By Theodore Panayotou
The hard austerity prescribed by the Eurogroup is based on the idea that, if overspending and wasteful use of resources are the root of large public deficits and accumulated unsustainable national debt, then a drastic cut in spending (and some increase in taxes) will restore the balance between revenues and spending. Hard austerity is imposed because it is seen as a sensible way to ensure that financial aid (a loan at below-market interest-rates) will be repaid and the country will return to financial health. The collateral damage of this logical approach is a fall in demand, the closing down of businesses, the increase in unemployment and negative growth with all the accompanying negative socioeconomic consequences. All therapies unavoidably involve some temporary pain in exchange for the benefit of improved long-term health.
Was the hard austerity the optimum policy?
The question is: is hard austerity the optimum treatment to secure the greatest benefit, namely the fastest possible return to stability and growth at the minimum cost? Opinions differ. The Keynesian view is that, in recessions, we need expansionary fiscal policy (more deficit spending) to stimulate demand and economic activity, and only when strong growth returns should one implement structural changes, because with the economy growing spending cuts and more taxes are easier to take.
My view is that the optimum solution is a creative combination of the two approaches: cut spending on unproductive and wasteful uses and direct the saved resources to more productive uses, along with restructuring and the provision of additional funding (from external sources such as the Eurogroup) for high-return investments to stimulate growth.
Can the euro survive in the long run?
This is the trillion euro question. There is no doubt that the crisis in the eurozone and the hard-austerity response to it has accentuated the divisions between North and South Europe, essentially creating a two-tier, two-euro Europe. In its efforts to restore financial stability and secure the future of the euro, eurozone leaders created more uncertainty, and loss of confidence and trust by depositors and investors. The bail-in, in particular, as a way of resolving banking crises, especially as it was applied to Cyprus, has undermined the investment climate in Europe, and reduced public faith in the EU in general.
Can the euro survive as a common currency if the gap between the ‘two Europes’ continues to widen? The answer is clearly ‘no’ and this is why the eurozone (and the EU as a whole) is moving closer to the US federal system with its unified fiscal and banking systems. At any rate, the euro may survive but the eurozone will be a less attractive place for investment, and a less innovative, less competitive economic region compared to the US and the emerging economies. This will not be unrelated to the unimaginative ways the economic crises of its members were addressed.
Is the MOU a curse or a panacea?
It is neither. Those who counsel exit from the Memorandum of Understanding (MoU) Cyprus signed with the Eurogroup should propose viable alternatives with hard figures and willing sources of financing. They should also explain how this disaster would not be repeated without the structural changes that the MOU requires us to do. (These are the very changes which we had the time to do before and proved ourselves incapable of doing.) Those who claim that the MOU is the only way out of our current crisis are correct since the troika are the only ones who will lend us the money we need (we tried others and failed). They are also right that the provisions of the MOU are necessary conditions for turning the economy around, but they fail to mention that they are also insufficient by themselves.
We should take additional measures if we want to bounce back soon and return to growth and prosperity. We should first decide what Cyprus we want. What are the vision and the strategy? What is the new economic model? How do we regain our international competitiveness? We need to promote innovation and entrepreneurship. We need to find creative ways to employ the unemployed. We need to reform our educational system. We need to build a leaner and more efficient public sector. We need to take action at home to reestablish trust in our institutions and international campaigns to regain credibility in both the state and our financial and banking system.
How long would it take to bounce back to growth?
It depends what one considers a reasonable timeframe. One year is too short, five years is too long. So the question boils down to whether the economy will recover in the next couple of years and begin growing again by 2016 at rates of 2-3 per cent. The question is by no means easy to answer. No one could have predicted two years ago that in 2013 the economy would shrink by 8 per cent and another 4 per cent in 2014. On the positive side, we have signed a memorandum and a 10-billion-euro loan agreement.
Our banks are now recapitalised and reforms are under way. We also have the first assessment by the troika which is largely positive. On the negative side, the trust and credibility of both the state and the banking and financial system of Cyprus have been shaken and they are not likely to recover as long as the restrictions on capital movements are in effect. Without trust and credibility, Cyprus is not likely to attract the deposits and investments necessary to fuel economic growth.
Dr Theodore Panayotou is Professor of Economics, Ethics and Entrepreneurship and director of the Cyprus International Institute of Management (CIIM). He served as professor of Economics and the Environmental Management at HarvardUniversity for 25 years, as consultant to UN agencies and as advisor to governments in the U.S., China, Russia, Brazil, Mexico, Thailand, Costa Rica and Cyprus, among others. He has published more than 100 books, monographs and peer-review articles on economic, business, and environmental issues. He was recognised for his contribution to the Intergovernmental Committee on Climate Change won the Nobel Peace Prize in 2007.