Friday, 7 September 2012

European austerity: trying to have your cut and eat it....

Image: Onkel Tuca
The 2012-2013 Global Competitiveness Report was released today by the World Economic Forum. The results, which comprise a wide range of measures of competitiveness,  will not be reassuring to those in Brussels's or Frankfurt's corridors of power. Europe has broadly stood still. But while those in strong positions were able to enjoy record low borrowing rates and make progress with even greater structural reform, those in weak positions remain stymied or deteriorated.

Portugal, falling four places to become the 49th most competitive country in the world, has made progress on stabilising its fiscal position but is suffering from a chronic shortage of investment. Spain (steady at 36th most competitive country in the world) saw the country's fiscal position sacrificed at the altar of reform.  These two cases highlight that the twin aims of fiscal consolidation and competitiveness enhancements are diametrically opposed forces: to enhance competitiveness a country should cut taxes and bolster infrastructure; to consolidate its fiscal position a country should raise taxes and slash spending.

This point is best illustrated by Ireland, which robustly defended its low corporate tax rate during bailout negotiations with the troika. That tax rate is a supreme source of competitiveness for Ireland - an unfair one the Germans argued - and, rightly or wrongly, its retention has facilitated Ireland's competitiveness recovery. Ireland rose two paces to become the 27th most competitive country in the world.

Another flaw in the current drive of policy is that competitiveness reforms take too long to bear fruit. Greece for example has fallen by another six places (to 96th) due to its deteriorating economic conditions.  The troika will make a decision on whether to massage Greece's bailout terms yet again in October, and recent comments from German Finance Minister, Wolfgang Schaeuble, suggest that some leeway will be found despite an insistence that Greece meet the programme of reforms it has thus far been unable to satisfy. 

Pivotal in Greece and many other European countries is that reform should make it easier, and less costly, for companies to terminate employment.  Over the course of an economic cycle employers will be more willing to hire workers if doing so doesn't mean being lumbered with them indefinitely.  But right now, with the Greek economy shrinking at an annual rate of around 6%, reform of the labour market can only possibly mean the loss of yet more jobs and, with unemployment already believed to be close to 30%, Greece's reluctance to swallow this medicine should surprise nobody.

Guy Foster
Head of Portfolio Strategy

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