Spain leads Europe's rebellion against German austerity

Prime Minister Mario Rajoy told EU officials that Spain would not meet its deficit target for 2012. Other countries, struggling to avoid further recession, may follow suit. 

Europe’s economic crisis is moving to the less predictable national political arenas, where country leaders are struggling to balance draconian austerity with the dire need for growth. Facing populations that are losing patience with worsening economic pain and an economic picture that has failed to improve, leaders are beginning to defy demands from Brussels. 

Leading the rebellion of sorts against the European Union’s mandated all-cut-and-no-growth strategy is Spain, the focus of market concerns. Spain’s economy is too big to bailout and the country has been among the most supportive of austerity measures. 

 “Now more than ever it’s imperative that we distance ourselves from delusional proposals, that we deal with realistic figures, and that we implement policies accordingly,” said conservative Prime Minister Mariano Rajoy yesterday in an address to European delegates of the People Party, which governs in most of Europe. “Only this way can we strengthen confidence [in policies] among citizens, our partners, and the markets.”

Mr. Rajoy was explaining why he defied the EU and abandoned Spain's commitment to cut its 2012 deficit equal to 4.4 percent of gross domestic product, recasting it at 5.8 percent. He left the 2013 binding target of 3 percent unchanged.

With its defiance, Spain drew a line. It has already delivered austerity and necessary reforms in the past four years, but now needs to stimulate growth to increase its tax base and spur job creation. Without growth, Spain’s debt problems and budget cuts can’t be resolved – politically or economically.

While not completely unexpected, many in the EU were surprised by the timing of Rajoy's announcement. Along with 24 other EU leaders, he had just signed the German-led fiscal compact that will force governments to balance their budgets by 2013, under the threat of hefty penalties. 

'The canary in the coal mine'

Spain is the first country to officially demand more flexibility with its deficit, at least for 2012. But it likely won’t be the last, analysts say. Belgium, Cyprus, Hungary, Poland, and Malta have already been warned that they are on track to miss their targets. France could also follow if voters boot out President Nicolas Sarkozy in the upcoming election.

Italy is increasingly balking at reforms. And even Germans and the Dutch are demanding more growth-oriented policies from their governments, even if they balk at more bailouts for their southern neighbors. 

“Spain is like the canary in the coal mine,” said José Ignacio Torreblanca, a senior policy fellow of the European Council on Foreign Relations. “It’s trying to avoid an either/or choice between austerity and stimulus.”

Until now, peripheral countries have had little choice but to accept austerity, not only because it was necessary, but because it was the only way to convince a German-led northern Europe to bail out Greece, Ireland, and Portugal to avert a wide meltdown of the eurozone.

But rising violent protests, unemployment, and poverty levels are swinging the debate to the national level as European governments recalculate the political fallout. Governments are under increasing pressure to seek more growth driven policies, even if it means less ambitious deficit targets.

On Friday, Spain’s biggest unions called for the first national strike against Rajoy on March 29, citing the government’s unwillingness to negotiate its economic reforms, especially the labor reforms enforced in February that make layoffs less costly and quicker and allows employers to lower salaries.

“Spain is saying Europe needs both. Austerity is a market condition, but it’s not the only one,” Mr. Torreblanca said. “This is the time to start talking about what comes after austerity.”

And there is a powerful precedent. “In 2003 it was Germany and France who asked the EU for more flexibility to meet its deficit,” Torreblanca said. “Germany is going to have to accept that this is just as good as it gets.”

Here, it's not about debt

Today the EU Commission acknowledged it sent delegates to Spain this week to review its deficit data, ahead of the government budget presentation late this month. Only then will the EU decide whether to seek penalties for failing to meet the deficit target.

When Rajoy came to power in December, he said the deficit was 8.5 percent, a serious deviation from the target set in 2009 of 6 percent that the new government has mostly blamed on overspending by regional governments with great autonomy over budgets. 

But Spain’s woes are not the result of spendthrift irresponsible politicians, at least not entirely, but rather the failure of an economic model based on construction and cheap labor – markets that collapsed with the beginning of the credit and debt crises. Spain has traditionally had much less debt than most of its neighbors, but it will take years to reconvert its economy and spur growth. 

“In Spain’s case, markets aren’t worried about reforms, but about jobs and growth,” Torreblanca said. “It makes no sense to ask Spain to commit suicide.” 

The Central Bank expects the economy to shrink another 1.5 percent this year, after four years of lethargic contraction. The government has already warned that the unemployment rate of 23 percent – by far the EU’s highest – will continue to rise this year and public services and spending will be trimmed.

While the EU Commission and Germany might not be satisfied by Rajoy’s new deficit target, it is still a substantial trim. It assumes around 40 billion euros in cuts, on top of tax increases, labor reforms, massive layoffs, and salary cuts in the public sector. More importantly, it comes after a battery of austerity cuts from the previous government.

“I don’t know if in modern history there is any EU country that has made such an effort [as Spain has],” said Rajoy.

The Socialist government implemented some of the most severe cuts in Europe starting in 2009, cutting its deficit of more than 11 percent of GDP in 2009, to 9.3 percent in 2010, and was supposedly in line to meet its 6 percent target in 2011.

Rajoy also said the new deficit target simply reflects a new reality. The previous government set the previous target in 2009 expecting growth to pick up starting 2011. The EU, OECD, and several institutions confirmed the targets then. But instead, the economies of Spain and the rest of Europe stagnated.

“With Rajoy’s government balking – rightly – at further austerity, the focus is now where it arguably should have been all along,” Paul Krugman, a columnist for The New York Times and frequent critic of Europe's tough austerity prescription, wrote in a blog post this week. 

“And with Spain now front and center, the essential wrongness of the whole European policy focus becomes totally apparent. Spain did not get into this crisis by being fiscally irresponsible. What’s clear is that even more austerity does nothing to help; all it does it reinforce the downward spiral, and bring the possibility of real catastrophe nearer,” Krugman concluded.

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