is about hard-nosed decisions we need to take about entrenching and sustaining the recovery we have all worked so hard for,” he said.
The cuts will hit “costs, inefficiencies, unnecessary programmes and lower priority budgets,” but front-line services such as healthcare, education and policing will be spared, said Brown.
Economists across Europe, meanwhile, agree that the question in the rest of the continent is not whether to cut spending, but when and how to do so.
High deficits mean cuts
“[Brown] could just as well be talking about other European countries where deficits are still too high and where they will have to be brought down eventually,” says Jacob von Weizsäcker, a research fellow at Brussels-based think-tank Bruegel, who deems the UK prime minister’s decision both “tough and reasonable”.
Von Weiszacker sees two options available for Europe’s governments: cutting expenditure or increasing taxes.
But he also recommends caution, as for some economies it may be too early to pursue a tough line on fiscal consolidation. “I welcome this debate, but countries will be emerging from the crisis at different speeds so have to be careful that the timing is right”.
UK and Ireland in a different boat
The timing for the UK and Ireland, which have pursued a similar line, is right at the moment, according to Simon Tilford, chief economist at the Centre for European Reform.
Tilford points out that the UK’s deficit rose quicker than its European counterparts, arguing that on current trends the UK will see exponential growth in public debt unless there are substantial cuts to public spending or tax increases.
The economist warns that due to the UK’s astonishingly weak fiscal position, the cuts will have to be far greater than either Labour or the Conservatives have admitted. “Everybody agrees that the cuts in the UK will be similar to the sweeping cuts that have been made across the board in Ireland as we have similar size deficits,” said Tilford.
According to the UK treasury, the deficit will reach 12% of GDP this year and next year.
The UK and Ireland have needed spending cuts because pre-crisis growth was underpinned by the financial services sector and by high property taxes: in a nutshell, “growth was based on unsustainable resources,” Tilford said.
In the medium-term, Britain is worse off than Germany or France, which were first to step out of the recession, because it entered the downturn with a big budget deficit.
But the situation in the UK and Ireland is not entirely bleak, says Tilford, thanks to their young populations, a reason why Britain in particular was able to sustain its post war debt. In the long-term, Spain and Italy will both have to grapple with rapidly ageing populations, the economist added.
Italy is in the worst position, he says, as the country is at risk of serious debt deflation. The Mediterranean country has exacerbated pre-crisis stagnation by raising taxes which have depressed growth further, Tilford says.
Financial markets across the globe went into a tailspin following the US sub-prime mortgage crisis in early August 2007, forcing central banks to make massive cash injections to keep the system rolling and fend off a possible liquidity crisis.
In September 2008, the crisis stormed into Europe, pushing member states to rescue banks and help the economy to recover from the worst depression in decades.
The euro zone entered into recession in the second quarter of 2008 when the overall GDP fell by 0.3%. The downturn hit its current lowest point in the first quarter of 2009 with GDP shrinking by 2.5% on a quarterly basis, and by 4.9% compared to the same quarter of 2008.
The latter half of 2009 is seeing a return to growth according to official data. The latest data from the European commission show the euro zone is emerging from recession. According to its September interim report the economy would grow by 0.2% between July and September and by 0.1% in the final quarter of the year. However rising job losses, according to the figures, would continue to sap growth.
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