Five years ago, early in 2010, two crises coincided. On one side was the British economy, facing the after-effects of the Lehmann collapse. The Labour Party, then in office, was facing an election by the summer. On the other hand was Greece, the first among the Eurozone countries to hit the buffers as the markets began to price its debt realistically.
Both countries had similar sized deficits—around 10% of the GDP. The then chancellor of the exchequer, Alistair Darling, realised the enormity of the shock which the British economy, with a very large financial sector, had suffered, and decided that, if re-elected, Labour would commit to halve the deficit by the end of five years. This was not welcome to Gordon Brown, the prime minister; so, the party ran on a platform of growth and investment. It lost the election and a coalition of Conservatives and Liberal Democrats took office pledging to eliminate the deficit in five years. This was widely criticised as irrational and un-Keynesian. Many economists were urging borrowing, and spending the way out of the recession.
The Greek economy had no serious plan to cut its deficit in any organised way. Indeed, Greece and the Eurozone were in denial about the problem. Nor was the latter ready to cancel Greek debts which had risen to an unsustainable multiple of its GDP—180%. Greece was soon joined by Spain, Ireland, Portugal and Italy. All these countries had unsustainable public debts or private (bank) debts which could become public liability.Over the next five years, the UK managed, with a tough austerity regime, to more than halve its budget deficit—3.7% as of the Budget presented on July 8. What is more, after a bad two years of low growth, the economy has begun to grow at around 2.5%. The growth will be sustained over the next five years and George Osborne, the chancellor, predicts a total elimination of deficit by 2018-19 and a surplus thereafter. My own view is that the consistency and good design of the austerity programme have paid good dividends. Net borrowing will decline over the next five years, from 70 billion pounds (4% of the GDP) to 13 billion pounds (0.6%) by 2017-18, and then turn into surplus, i.e., negative borrowing. The debt-GDP ratio will go down from 80.3% in 2015-16 to 68. % by 2020-21. The success has been achieved by staying tough in the early years when recessionary conditions were rife. Now the resumption of growth makes the task of cutting the deficit lighter.
The contrast with Greece could not be sharper. Over many negotiations, the Greek austerity programmes have not tackled the core issue. Some privately-held debt has been forgiven. A lot of private debt has been taken over by the countries within the Eurozone, the IMF and the ECB. Even so, there is no guarantee that Greece can produce a sustained austerity programme which can make it able to pay its enormous debt back. The Sunday referendum on July 5 rejected the previous offer. Now, the same critical situation has arrived again. Then finance minister, YanisVaroufakis, has resigned as his style offended the creditors. The new finance minister, Euclid Tsakalotos, is trying to put together another package which is being debated as I write this on the afternoon of July 10. We will know late Sunday night or early Monday morning, whether there is a deal which is credible and can deliver debt relief. If there is no deal yet again, then Grexit beckons. Greek banks will have to be saved from bankruptcy by injecting new capital and a new currency will have to be created which Greece can control and which can be depreciated vis-a-vis the euro.
Spain and Ireland had private bank debts which became public liability rather than a budget deficit problem. They have tried a harsh austerity programme and have survived, albeit with high unemployment in Spain. Ireland has also come out of the recession without too much damage. These countries, within the Eurozone, are against Greece being given too many concessions as they have managed to bear their pain successfully.
A key element in the success of any austerity programme seems to be the flexibility of the labour market. UK has downsized its public sector bureaucracy but the million civil servants have been re-employed in the private sector. Unemployment has stayed low throughout the austerity programme. While wages have not risen, jobs have been found. Greece seems to have missed out on this reform as has Spain. If the labour market is rigid and prevents flexible hour contracts from emerging or does not allow for wage flexibility, the result of any austerity programme will be high unemployment. The Keynesian cure presupposes no flexibility and hence predicts very high unemployment in absence of public spending boost. What we have found in the UK and Ireland is that job availability is helpful in bearing the costs of austerity. We will need to rewrite some macroeconomics when all this is over.
The author is a prominent economist and Labour peer