Eurozone recession ends -- but it's too soon to celebrate

Story highlights

  • The eurozone's second quarter growth rate reached 0.3%, better than last 18 months
  • There is joy in Brussels and Berlin as European leaders credit austerity with the shift
  • But, Paul De Grauwe says, the change could be due to a softening of austerity
  • And it is too early to celebrate an emergence from crisis

Spring is in the air. That's the feeling in Brussels and Berlin. The latest economic numbers issued by the European Commission seem to indicate that the eurozone has slowly crawled out of the recession.

The eurozone's second quarter growth rate reached 0.3%, still below the U.S. and UK growth rates, but better than the negative numbers of the last year and a half. Time to rejoice.

The joy was particularly felt at the headquarters of the European Commission. According to Olli Rehn, the Commissioner responsible for economic and financial affairs, this timid recovery vindicates the budgetary austerity strategy imposed on the eurozone member countries since the start of the sovereign debt crisis.

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According to the champion of austerity in Europe, the salutary effects of sustained austerity manifest themselves in the eurozone and explain the recovery. We should be grateful to Olli Rehn for having designed this strategy.

The facts, however, point to something very different.

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In recent months the European Commission has had to relax its austerity programs in a number of eurozone countries, mainly because it became patently evident the programs did not work. Thus if there is a recovery today, it is because the Commission had to relax its austerity strategy.

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This relaxation allowed budgetary policies in a number of countries, in particular France, to sustain economic activity, however feebly. The only country that has maintained budgetary austerity in all its severity is the Netherlands. It is also the country that, together with Italy, remains stuck in a recession.

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The view that fiscal discipline is the cause of the recovery is extraordinary, even surreal. It's like a thug who has beaten up his victim. After he has stopped the beating, the victim regains consciousness. That's when the thug says to his victim that he should be grateful, because the beating has made him stronger and allowed him to recover.

How sustainable is the recovery in the eurozone going to be? I see two risks that endanger its sustainability.

First, as the victim is recovering, chances are that the European Commission will want "to start the beating" again -- or intensify the austerity programs.

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The relaxation from austerity that the European Commission decided last year was done halfheartedly. The recovery may be the occasion the Commission is waiting for to return to its favored strategy of intense fiscal discipline. If this is allowed to happen, the recovery will turn out to be only temporary.

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A second more fundamental risk endangering a long-term recovery arises from the continuing split between the North and the South of the eurozone. This split has its origin in the fact that the North has accumulated large current account surpluses and the South current account deficits during the time before the eruption of the financial crisis.

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All this has led to the situation in which the North consists of creditor nations, which want their money back from the debtor nations in the South. The whole austerity strategy has been driven by this split. It is a strategy imposed by the creditor nations and implemented by the European Commission, with the aim of making the South pay back its debt towards the North.

This strategy has had as a paradoxical effect of dramatically raising the debt to GDP ratios of Southern countries, because GDP has imploded while the debt could not be contracted. These debt ratios now exceed 100% in many Southern countries and continue to increase at a fast pace. Countries like Greece and Portugal have become insolvent, and others like Spain are reaching that state quickly.

Sustained recovery will only be possible if the creditor nations in the North, especially in Germany, recognize that the claims they hold on the Southern eurozone countries will not be repaid.

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Insisting that these countries repay in full condemns these countries to years, if not decades of recession and low economic growth. In the end they will not repay their debt. The reason is simple. Politicians in the South will not, for much longer, accept that fruits of austerity are used to service debts to foreign nations while inflicting great pain on their own citizens.

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The best growth strategy for the eurozone would consist in recognizing this fact and in accepting debt relief. This would make it possible for the Southern European countries to restart their economies unhindered by the shackles of unsustainable debt levels.

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Unfortunately, this is unlikely to happen soon. The largest part of the claims held by Northern eurozone countries are now stacked in the hands of public institutions in the North of Europe. This makes it difficult to come to a rational solution.

In many Northern countries, emotional views of good and evil prevail today, leading to a desire that evil be punished. Southern eurozone countries are seen as having followed bad policies.

These have to be punished, lest they start behaving badly again. This attitude makes it difficult for politicians in Northern countries to choose the rational outcome of debt relief that would make a sustainable economic recovery possible.