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Spoiling the fun

30 January 2012 By Hugo Dixon

Investors are feeling more optimistic about the euro crisis. So are policymakers. That much was evident last week at the World Economic Forum’s annual meeting in Davos. There was much satisfaction over the early performance of the Super Mario Brothers – Mario Draghi, president of the European Central bank, and Mario Monti, Italy’s prime minister. What’s more, a deal may be in the works to build a bigger firewall against contagion, constructed out of commitments from euro zone members and the International Monetary Fund. And it looks like there will be another short-term fix for Greece.

But three bad fairies were lurking at the Davos feast. Spain and France are relatively new problems and Greece is an old one. All three are powerful menaces.

Madrid is staring at a particularly vicious version of the austerity spiral afflicting most of the euro zone. The last government missed its fiscal targets, leaving the country with a budget deficit of 8 percent of GDP in 2011. The programme agreed with the European Union commits Spain to cutting this to 4.4 percent in 2012. Doing so would be hard in good times. Trying to reach this target when GDP is set to shrink by at least 1.5 percent and the unemployment rate is already 23 percent would be nearly suicidal.

Mariano Rajoy’s new conservative government is making a lot of the right noises. It is steeling itself for a long overdue overhaul of the labour market. It is also preparing to clean up its banks’ toxic balance sheets. But requiring it simultaneously to throttle the economy with such a severe squeeze would set it up to fail.

There’s an obvious trade-off: in return for going full steam ahead with the structural reforms, Madrid could be allowed a little longer to get its deficit under control. Such a deal could be applied to other countries too. But it would require Germany’s blessing – and that doesn’t yet appear to be forthcoming.

Now look at France. The majority of voters there have not grasped the need to reshape the welfare state to make it affordable. Nicolas Sarkozy spoke of reform at the beginning of his five-year presidential term, but did little more than push up the state pension age from 60 to 62 – which is still inadequate – and even that provoked howls of protest.

In his re-election campaign, Sarkozy is belatedly promising more changes, such as a shift in taxes from labour to consumption. While these could boost competitiveness, the incumbent is lagging in the polls for the April ballot. His leading rival, the socialist Francois Hollande, has suggested weakening the few reforms Sarkozy managed to enact. A rise in bond yields may be needed to shock the French out of their reverie.

Finally, don’t forget Greece. Even before the deal to restructure its debts has been inked, attention has turned back to Athens’ record as a serial breaker of promises. Given that up to 90 billion euros is supposed to be handed over to Greece in the next bumper bailout payment, it’s hardly surprising that some politicians in Germany are ratcheting up the pressure to make the country keep its side of the bargain.

The latest proposal doing the rounds in Berlin is for a virtual economic protectorate over Greece, an EU budget commissioner who could overrule the decisions of the Greek government and parliament on taxes and spending. This reduction of sovereignty has already provoked an angry response from the Greeks. But something clearly needs to be done to get the country on track. If the politicians in Athens are unwilling to accept help from abroad in running the machinery of government, Greece really will find itself squeezed out of the euro.

A compromise may resolve the latest Greek standoff, just as ways may be found for Spain to avoid an austerity spiral and for the French to recognise the need for reform. But solving the euro crisis is like running a marathon with hurdles. Each hurdle may in itself be possible to jump, but the race isn’t over and the runners are getting tired.


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