(Bloomberg) – Europe’s leaders may agree that money has to be thrown at economies during the coronavirus crisis, but they still have to figure out how to pay for everything.
This settlement could force governments across the region to make difficult decisions about where to bear the burden of voters who are already disillusioned with political institutions – a decade after the global financial crisis presented them with past bills to resolve.
Europe’s austerity measures since then, from Greece to the UK, provide warning stories about the economic damage or election fatigue that spending cuts can cause. Given these bitter experiences, politicians are already asking questions about tax increases on wealth or income – even if they too could threaten growth.
Alternatives are tolerating higher levels of debt, like in Japan, or trying to inflate inflation to get rid of it – some sort of tax. Given historically low government borrowing costs, such approaches can look tempting as bills rise quickly. Debt ratios in the euro area and in the UK could exceed 100% this year.
“There are very few simple or politically attractive ways to deal with it,” said James Athey, money manager at Aberdeen Standard Investments. “The ideal way to pay for this is to achieve growth that is higher than your financing costs. Unfortunately, I think it will be very difficult.”
With European governments rapidly boosting borrowing to support economies, the region’s austerity measures are driving the debate about debt reduction. The overuse of such drugs in Greece in 2010 led the International Monetary Fund to conclude that it had done more harm than good to public finances and growth.
In Great Britain, whose deficit also rose to a Greek level in 2010, the austerity measures under former Prime Minister David Cameron coincided with years of negligible growth. Regardless of whether this was due to spending cuts or not, it led to discontent that contributed to its political decline when the country voted to leave the European Union.
“European governments were concerned about the sharp rise in debt and switched to austerity measures, which were likely to slow the recovery excessively,” said former IMF chief economist Olivier Blanchard.
A discussion in Europe is whether taxes should increase when the recovery takes place. The Swiss Social Democrats want higher income taxes, and the British media are also full of speculation about possible tax increases.
Another argument concerns wealth tax. The minority partner in the Spanish coalition is considering such a proposal, while in France, where the government recently cut wealth taxes, economist Thomas Piketty says history shows that such measures are the best way to reduce the huge public debt.
French budget minister Gerald Darmanin even called for a revival of the mechanisms created by Charles de Gaulle in the 1960s to distribute more capital and profits to workers and help them gain influence and purchasing power.
Camille Landais, professor of economics at the London School of Economics, even proposes a temporary, Europe-wide wealth tax.
“If there has to be some form of mild realignment of public finances, it has to be done fairly and essentially aimed at those who can best survive,” said Landais.
Chancellor Angela Merkel was already forced to reject plans for higher taxes for the time being, while French finance minister Bruno Le Maire said he did not want to reapply the country’s property tax. Athey says such reactions are understandable.
“The idea of levying taxes that don’t slow growth is very difficult,” he said.
The crisis could also trigger renewed calls to change the way of thinking in the euro area, in which the limits set by Germany for deficits and debts in the monetary union were cemented. In Japan and the United States, higher direct debt burdens are being accepted longer while governments stabilize spending and curb borrowing through economic growth, thereby transferring part of the burden to future generations of politicians. Central banks are taking action to help governments keep debt costs under control. Borrowing has largely eliminated concerns about rising borrowing costs in the early 2010s and laid a foundation for public finances to repair themselves.
“The only sensible way out of over-indebtedness or high debts is more economic dynamism,” said Marcel Fratzscher, President of the DIW Institute for Economic Research, this month. “This is the lesson after the global financial crisis.”
Central banks could also be under pressure from governments to keep monetary policy relaxed for longer and tolerate inflation that undermines the value of government debt – a tactic that helped the UK keep its credit under control after World War II bring to.
Inflation, which has long been sought after by the monetary authorities since the financial crisis, would also affect savings and provoke painful memories in some countries, from Germany in the 1930s to Britain in the 1970s. Fratzscher says that a debt reduction policy is “harmful”.
But what if debt simply cannot be controlled? William White, senior fellow at C.D. The Howe Institute in Toronto and a former chief economist at the Bank for International Settlements say the outcome is a real possibility.
“We are on a bad path of debt accumulation here,” he said. “It is necessary to think much more seriously about proper debt restructuring.”
Bloomberg Economics: G-20 debt dashboard
(Updates with the French Minister of Budget in the 11th paragraph.)
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