Can Europe Make It?

Trouble in Austeria

Can the EU still be rescued following its disastrous failure to tackle the economic crisis? 

John Grahl
6 January 2014

A sign from a protest in Brussels, Belgium. Demotix/el korchi abdellah. Some rights reserved.

The wheels are falling off the EU’s austerity wagon. Unfortunately, no new wagon is in a state of readiness. There are some signs that European, and in particular German, social democracy is beginning to change direction - but because the EU is such a large and complex institution it can’t be expected to change direction too quickly.

One of the loosening wheels on the austerity wagon is scientific respectability. From the start a large number of economists and economic commentators have been opposed to the austerity agenda, but that opposition has now widened and deepened. Thus, for example, Carmen Reinhart and Kenneth Rogoff’s influential 2010 study, Growth in a Time of Debt, frequently invoked by the proponents of austerity, has now been widely discredited.

This study was taken seriously on publication because its authors are not free market ideologues but economists who are respected for their careful empirical approach. They had recently published a detailed history of economic crises, This Time is Different: Eight Centuries of Financial Folly, which, although it certainly attributed many crises to misguided public policy, had not spared private investors, banks and other financial corporations; these were held responsible for many others, especially in OECD economies and in more recent times. The book certainly added to the prestige of Growth in a Time of Debt, which claimed that a high level of government debt (more than 90 per cent of a country’s GDP) was a decisive barrier to economic growth. The paper has been frequently cited - including by George Osborne and Olli Rehn, who is responsible for economic policy at the European Commission - to justify the sacrifice of all other objectives to deficit and debt reduction.

It has subsequently turned out that the study was full of errors and miscalculations, as was discovered when professors at the University of Massachusetts at Amherst set, as an exercise for their graduate students, the reproduction of results in a number of well-known economic articles. The student assigned the Reinhart-Rogoff paper was quite unable to replicate its calculations. Further inquiry confirmed that the student was right and the authors wrong. Reinhart and Rogoff have since tried to minimise the damage both to their own reputations and to the argument they were making, but the argument, at least, seems to be holed below the water line. [1]

A second detaching wheel is support for austerity policies from the IMF, which, as the third member of the ‘Troika’ along with the European Central Bank and the European Commission, has helped to impose drastic budgetary restrictions on those member states which have accepted emergency loans. Some time ago the IMF’s chief economist Olivier Blanchard raised questions about the speed and intensity of budgetary retrenchment in an IMF working paper jointly written with Daniel Leigh, which presented convincing evidence that governments were underestimating the ‘fiscal multiplier’: that is, they were underestimating the costs of spending cuts and tax increases to the wider economy in terms of their effects on lost output and higher unemployment. The paper itself did not commit the IMF to this view, but when the core of its argument was prominently displayed as a box in the IMF’s World Economic Outlook in October 2012, it seemed to be gaining official support. The most recent Outlook, published in April 2013, goes still further in its questioning of current policies in the EU. It stops short of direct criticism of policy-makers, but suggests that the balance between budgetary consolidation and maintenance of economic activity and employment needs to be changed: ‘There is no silver bullet to address all the concerns about demand and debt. Rather, fiscal adjustment needs to progress gradually, building on measures that limit damage to demand in the short term ...’ (p xvi).

A further sign of disarray among the Austerians is a widening gap between the European Commission and the German government. Until recently the Commission always echoed the position of the German government: no concessions to the supposedly profligate periphery; fiscal rectitude at all costs; and an extremely intrusive regime of permanent supervision of the weaker member states to ensure that the necessary disciplines were respected. Now, however, there are signs that the Commission feels that it needs more room for manoeuvre than the German representatives are prepared to concede.

The most important source of this friction is a difference regarding a banking union in the eurozone. Such a union could in principle be a big step towards a resolution of the crisis. Weaker member states are trapped in a vicious cycle (the so-called ‘doom-loop’) in managing their banking sectors. Domestic banks - in Italy, Greece and Spain, for example - hold a lot of their own government’s
debt. Therefore, when the government is seen as having financial difficulties in repaying its debts, the value of the banks’ holdings is called into question, and they themselves come under financial pressure. But, since the health of the banks is a member state responsibility, any weakening of the banks is seen as possibly requiring support from the government and so the government’s own financial difficulties are further amplified.

A banking union would block this feedback process by making the working of all banks in the eurozone a central, collective, responsibility. The Commission is strongly in favour of such a measure, which would both relieve pressure on the weakest member states and increase the powers of EU institutions. The German government is in favour of the banking union in principle, but wants to delay proceedings until such a time when each member state has already stabilised its own banks at its own expense. As the German finance minister, Wolfgang Schäuble, put it in a recent article in the Financial Times, at present there should only be a banking union of wood: a union of steel is for the future.

There are three main reasons for this German reluctance. Firstly, to centralise responsibility for banks right now would involve heavy costs as weak banks were either recapitalised or merged into stronger ones with official subsidies. Much of these costs would fall on Germany, as by far the strongest member state. Secondly, to relieve governments in Greece, Portugal or Spain of concern for their domestic banks would considerably strengthen their position in negotiations with the Troika: they would be able to reduce or delay repayments of their debts without having to worry about the consequences for the payments system or for bank depositors. Finally, the German position might be influenced by the lobbying of the German banks themselves. These are in not too healthy a position and would prefer to be supervised by German authorities sympathetic to their case rather than subjected to what would probably be a more rigorous EU-level regime. [2]

The Irish are victims of this German strategy. As is well known, the Irish government had no financial problems prior to the global financial crisis. It was Irish banks, enthusiastic participants in the boom of global finance, which precipitated the enormous crash, bankrupting large numbers of builders and house-buyers, destroying tens of thousands of jobs and saddling themselves with billions in bad debts. Now there was certainly an Irish interest in avoiding multiple bank failures, but the decision of the Irish government to rescue not only the Irish banks but also all those banks’ creditors - a decision more than dubious in retrospect - was strongly encouraged by the European Central Bank. And it was only this wider rescue which rendered the Irish government insolvent and exposed the Irish people to the tender mercies of the Troika.

The responsibility of the EU for the financial debacle is not only evident in this pressure on Ireland and on other countries with insolvent banking systems (such as Cyprus). For ten years the Commission was pushing forward a programme for financial integration based on deregulation and on a slavish imitation of the most reckless practices of US finance.[3] Only after the debacle did the Commission start to worry about excessive leverage in the financial sector. Thus the huge liabilities resulting from bad debt that were imposed on the Irish government (and the situation in Spain is similar) are to a considerable extent the responsibility of the EU. If the EU were to look at the problems of banking stabilisation retrospectively, relieve member state governments of most of the costs of stabilisation, and compensate the Irish government for the disproportional expenditure it undertook to rescue its banks, this would amount to no more than an acknowledgement of its obvious responsibility. So far, however, the opposition of the German government is preventing any such resolution of the problems of banks in the eurozone.

Rumblings in the EU Commission

The cumulative failures of the austerity drive seem also to have shaken up the situation inside the Commission. In the recent past the Directorate-General for the Internal Market seemed to be hegemonic within the Brussels regime, but there are some small signs that this is changing.

It was the hooligans of D.-G. Internal Market who brought us such blessings as the proposed Bolkestein Directive, which in its original form would have comprehensively deregulated EU labour markets while at the same time producing juridical chaos across the member states.[4] In the end, however, the directive was considerably diluted by the European Parliament after a major trade union campaign. Another impressive initiative from the hooligans would have abolished all member state restrictions on hostile take-overs, giving EU employees fewer rights than those in the US. In an astonishing expression of their extreme neoliberalism they asserted that ‘the disposal of securities concerns only the holder of those securities’. In a case where the securities in question are shares conferring control over a company, this amounted to saying that the interests of a company’s workers, suppliers and other stakeholders should be given zero weight in determining its future. But the take-over directive that would have enacted these changes was rejected by the European Parliament in a dramatic tied vote, and was subsequently passed in a much diluted version. Hooliganism reached its zenith in the D.-G Internal Market’s 2005 Green Paper on mortgages; here they were effectively proposing going straight for a European sub-prime system, distinguished from that of the US only by an even more complete absence of regulation. Fortunately this fatuous proposal was abandoned when the US mortgage market collapsed.

But although arch-hooligan Commissioners Frits Bolkestein and Charlie McCreevy have now left the scene, hooliganism itself is by no means a thing of the past. For example the Commission is currently demanding that the Spanish ship- building industry repay subsidies it received from the Spanish government, which it says are in breach of EU competition rules. The probable outcome will be a loss of ship-building jobs at a time when unemployment in Spain stands at 26.8 per cent, and is forecast by the OECD to increase. And the Commission has also been using its role as a Troika creditor to enforce competition rules on countries which have had to take emergency loans. Thus the Portuguese and Greek governments are being forced to open up more public sector procurement to foreign enterprises at a time when increased imports can only aggravate their deepening depressions. Such measures are completely dysfunctional from the point of view of public finance in these countries - but they are being sneaked in by the Commission because the view remains prevalent that market-led integration is the absolute priority in EU policy-making.

Nevertheless, there are signs that the Commission is waking up to the political dangers of its current stance. In April, Commission President José Barroso sounded the alarm: ‘While I think this policy [austerity] is fundamentally right, I think it has reached its limits. A policy to be successful not only has to be properly designed, it has to have the minimum of political and social support.’ (And the political situation for the EU and for the European project has only deteriorated since, not least in Barroso’s homeland, Portugal.) That was a speech that did not receive a warm welcome in Berlin, but Barroso has also had to offend German leaders again, by pressing for rapid progress on the banking union and a temporary relaxation of the Stability Pact rules.

On banking, Barroso has argued: ‘We cannot eliminate the risk of future bank failures, but with the Single Resolution Mechanism and the Resolution Fund it should be banks themselves – and not European taxpayers – who should shoulder the burden of losses in the future.’ This approach would still involve potentially massive international transfers, as banks in one country (or, more strictly, their shareholders and customers) pay for losses in another. And it is the treatment of the losses which is located in the future: the losses themselves may already exist - in Spanish banks, for example. On the Stability Pact, meanwhile, countries are being invited to put forward public investment projects with the promise that the related expenditures will be exempt from the usual rules.

Another sign of change in Brussels has been an increasingly assertive promotion of social objectives. From the 1950s to the beginning of the 1980s, European social policies and economic policies ran in tandem. It was only with the European Single Act, and with the drive to ‘complete the internal market’, that economic policy - now understood purely in terms of competition and market integration - began first to eclipse social policy at EU level and then to place ever tighter constraints on member state social provision. This in many ways has a resonance with Walter Bagehot’s account of the English constitution: EU social policy represents the ‘dignified’ - purely ceremonial - component of the EU structure, while the ‘efficient’ component - the one which involves the exercise of power - is represented by economic, and especially competition, policy.[5]

László Andor, the current Commissioner for Employment and Social Affairs, is one of a small number of Commissioners who rejects this kind of relegation. On his appointment Andor adopted a more critical view of labour market flexibility measures (although that has not stopped other sections of the Commission from promoting them as conditions for Troika loans). He has also insisted on recognising the acute social problems provoked by austerity, and taking some steps towards an EU-level response. As he has observed, if the EU does not act to prevent economic and social divergence, people will seek a solution in disintegration. Andor has also pointed to the contribution to the crisis of ‘the incomplete character of our Economic and Monetary Union, without any central budget or common growth policy, and without political union’; ‘the ECB’s predominant focus on price stability’; and the ‘very incremental character of Europe’s crisis response, which for a long time focused on safeguarding the confidence of financial markets and protecting the creditors rather than re-starting the real economy’.[6]

However, the acute lack of resources at EU level, and the fact that member states retain most responsibility for social policy, means that D.-G. Employment is only able to encourage social policy developments at member state level. So far the most important social initiative has probably been the Youth Guarantee, an agreement in principle in the European Council ‘to ensure that all young Europeans receive a good quality offer of employment, continued education, an apprenticeship or a traineeship within four months of leaving school or becoming unemployed’. Implementation of this guarantee will, however, be problematic, especially in the crisis-struck states where it is most urgently needed. Such funds as can be mobilised at EU level are being deployed, but in Greece, for example, the 517 million euros provided by the EU will not go far for the 350,000 young people who are being targeted - it corresponds to a value of about two months employment for each of them at the newly reduced minimum wage (32 per cent down for workers under 25 years of age, 22 per cent down for older workers). The figure of 517 million can also be compared to the reduction of 18 billion euros in Greek annual public expenditure between 2009 and 2012, and the much more to come.

Nevertheless, D.-G. Employment’s heavy emphasis on the plight of the young unemployed is politically astute. Eurostat reports that ‘in May 2013, 5.525 million young persons (under 25) were unemployed in the EU-27, of whom 3.555 million were in the euro area’. This is the group most severely affected by austerity programmes, while its situation clearly shows that the EU is currently unable to safeguard its own future. And, given that all EU countries face the problem, EU-wide programmes in response could make sense - although the problem is far more acute in the peripheral economies, so that expenditure in proportion to the numbers of unemployed could also be strongly redistributional. 

Table 1: Youth unemployment 2012 

Youth = (15-24)


 Unemployment rate         

Unemployment ratio


























































Source: Eurostat 

The unemployment rate is the number of unemployed as a percentage of the labour force (that is, of the employed plus the unemployed). It tends to give a very high figure for young people because most students are treated as not being in the labour force. The unemployment ratio expresses the number of unemployed as a percentage of the entire age group. It tends to give figures biased downwards because some people classified statistically as full-time students are, in reality, unemployed.

The best (or the least bad) performance in the eurozone is that of Germany, where, in spite of the prevalence of free market doctrines, government, unions and employers are still capable of a coordinated response to the emergency and can mobilise resources on an appropriate scale. Thus the argument could be made to generalise the German response with a mobilisation of resources at the eurozone level. This might be the most promising type of initiative to begin to translate the notion of social Europe into reality. It would also recognise that EU and eurozone structures and policies are largely responsible for the unemployment crisis, and that therefore the EU and the eurozone should play a major role in starting to put things right.

Italy: austerity hits its limits

Barroso’s reference to the absence of political support for austerity measures expresses an anxiety that is now widespread among European political leaders. He may have had in mind recent political developments in several countries, including Spain, Greece and his native Portugal, where tolerance for austerity-driven chaos is running low. No one except the far right is looking forward to the European Parliamentary elections in 2014. However, it might well be Italy that is his biggest headache. Italy is a founder member of the EU, with the third largest economy in the monetary union. It is simply not going to be possible to subject Italy to the same kind of treatment that has been handed out to Greece, Portugal or Ireland.

One key macroeconomic aspect of austerity has been ‘internal devaluation’: reductions in real wages that are supposed to improve the competitiveness of the countries concerned and thus act as a substitute for the currency devaluation which could have been used for the same purpose if these countries still had their own currencies. But Italy, although it has suffered a serious recession, has not experienced anything like the same process of wage deflation as other troubled EU economies (see Table 2): there are both political and economic barriers to a full-scale austerity programme in Italy.

The political barriers were clearly revealed in the February election when Mario Monti’s group - the only one supporting the EU’s austerity nostrums - was not only defeated but humiliated. The Democratic Party, which is the strongest force in the new coalition, will probably attempt some further retrenchment of public finances (although Berlusconi’s allies will not be keen on effective tax reforms). But the huge programmed attacks on public provision and on working people seen in Greece or Ireland simply do not seem possible. The most recent National Reform Programme submitted by Italy to the Commission was prepared by Monti before the current government took over, and thus does not reveal much about the line it will take. But even Monti’s document indicates significant differences between the Italian and Greek cases. 

Table 2: Nominal unit wage costs in the periphery

(2005 = 100)





























Source: AMECO

From 2005 to 2009 wage costs rose much faster in the periphery than in Germany. But this short-lived convergence was not matched by a sustained increase in efficiency. Since the launch of drastic austerity programmes in 2009, wages have been driven down in the periphery, while they have tended to rise faster in Germany. However it is doubtful whether this pattern will lead to convergence in the future because competitive pressure on the weaker economies will prevent them from renewing their productive systems.

Although many austerity measures have been taken according to the usual agenda - with a consequent recession and rapid increase in poverty - the labour market measures which have been adopted seem to indicate that some weight was given to trade union views: instead of the usual attempt to destabilise standard labour contracts of indefinite duration, some measures have been taken to reinforce the position of precarious workers. And Monti has taken pride in having preserved Italy’s autonomy by keeping it out of the hands of the Troika. It is to be hoped that the new government will move further in this direction.

The economic problems that will arise from extending more severe austerity into Italy seem even more formidable. The austerity programmes promoted by the Commission in smaller economies had already pushed the eurozone back into recession in 2012. The scale of Italy’s economy - it is responsible for 16 per cent of eurozone production - makes any further decline in Italian economic activity very dangerous to eurozone recovery. So also does Italy’s location. In the past to combine the words ‘periphery’ and ‘Italy’ meant that one was discussing the Mezzogiorno - Italy south of Rome and the island of Sicily. It was taken for granted that the great cities of Northern Italy, such as Milan, were part of the highly productive and prosperous core of the Western European economy, clearly within the ‘blue banana’ used by some geographers to designate the EU’s economic heartland. The tight interconnections between Northern Italy, France and Germany mean that continuing decline in the first could have devastating consequences for the other two.

Dramatic events in Greece have given rise to the thought that Greece might represent a limit to the austerity drive. This could still be the case, given that the consequences of Troika policies in Greece have been so disastrous. But the Italian case also seems to set a material limit to the continuation of the drive for fiscal consolidation at any cost.

Mistakes and remedies

All this means that austerity policies are being increasingly called into question, but at present there is no sign of the clear change of direction that is needed. The eurozone crisis originated on the one hand from the collapse of the global financial system, and on the other from the structural weaknesses of the monetary union - which were there from the start but were disguised for a while by the financial bubble and the associated upswing.[7] Gven given this background, however, the management of the crisis was marked by disastrous errors. Michel Aglietta in his recent study of the crisis emphasises three of them: the failure to deal decisively with the Greek crisis, so that doubt about the financial situation in other countries spread like a contagious disease; the failure to resolve the problems of eurozone banks, which continues to hold back recovery in both core and peripheral economies; and the self-defeating drive for immediate fiscal consolidation which provoked recession and intensified the financial problems it was meant to resolve.[8]

These errors have to be associated with the names of Angela Merkel and Nicolas Sarkozy. Although the story told here has pointed to the failings of the European Commission, the European Council, which represents member state governments, has in recent years increased its control over the Commission, and was in a position to challenge the austerity strategy. In reality it encouraged all the worst measures adopted by the Commission, and has sought to lock eurozone members into permanently restrictive economic policies by a whole range of legislative measures and quasi-legal compacts. And since centre-right governments in France and especially Germany have dominated the European Council during the crisis it is fully justified to hold them responsible for the debacle.

But the centre-left have hardly distinguished themselves in the eurozone crisis. Running scared of growing euro-scepticism among their own voters, social- democratic parties in the economically stronger states have tended to accept the Merkel line, blaming the victims for the dysfunctions of the eurozone and accepting her punitive approach to the weaker member states. François Hollande has been particularly disappointing in this respect (although the Austerian stance of Ed Balls and Ed Miliband in Britain is hardly inspiring). And the pusillanimity of the social democrats has in turn exposed the forces to their left who have wanted to argue for a European solution to the crisis but who could suffer greatly from the anti-EU sentiment now being whipped up. The recent intervention by previous leader of Die Linke Oskar Lafontaine to promote a break-up of the eurozone shows how strong these pressures are.

In this political situation it is appropriate to welcome some signs that German social democrats may be ready to adopt a more constructive view of the EU. A recent text from their ‘committee on basic values’ calls for a complete re-foundation of the EU.[9] One theme of this document is the necessity of a solidaristic approach to the crisis, which implies the acceptance of transfers and liability-sharing among member states. In turn the legitimacy of such a development would require a strengthening of the European Parliament. The re-foundation would also involve introducing a different balance between economic and social priorities. The committee argue that ‘basic social rights must be anchored as directly valid EU-rights and acquire priority over the competition rules; and that ‘binding provisions must be introduced into the Treaties to the effect that the EU works not only for economic but also for social progress’. In order to reconnect social and economic advance, these writers propose a ‘social stability pact’, which would require each member state to link its social programmes and its provision of social services to its economic performance, thus avoiding the recent pattern whereby countries sacrifice social provision in order to reinforce their competitiveness.

At the time of writing, it remains to be seen, firstly, whether the social democrats will in fact participate in the next German government, and secondly, whether any of these proposals could, in that event, have any influence on actual policies. In the 2013 campaign the SPD certainly did not say much about the catastrophic situation of Greece or Cyprus. On the other hand the Merkel government can hardly claim that its European policies are a success. And Christiane Krajewski, chief economic advisor to SPD leader Peer Steinbrück, recently acknowledged that the introduction of joint liability for some existing debts would be inevitable after the German election.

The dilemma for the EU is that the leap towards a federal solution - Europeanising the debts of the weakest countries, introducing a genuine social policy at EU level, transferring political powers to the European Parliament - although increasingly necessary, may no longer be possible. The subordination of EU citizens’ working and living standards, their social protection and their job security, and their own political priorities, to the imperatives of the single market and the stability pact has already so weakened support for the European project that any such move in a federalist direction may be rejected as completely illegitimate. The strongest forces challenging the status quo are based on national opposition movements, and seem to be clearly centrifugal in direction.

In the hope that, although it is very late, it is not yet too late to save the monetary union and thus the EU as such, this article ends with an overview of some of the immediate steps that could launch a democratic rescue of the EU. These are also taken from the SPD document referred to above, which introduces its recommendations by arguing that, given that current tendencies towards dissolution are taking us in the wrong direction and making long-term solutions impossible, a change of direction in present crisis management policies is urgently necessary.

The first suggested step is a declaration by the ECB and the European Stability Mechanism (which they argue should be converted into a bank to multiply its lending power) that there will be unlimited and unconditional refinancing of states threatened by speculation, in order to remove pressure on their interest rates and allow them to refinance themselves at near zero rates. Secondly, there is a need for a basic readiness on the part of the European states to accept in common the liabilities of the ESM and ECB. This is necessary for strengthening the euro so that it can sustain itself against pressure from financial market actors, and it would also be an important confidence-building measure among the members of the monetary union. European states must be ready to accept collective management of debt and the introduction of an effective bank regulation system. Thirdly, there must be an end to the austerity drive. A fixation on budgetary discipline via rigorous reductions in public spending increases indebtedness and cannot promote recovery from the recession. Fourthly, a common European growth strategy is necessary, both for budgetary consolidation and economic recovery: this should include, among other measures, a European New Deal for investment in training, research and development, and energy-saving and climate-protecting initiatives - ‘a growth pact rather than a competitiveness pact’.

If some such programme emerges in the very near future, it could signal a real attempt to keep the EU show on the road. Continuing austerity on the other hand could mean that the political will to save the project no longer exists.

This piece, originally published in the winter edition, 2013 of Soundings magazine is republished with thanks to author and publisher.


[1]. Paul Krugman pointed out in his New York Times column that another influential academic argument for austerity, by Alberto Alesina and Silvia Ardagna, has been debunked in a similar way.

[2]. Martin Hellwig and Anat Admati argue in The Bankers’ New Clothes
that banks in Germany and other economically powerful countries are undercapitalised to a very large extent and that this leads to serious economic problems.

[3]. See John Grahl, ‘The Subordination of European Finance’, Competition and Change, 2011.

[4]. I owe this very appropriate characterisation of D.-G. Internal Market to Jan Cremers, formerly a Dutch Labour Party MEP.

[5]. See John Grahl, ‘The End of Social Europe?’, published on-line in State of Nature, 2012:

[6]. ‘But the main worry is that ... the euro area will not be able to adjust to the continuing asymmetric shock in a way that would offer the peripheral countries an acceptable economic future ... In a situation where the automatic stabilisation role of our social protection systems has waned or even ceased to apply, there is a clear need for more solidarity between the Member States’ (speech in Amsterdam 4.6.13).

[7]. For problems in the current EMU see John Grahl, ‘Time to join the EMU?’, Soundings 43.

[8]Un New Deal pour l’Europe, Odile Jacob, Paris 2013.

[9]. Grundwertekommission beim Parteivorstand der SPD, Europa muss sozial und democratisch werden: für eine grundlegende Reform der Europäische Union, Berlin, November 2012,

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