However, European states have had to deal with sizeable deficits before today. Daniel Gros, Director at the Centre for European Policy Studies (CEPS) and Cinzia Alcidi, a Research Fellow at CEPS, have put together an excellent paper looking at how well—or badly—European states with large deficits have done in the past in their efforts to reduce those deficits. Their paper “The European experience with large fiscal adjustments,” starts from the premise that the key question, right now, in Europe is “whether Greece can make it”—and so, by extension, whether other states with large deficits can “make it” in their turn.
They take the 12 largest fiscal adjustments observed over the last few decades in the EU, based on data published by the European Commission. What they find initially looked quite promising. In the period from 1989 to 1994 Greece actually managed to bring about close to an 11% reduction in its fiscal debt, reducing the budget deficit by an average of 2.2% per year over a five year period. Other states achieved similar successes. Denmark, for example reduced its debt ratio by 10% over four years, from 1982 to 1986, an average of 2.5% per year. Sweden managed a 9% percent reduction during the period 1993 to 1998, with the average reduction being 1.8% of GDP per year, and so on and so on. At first glance the table Gros and Alcidi provide makes one feel, “OK, so where’s the problem? It’s been done, and done again and again.”
Only it hasn’t, at least not properly by the Club Med countries (Greece, Italy, Portugal). There are two ways of reducing a fiscal deficit. The first way, the road of austerity, is about government cutting its budget drastically, spending much less on the key things people care about, such as health, education, pensions and infrastructure improvements. The alternative to the belt tightening approach is to keep on spending just as much as you were before, but somehow generate at least two or three percent additional tax revenue per annum.
What Gros and Alcidi found was that the Mediterranean countries (Greece, Portugal, and Italy) invariably went for the second route, in sharp contrast to the Nordic countries in particular, who achieved their fiscal deficit reductions though taking additional pain. What is worse, the CEPS team found that while the fiscal deficit might have been trimmed back for the countries in Table 1, very often the country’s gross debt ratio increased, sometimes quite sharply, even while it was bringing its fiscal deficit back into line. For Greece, Portugal and Italy, the debt-to-GDP ratio continued to increase by more than 20 percentage points of GDP during the period where the budgetary deficit was improving.
Paper here:
http://www.ceps.eu/book/european-experience-large-fiscal-adjustments
