The Decline of Austerity Politics

By Lili Bayer

In September 2011, German Finance Minister Wolfgang Schäuble wrote a piece in the Financial Times entitled “Why austerity is only cure for the eurozone.” But in reality, Schäuble’s stance was that austerity in southern Europe was the only cure acceptable for Germany – Europe’s largest economy and a major creditor, whose economy depends on the stability of the eurozone. However, there are now growing indications that Germany is being forced to shift its commitment to austerity. Several key factors are contributing to this evolution. Germany’s export crisis, lower interest rates, the refugee crisis and political changes across the Continent have led to a change in Germany’s constraints and priorities.

Over the past few years, the debate over austerity had serious implications for European politics. One of Germany’s top preoccupations was debt levels in some European economies. Berlin pushed some European governments, especially in southern Europe, to adopt harsh austerity measures. Southern European leaders have long fought against Berlin’s insistence on austerity.

We have written about Germany’s recommendation that the EU not fine Spain and Portugal for their excessive deficits, as well as German Chancellor Angela Merkel’s recent call for the EU to show Italy more flexibility in terms of spending. But these are not one-off decisions, and we can expect Germany and the EU to increasingly soften their stance on austerity.

Germany’s export crisis is one of the driving forces behind Berlin’s reduced focus on austerity. Following the onset of the 2008 crisis, Germany faced a dilemma: on the one hand, it was a major creditor nation. Berlin feared that southern Europe’s growing debts posed a serious risk to the stability of Germany’s banking system and to the sustainability of the eurozone.

On the other hand, the eurozone is an important destination for German exports, and austerity policies – which prevented governments from adequately addressing low growth and unemployment – hurt demand for German goods. But Berlin ultimately opted to push for austerity, in the hope that it would help shield German banks from further risk-taking in southern Europe and bring fiscal health and stability to eurozone economies. German exports, it was assumed, would ultimately weather the storm.

But today, Germany’s choices look different. We often point out that exports make up over 47 percent of Germany’s GDP. The country is now facing an exports crisis, with overall exports in July falling by 10 percent compared to July of 2015. Germany thought that it could continue as an export-driven powerhouse. This belief has now proved untrue. But stimulus in southern economies could help revive some demand for German goods.

At the same time, despite austerity, German banks are currently facing the risk of contagion from southern Europe’s banks, which are saddled with non-performing loans and suffering due to low growth and low interest rates. As a result, many European policymakers have prioritized banks’ stability over austerity. In late August, the European Commission approved plans for a 5 billion euro ($5.6 billion) recapitalization of Portugal’s Caixa Geral de Depósitos, a state-owned entity and Portugal’s largest bank by assets. The plan includes a government injection of 2.7 billion euros which the EU has agreed not to consider state aid. European authorities are showing great flexibility on banking and budget rules for Portugal because they fear contagion from Portugal’s ailing banking system: the country conducted two banking rescues in 2014 and 2015, and its banking sector is still saddled with 33.7 billion euros worth of non-performing loans, representing 12 percent of total loans.

Moreover, low interest rates have reduced the need of some southern European economies to radically cut spending by lowering their interest expenditures. For example, according to data from the European Commission, Italy’s deficit stood at 2.6 percent of GDP in 2015, down from 3 percent in 2014. However, this reduction was mostly achieved because of lower interest expenditures, not austerity policies. Italy’s interest payments declined to 4.2 percent of GDP in 2015 from 4.6 percent in 2014.

The refugee crisis has also contributed to the decline of austerity politics, as the vast majority of asylum seekers arrive in two key southern European economies – Italy and Greece. According to the U.N. High Commissioner for Refugees (UNHCR), there are currently 57,000 refugees in Greece. In June, the UNHCR and partner organizations complained that they had only received half of the funding needed to implement their plans for helping refugees in Greece. While arrivals to Greece have been declining, in part due to the EU’s deal with Turkey, refugees continue heading to Italy in large numbers. Thus far in 2016, 165,409 people have arrived in Greece and 129,126 in Italy. The continuation of the refugee crisis and its disproportionate impact on southern Europe are giving the region’s governments ammunition in their negotiations over austerity.

Finally, the rise of anti-establishment movements across Europe is now beginning to impact how Berlin and Brussels approach austerity. The electoral success of the Euroskeptic and anti-establishment Five Star Movement in Italy, the Portuguese government’s dependency on an anti-establishment party called the Left Bloc, and Spain’s perennial political gridlock have made European officials more cautious about fanning anti-EU sentiments. Germany’s priority is maintaining the coherence and unity of the eurozone to safeguard its access to export markets. Euroskeptic and anti-establishment parties in southern Europe pose a direct threat to the bloc’s cohesion, and Germany is thus willing to make compromises in order to reduce the influence of these forces.

Southern Europe’s economies are fragile, and the decline of austerity politics does not mean that the problem of debt is going away: Italy’s gross public debt currently stands at 132.7 percent of GDP, while the European Commission puts Portugal’s gross public debt for 2016 at 126 percent of GDP and Spain’s at 100.3 percent of GDP.

Haggling between governments and Brussels over budgets will continue, and some political forces in Berlin will still prefer to see spending cuts in southern Europe. But fiscal health and spending cuts in the region are gradually taking a backseat as German leaders turn their attention to the export crisis, banking stability, refugee issues and the rise of anti-establishment parties. In the long run, this may be a risky choice, and for some countries austerity could come back with a vengeance. But as Europe fragments, EU members – and Germany in particular – will become more flexible on issues like austerity as they race to address pressing crises and keep the bloc together.