Europe’s debt-hit nations slash spending; some worry austerity risks another recession

Can Europe cut its way back to economic health?

DUBLIN — It’s a rule of economics dating back to the Great Depression: When fighting recession, governments are supposed to step in and spend more to compensate for slackening outlays by their hard-pressed consumers and businesses.

The global credit crisis and the harsh terms of an EU-IMF bailout to rescue Greece from bankruptcy have turned that principle on its head across Europe. From Madrid to Athens, governments under pressure to tame their runaway deficits are unveiling emergency budgets that slash tens of billions from their economies.

They hope that this coordinated commitment to austerity will turn the corner on the debt crisis by impressing the bond markets, repairing credit ratings and making it easier for them to borrow more cheaply going forward.

But many economists, particularly in the United States, insist that Europe still stands perilously at the crossroads between recovery and renewed recession — and too much austerity, too soon, represents the wrong way to go.

“If all of Europe puts on the brakes at the same time, it’s not a good thing,” said Irwin Collier, an economics professor at Free University of Berlin. He argues that the Germans — who already generate a quarter of the euro9 trillion economy of the 16-nation eurozone — ought to spend more and lead the continent out of recession even if it means running higher deficits.

This month’s slight recovery in the euro following weeks of rapid declines suggests that confidence in Europe’s economy is holding, for the moment, boosted by EU agreement on a $1 trillion backstop for troubled governments. The euro was up 0.7 percent Thursday around $1.24, up from a four-year low last week near $1.19, as EU leaders met to talk about the economy at a summit in Brussels.

But shadows still loom; Spanish officials have had to repeatedly deny news reports that a financial rescue is under discussion for them, too. Experts say any fresh bout of bad news — for example, a credit downgrade on another European government, a surprisingly sharp rise in an unemployment figure, or a bank failure — could spark another investor panic that would once again send Europe into a tailspin.

And resumed appreciation of the euro, while signaling growing confidence in Europe’s economic stability, would undercut its recovery by making Europe’s products uncompetitively expensive overseas.

“While a falling euro might say something bad about the euro zone, it’s really what the doctor ordered,” said Dan McLaughlin, chief economist at Bank of Ireland.

All of the uncertainty about growth prospects and a double-dip recession make many in the U.S. argue that the biggest priority is ensuring that the recovery is not stifled.

The thinking about the government’s role is a legacy of the Great Depression of the 1930s, which economists now think was worsened and prolonged by government efforts to restrain spending in line with the conventional wisdom of the time.

U.S. Treasury Secretary Timothy Geithner has appealed to EU finance chiefs to emulate the aggressive-spending, deficit-boosting, inflation-risking approach of the Obama administration, although the European Central Bank lacks U.S.-style powers to print more money and distribute it to member states.

“The core nations of Europe, the strongest, richest countries in Europe, (should) keep active to help support recovery,” Geithner told European leaders at a G20 summit earlier this month.

Not that such arguments have even won out on Geithner’s side of the Atlantic.

Obama is facing a growing backlash among Republicans alarmed by the gargantuan U.S. deficit. Democrats this week have offered cuts in welfare and Medicare payments as the latest gambit to persuade Republicans to back a new sweeping tax-and-spending bill. Such cuts would mean a slower growth in the deficit, and less spending money in people’s pockets.

Nonetheless, analysts agree that America has moved much more aggressively than Europe to force-feed money into its rattled economy. Nobel-winning economist Joseph Stiglitz says Europe must push harder for growth first, then attack deficits from a position of strength.

Stiglitz says Britain — enjoying greater fiscal control because it has remained outside the euro — could “set itself up as Europe’s growth economy” despite its deficit surpassing 150 billion pounds ($220 billion) or 11 percent of GDP.

Stiglitz said bond investors and ratings agencies claim to want budget cutting, but discount the moves almost as soon as they happen.

“Appeasing the markets is like trying to reason with a crazy man,” he wrote this week. “After Spain announced its cutbacks, the ratings agencies downgraded its debt because of lower growth prospects as a result of those cuts! You can’t win with markets.

“Better to follow the right policy: supporting growth through higher spending on public investment and infrastructure, which will help the economy grow faster in the long term,” he wrote.

But the view in European capitals now is that cutting as much as possible now will help avoid more savage cuts later. The countervailing fear is that such belt-tightening will handicap growth for years, risking a second dip into recession that deepens debts through lower tax collections.

The circular nature of the problem is stirring debate and spreading a sense of gloom.

German Chancellor Angela Merkel and the new British government of Prime Minister David Cameron insist that financial austerity can’t wait for a return to healthy growth, because the continent’s debts are already so severe they could lead to a domino effect of defaults.

Merkel plans to cut euro80 billion in spending over the next four years, some 3 percent of German GDP, while Cameron is unveiling his first emergency budget next week with widespread cuts to welfare benefits and the wages of state employees.

Merkel, in particular, has preached frugality as a virtue she hopes all EU nations will emulate.

“We can’t have everything we want if we are to shape the future,” Merkel said.

Leaders of other EU states, particularly France, are promoting a middle road involving cuts and stimulus in equal measure.

Norwegian Prime Minister Jens Stoltenberg said he was worried that European nations would impose cuts “too strong and too fast … because that could lead to a new setback and further increases in unemployment.”

Some economists think Europe, and the eurozone particularly, are poised to withstand the negative shock of budget cuts. They note that the depreciating euro — which has lost about 20 percent of its value in the past six months — is making life easier for European exporters because their goods outside the eurozone are cheaper to buy.

“To be honest, I think Europe already has turned a corner,” said Fabio Fois, an analyst at Barclays Capital in London who charts the industrial output of European nations.

Fois said industrial activity is recovering more than expected throughout virtually all of the EU in the current quarter, with shellshocked Greece the only laggard, driven significantly by the weaker euro. He forecast the EU’s combined GDP would grow 0.5 percent from March to June, up from 0.2 percent in the first quarter in 2010.

But the example of Ireland — arguably the hardest-hit from the credit crisis and the first to slash spending in response — may give the optimists reason for pause.

The government of Prime Minister Brian Cowen used three emergency budgets in a year to raise workers’ income taxes 15 percent or more, cut billions from welfare and other government services equivalent to 3 percent of GDP, and funneled euro13 billion from its pension reserve fund into nationalizing or propping up the nation’s half-dozen banks.

Unemployment has tripled over the past two years to above 13 percent, while deflation peaked at nearly 7 percent in 2009 before easing. Despite all the pain, the deficit this year is forecast to exceed 14 percent of GDP, so three more years of cuts loom.

“Very few Irish people believe the worst is over,” said John Cotter, associate business professor at University College Dublin, who noted his own paycheck had suffered a 27 percent net decline because of the emergency budgets.

Incredibly, budget cutting can be a vote-winner in the new debt-fearing climate. Last week, in the first national elections since the Greek crisis, the voters of the Netherlands handed power to the center-right VVD party — which had campaigned on a promise to cut spending 3 percent and balance the already well-managed Dutch budget.

“Of course the economic revival will be slowed down, but I think that’s the price we have to pay,” said Roel Beetsma, a macroeconomics professor at the University of Amsterdam.

In the countries worst hit by recession and red ink, small businesses fear they could go to the wall before their economies rebound. They dearly wish their governments would do something to encourage people to spend like the good old times of 2007.

“There are days when no one shows up,” said Athens jeweler Popi Stavrianos, 44, sitting in her shop in an upscale suburb of the Greek capital.

Stavrianos said local residents “have money but are being very tight with it,” and currently shop only for her cheapest items. “Even people who bring in their jewelry for repairs do not come to pick them up,” she said. “I don’t know if the economy is going to pick up or not. But I see people are not going to start spending again any time soon.”

And in Spain and Portugal, where governments are just starting to impose the scale of cutbacks already suffered in Greece and Ireland, state-paid employees are struggling to come to terms with how far their pay will be pruned. They voice the common Europe-wide protest that common citizens are being unfairly forced to pay for the failures of banks and billionaire investors.

“Those who have caused the crisis … haven’t been touched. The great fortunes have come out smelling of roses,” said Maria del Mar Sanz, a Barcelona resident who works in the traffic section of the regional Catalan government of Spain.

Associated Press Writers Robert Barr in London, Kirsten Grieshaber in Berlin, Demetrias Nellas in Athens, Toby Sterling in Amsterdam, Harold Heckle in Madrid, and Valeria Criscione in Oslo, Norway, contributed to this report.