Europe's Growth Woes Worsen

15.02.2012 09:12

WSJ: Economic output in Greece and Portugal plunged last year, according to figures released on Tuesday, challenging the prevailing European view that fiscal belt-tightening will foster growth.
Greek gross domestic product fell 7% in the fourth quarter from the year-earlier period, the country's statistics agency said, bringing the total GDP drop since the end of 2007 to more than 16%. Greece's statistics service hasn't issued quarter-to-quarter data for the past several quarters because of methodological problems adjusting for seasonal swings in activity.
Portugal's decline was milder last quarter—2.7% from a year earlier. But the downturn is accelerating. GDP fell 5.3% in the fourth quarter from the third, at an annualized rate, or 1.3% on a quarterly basis. Portugal's economy is expected by some economists to contract as much as 3.5% this year.

The steep contractions are fueling criticism of the strict austerity policies adopted across Europe's periphery in response to the debt crisis. A number of economists argue that continued government spending cuts will make it even harder for the most vulnerable countries to recover.

"The whole nonsensical doctrine of expansionary fiscal consolidation that [former European Central Bank President Jean-Claude Trichet] and the European Commission were talking about, that whole discussion is gone," said Jacob Funk Kirkegaard, an economist at the Peterson Institute for International Economics. The austerity debate isn't confined to the euro zone.
A warning on Monday from Moody's Investors Service that the U.K.'s credit rating could be at risk reignited a discussion in Britain about the government's cost-cutting approach. Moody's cut Portugal's rating further into junk territory and also reduced ratings of Italy and Spain.

U.K. Prime Minister David Cameron, along with Chancellor of the Exchequer George Osborne, has touted the views of the credit-ratings firms as key measures of the success of their economic policy. Since coming into office 18 months ago, the government has embarked on its most sweeping spending cuts since World War II.

The opposition Labour Party, which has argued that Messrs. Cameron and Osborne are cutting too far and fast, said the move by Moody's showed the government's approach isn't working. "Without growth and without jobs you can't get the deficit down," said Ed Balls, Labour's finance spokesman.
Still, Moody's made no suggestion that the U.K. relax its austerity plan. Rather, it said a catalyst for a downgrade would be if there were slower growth and the government eased up on efforts to cut debt.

Mr. Osborne on Tuesday said the government would stick to its cost cuts. "This is proof that, in the current global situation, Britain cannot waver from dealing with its debts," he said.

A more detailed picture of the European economy should emerge on Wednesday, when most euro-zone countries are scheduled to release fourth-quarter GDP data. The 17-member euro bloc is expected to have shrunk around 1.5% at an annualized rate from the third quarter, a forecast supported by a 2% slide in industrial output in December from a year earlier.

Deep recessions in Greece and Portugal haven't significantly affected euro-zone GDP. The two combined account for only 4% of the bloc's €9.5 trillion ($12.6 trillion) economy. Still, they are tests of Europe's gamble that by reducing spending and raising taxes, fragile countries would boost confidence and generate growth. So far, there is no evidence the strategy is working.

Greece's recession, now entering its fifth year, is deepening after austerity measures in September—higher excise taxes and new property and income taxes—hit consumer spending. Athens will cut the private-sector minimum wage 22% and abolish 15,000 public jobs this year.

Vasiliki Gerani, a 27-year-old insurance-company employee, said she must accept wage cuts, fearing that otherwise she will join Greece's army of unemployed, which now tops one million in a labor force of around five million.

"I keep cutting down my expenses but still the situation is really bad. Of course I have to accept the new measures in order not to lose my job and should be happy with that since there are so many unemployed people, especially at my age," she said.

Ms. Gerani's experience shows the pitfalls of austerity. When consumers and businesses cut back on spending to reduce debt, someone needs to fill the gap in output. Export powerhouses such as Germany can sell goods and services abroad, offsetting weakness in their domestic economies. But Greece, Portugal and Spain all run trade deficits.

"If everyone is deleveraging and fiscal policy is tightened against that backdrop, then no one spends," said Philip Whyte, an analyst at Centre for European Reform.

European officials didn't envision that dynamic when they insisted Athens institute draconian austerity measures in 2010 and 2011, and then extended the same medicine to Ireland and Portugal.

Mr. Trichet, who ran the ECB for eight years until last October, said lower deficits would boost confidence and growth. "I do not buy the very simple reasoning that would suggest that pursuing sounder fiscal policy would hamper growth," Mr. Trichet said in an interview last year. Many economists, particularly in the U.S., scoffed at that theory, saying reduced spending and higher taxes would weaken economies in the short run.
ECB President Mario Draghi has taken a pragmatic view since taking office in November. "There is no point in denying that consolidation is contractionary. The question is: how do we mitigate this," he said in January.

Goncalo Pascoal, chief economist at Millennium BCP in Lisbon, estimates that austerity measures sliced one to 1.5 percentage points from Portugal's GDP last year and will do so again in 2012.

The ECB took steps to cushion those effects. Under Mr. Draghi, the ECB cut rates in November and December. Such steps stimulate growth in Southern Europe and Ireland because consumer and business loans there are often tied to short-term interest rates. But the ECB is limited in how much it can do for Greece and others. Jens Weidmann, head of Germany's powerful central bank, reiterated the ECB's opposition to taking losses on its Greek hold holdings in an interview with the German business daily Handelsblatt.

The question, economists say, is whether wealthy countries such as Germany follow suit and give Portugal and Spain extra slack if they get the big reforms right to make their economies more competitive but in the process miss some deficit targets.

"There has been a sea change in emphasis" from austerity to growth in much of Europe, Mr. Whyte said, "but I don't detect much of a change in German thinking."

Nektaria Stamouli contributed to this article.
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