Voters across Europe have spoken in the last week and the message they have sent has upended the fragile consensus that budget cuts and fiscal discipline would bring the continent back from the brink of debt Armageddon.
In national elections in Greece and France, as well as local elections in Germany and Italy, voters turned out governments that backed so-called “austerity” programs that would have brought a measure of sanity back to budgeting and debt management, while electing socialist politicians who promised that economic problems could be solved by implementing “growth” policies — policies that include massive new spending, tax increases on the “rich,” and a rollback of budget cuts.
Greece appears to be a nation in full denial, rejecting the coalition that negotiated a bailout package worth 180 billion euros that would have kept the nation in the euro zone, and embracing a radical socialist party that wants to scuttle the deal. French voters had other problems with former President Nicholas Sarkozy, but it was primarily his tepid attempts to reform labor laws and the education system that led to his downfall in the May 6 election.
President-elect Francois Hollande has promised to restore what Sarkozy cut, while making it clear that he wants to “renegotiate” the carefully crafted “fiscal compact” that sets budget and deficit guidelines for the entire euro zone. The compact was the work of German Chancellor Angela Merkel and Sarkozy — “Merkozy” as the duo was referred to in the European press. The defeat of Sarkozy calls into question the France-Germany relationship, which is largely responsible for keeping the EU from disintegrating in these last two years of crisis, as the leaders of the two largest economies in Europe successfully navigated the panics that almost tore the euro zone apart.
In Spain, where one in four workers are unemployed, the government has come under massive pressure from the left to change course from the painful medicine of cutting services and firing government employees and embrace massive increases in spending. Prime Minister Mariano Rajoy is determined to stick with his budget cutting and deficit reduction. Madrid announced this weekend that it may take over the finances of an entire region because the local government may not be able to meet his deficit targets. He has also vowed to clean up Spain’s tottering banking sector, taking over Bankia, the country’s largest mortgage lender, just this week.
But for all of Rajoy’s cutting, it is likely he will not meet his deficit target for the year. Instead of a projected deficit of 5.3% of GDP, Spain is likely to see a 6.4% shortfall. This is down from 8.3% last year, but is not likely to appease investors in Spanish debt who will demand a premium that may lead to even more financing problems for the country. Ten year notes ballooned to over 6% this past week — an unsustainable level that would set off a ruinous debt spiral of increased deficits due to costlier debt servicing, which would panic investors even more, leading to higher interest rates on bonds to finance the debt.
Spain’s economy is expected to contract almost 2% this year, with anemic growth projected for 2013. With budget cuts just beginning to bite and no growth in sight to bring the unemployment rate down significantly, the future is not bright for Rajoy’s efforts. Hundreds of thousands took to the streets on Saturday in Spain’s major cities to protest against Rajoy’s efforts to bring Spain’s fiscal crisis under control. It is doubtful, given what we’ve seen across Europe this past week, whether he can hold together the consensus to continue his austerity program.
Spain may flirt with disaster in the coming months, but the spotlight this past week was on France, and especially Greece, where national elections have unleashed the socialist left and promise to bring the euro zone back into a full fledged crisis sooner rather than later.
The election of Francois Hollande in France — the first socialist to win the presidency since Mitterand 16 years ago — has had the immediate effect of breaking the alliance between Merkel and Sarkozy that proved to be the linchpin that held the EU together during the worst of the sovereign debt crisis. Their partnership produced several measures that will allow the European Central Bank more leeway in dealing with future crisis while their collaboration on the EU fiscal compact has tied the economies of the EU together in a way never before attempted.