Greece, Portugal and Spain are staring into the same economic abyss

Even from a Greek perspective, the austerity measures the Spanish government adopted last week were alarming. The cuts to civil servants’ salaries and unemployment benefits, the rises in VAT and the rest triggered the shocking realization that yet another country is about to walk the same treacherous road of abrupt fiscal adjustment that Greece has been stumbling along for the last two-and-a-half years. But it was the sight of riot police clashing with protesting miners and their supporters in Madrid that really drove the chilling reality home. Whereas Greece has been suffering a painful but largely lonely death, Spain seems poised to commit a spectacular mass suicide. The reasons that led the two countries to this point are not exactly the same but it is now clear that the miserable realities they face are absolutely identical.

While Greece’s rotten public finances have pushed its banking system and the country itself to the edge of collapse, it is Spain’s overexposed and undercapitalized financial sector that is threatening to raise public debt to dangerous levels and destabilize the country. Ultimately, taxpayers in both countries are suffering. Spain’s decision to adopt a new round of austerity measures, though, makes it more urgent than ever to answer the question of whether this suffering is part of an effective strategy to exit the crisis.

“These measures will only marginally improve the fiscal situation in Spain in the short term,” wrote the Economist Intelligence Unit (EIU) of the latest decisions by the Spanish government. “The main reasons behind the current level of the budget deficit are the fall in revenue owing to the economic contraction and the rise in spending on social benefits, also a consequence of the poor state of the economy. The measures announced try to tackle these issues, but will in the end harm the economy more than help the public finances.”

For Greece, these are familiar consequences of applying asphyxiating levels of austerity during an economic depression. The latest economic data released by the Greek government last week confirm the pattern that the EIU suggests: The deficit is shrinking but as the life is being squeezed out of the economy, tax hikes can no longer deliver higher returns and in many cases revenues are falling.

The figures for the first half of the year show that although Greece is ahead of its deficit targets due to deferring payments and reduced public investment spending, it is falling short of its goal for tax revenues by 1 billion. The effect of the austerity on revenues has been visible for some time.

In 2011, after two years of draconian austerity and repeated taxation measures, which included increases in all VAT brackets, the reduction of non-taxable income levels (from 12,000 to 5,000 euros) and the controversial emergency property tax levied through electricity bills, Greece’s revenues were marginally lower than in 2009: 88.1 billion euros vs 88.6 billion, according to the Hellenic Statistical Authority (ELSTAT). Taking into consideration that 2009 was the year of the absolute fiscal derailing that forced the country to seek assistance from its eurozone partners, the self-defeating nature of this policy mix is evident.

The argument is often put forward in Greece and abroad that one of the reasons the fiscal adjustment program has failed is because the focus on raising revenues has not been matched by an effort to cut spending. While Greece has yet to tackle some public sector privileges, the assertion that it has not addressed expenditure at all is false. Between 2009 and 2011, Greece cut its primary expenditure by 20 billion euros, a reduction of approximately 18 percent, from 112.7 billion euros to 92.7 billion. The public sector wage bill was reduced from 31 billion euros to 26.1 billion, or 16 percent.

Greece’s primary deficit in 2011 stood at 2.2 percent of GDP compared to 10.4 percent when the fiscal consolidation effort started. This reduction has come at great political and social cost: Greece has had three governments, two tense elections and countless protests, while social services such as education and healthcare have been stretched to breaking point. European officials who are quick to criticize Greece or who believe that fiscal austerity is the only possible answer to the perceived profligacy of the South should consider what kind of effect fiscal adjustments of this magnitude would have on their own societies.

For Greece, the cost of following this course will be that by the end of this year its economy will have contracted by about 20 percent from pre-crisis levels and 15 percent of the labor force will have been forced into unemployment, as the jobless rate closes in on 25 percent.

These figures suggest the country is reaching the limit of what it can do fiscally to address its situation. A fifth year of recession and third of austerity means that although there is still plenty to do in terms of structural reforms, the government has virtually run out of spending and taxation options.

Despite this obvious dead-end, Greece is being asked by the troika to find further savings of 11.5 billion euros over the next two years. While some of this spending rationalization can be achieved through the necessary intervention to reduce public sector waste, the government will eventually be forced to turn to more tax hikes and cuts to wages and pensions in a likely vain attempt to meet its latest targets.