Will debt forgiveness boost consumer demand? Flickr/Alex Berger. Some rights reserved.Those looking for an economic revolution in Europe will undoubtedly have had their eyes focused on Yanis Varoufakis, the newly-elected Syriza Minister of Finance in Greece, as he carried out his whistle-stop tour of the continent's capital cities. They may have then been disappointed when this culminated in decidedly reasonable proposals for managing the Mediterranean country’s debt. Far from being the pantomime spectre of economic destruction some have sought to paint him as, Varoufakis announced that his coalition government would not seek to cancel Greek debt but to reconfigure it into more a more manageable burden linked to economic growth.
All of this diverted attention from where the real seeds of change, and potentially an answer to Europe’s growth problem, may have been planted. From February 2, around 60,000 of Croatia’s poorest citizens are having their debts wiped under the country’s “Fresh Start” scheme. This figure carries greater significance when placed into context of Croatia’s population of around 4.4 million.
Having endured six years of recession, and with growth forecasts remaining stubbornly low, around 317,000 Croatians have found their bank accounts frozen due to debt, stifling economic demand. Those with a debt under the equivalent of around £3,300, with a weekly income under £91 and with no investments or savings have now found themselves with a clean slate.
The program is expected to cost around £20 million but the government is confident the long-term benefits will outstrip the immediate costs. Such a scheme is considered by many to be unprecedented and exceptional, dividing economic opinion.
Ending the debt trap?
Some warn that banks and private companies will be dissuaded from providing credit to the country’s citizens in the future due to fears of having to burden additional hits in the future. This may, damagingly, lead to higher interest rates as lenders seek to protect themselves from higher risk.
But others suggest this may be exactly what the ailing economy needs. Other European countries have looked to monetary easing in order to boost demand in the economy but this has been largely ineffective as banks have failed to pass on the benefits to potential borrowers. Instead, Croatia is taking a more direct route to stimulating demand.
By removing these people from their debt trap, thousands of potential consumers will suddenly be returned to the economy. This additional demand will stimulate further production and consumer sales. This, in turn, means more orders from suppliers and greater output needed from manufacturers. This can only have a positive impact on economic growth and potentially lead to additional social improvements, including more employment opportunities.
With its public debt at nearly 60% of its output, Croatia had limited options for boosting demand. While some may suggest this was a cynical ploy by a government behind in the polls and due to face elections this year, a burden-sharing scheme that has the agreement of both debtors and creditors may be just what the country needs to wake it from economic slumber.
Croatia is not alone in its growth problem. Low growth rates, despite low interest rates and attempts to stimulate demand, are rapidly becoming the continental norm. Much of the Fresh Start scheme’s success will depend on the private sector’s reaction. But private businesses and lenders may well view the forgiving of a small amount of debt as a fair exchange for a return to more favourable demand for their products and services.
Europe needs an answer to its prolonged stagnation. Governments, citizens and the private sector are all becoming increasingly willing to consider previously unpalatable options. Fresh Start may provide an option that not only leads to growth, but directly and immediately benefits those with little responsibility for the current economic crisis: the poorest. Mediterranean eyes will likely be watching closely.