Budget cuts in Europe: The "virtuosi" and the "laggards”

Paolo Manasse

26 July 2010

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Budget cuts, fiscal sustainability, exit strategies – the debate on what Europe should do is raging (Giavazzi 2010, IMF 2010). Less analysis, however, has been devoted to the question of who should do what – which countries are doing too little or too much from a European perspective? Who are the “laggards” and who the “virtuosi”? And what lessons can we draw from the evidence?

In a previous Vox column (Manasse 2010) I argued that the present allocation of budget cuts in Europe makes some sense.

  • The planned consolidations for 2010 to 2015 tend to be larger for countries with higher public debt-to-GDP ratios and larger primary fiscal deficits, as required by the need to address solvency issues.
  • Countries with larger current-account deficits have planned (ceteris paribus) tougher cuts, as required for correcting imbalances within Europe.

The snag is that cuts tend to be larger where unemployment is higher. This feature does not bode well for the recovery in Europe.

Laggards and virtuosi

The first column in Table 1 shows the planned cumulative budget cuts for 2010-2015 for countries in the Eurozone and the UK (source: CESIFO). On average (last row) the fiscal consolidation effort in Europe is substantial, 4.2% of the area’s GDP, and it is mostly concentrated in 2011-2013.

It would be misleading, however, to compare each country’s effort with the European (weighted) average, and to label a country a “laggard” or “virtuoso” if cuts are below or above the average. By doing so, one would wrongly conclude that Germany and the Netherlands are “laggards”, which obviously they are not.

Table 1. Budget cuts, debts, and deficits in Europe

 
Adj/GDP
Share (EUZ+UK)
 Public Debt
Prim_Bal -
(EUZ+UK) Pbal
Share of
 (EUZ+UK) GDP
AUSTRIA
0.90%
2.59%
1.46%
2.65%
BELGIUM
5.30%
4.60%
2.49%
3.38%
CYPRUS
 
0.14%
2.03%
0.16%
FINLAND
 
1.16%
1.17%
1.64%
FRANCE
4.50%
21.26%
-0.72%
18.04%
GERMANY
3.00%
24.96%
1.55%
22.46%
GREECE
10.70%
3.86%
2.59%
2.09%
IRELAND
3.20%
1.58%
-10.85%
1.46%
ITALY
1.60%
23.69%
4.08%
14.25%
LUXEMBOURG
 
0.09%
1.15%
0.37%
MALTA
 
0.06%
14.56%
0.05%
NETHERLANDS
2.10%
4.96%
0.22%
5.40%
PORTUGAL
6.60%
1.83%
0.03%
1.56%
SLOVAKIA
2.50%
0.34%
-0.36%
0.60%
SLOVENIA
 
0.20%
1.37%
0.37%
SPAIN
8.20%
8.68%
-2.98%
9.71%
UK
6.00%
15.25%
-3.66%
15.81%
Average EUZ+UK
4.16%
80.57%
-5.03%
 

Sources: Author's calculations from CESIFO, OECD Economic Outlook, EIU data.

Clearly, we have at least to consider each country’s debt and primary balance. Take Italy, for example. It accounts for 14.2% of the European GDP (Eurozone plus UK, last column of the Table), but is responsible for almost 24% of the outstanding public debt in Europe (second column). Presumably its adjusment should be higher than the actual meagre 1.6% of GDP (first column). Yet note that the primary balance in Italy in 2010 (at -1% of GDP) is more than 4 percentage points above the European (weighted) average (third column). Presumably, Italy should adjust less on that count. How can we put all this information together? Clearly, we need a “European” benchmark .

To this end, I construct such a benchmark with the help of a simple cross-section regression that adjusts for varying economic fundamentals – such as debt-to-GDP ratio, primary balance, overvaluation of the exchange rate, and the current account [1]. In essence, I ask how the adjustment of a particular country compares with the adjustment that the “average European ” would have chosen had it experienced the same economic fundamentals [2].

The results are illustrated in Figure 1, for two exercises (the first excluding and the second including Greece in constructing the benchmark). A positive/negative value indicates that the country “over/under adjusts relative to the European benchmark.

Figure 1. Excess cuts in Europe

Source: Author's calculations

A statistical identification of virtuosi and the laggards

The figure shows that the virtuosi include Belgium (with an excess adjustment between 1.5 and 1.8 percentage points of GDP in 2010-2015), The Netherlands and Germany (0.4 to 1 percentage points) and, somewhat surprisingly, Portugal (1 to 1.9%), Spain (0.8-1.3%), and Greece (0.7% of GDP).

The UK is roughly in line with the EU average (when Greece is excluded) and appears as a “virtuoso” (+1.8 points) when Greece is included in the exercise.

Ireland appears here as a laggard only because budget cuts have occurred before 2010 and are therefore are not shown here. There are two other small and one big laggards.

  • The small ones are Austria, whose adjustment falls below the benchmark by roughly half of a percentage point, and Slovakia (- 0.8% and -1.4%).
  • The “big laggard” is Italy. At the current level of debt (and primary and current -account balance and unemployment), Italy would need extra cumulative fiscal cuts of 2.4 to 2.7 percentage point of GDP in five years, to be in line with European consolidation efforts. 

Conclusions

This simple statistical exercise sheds light on Europeans' various fiscal efforts.

  • Greece, Portugal and Spain – which financial markets have singled out as the most vulnerable – have planned adjustments that other Europeans, at comparable fundamentals (but paying average spreads!) would not dream of.
  • Germany and the Netherlands are the virtuosi, but moderately so.
  • Among high debt countries, Belgium is overdoing it, striving hard not to join the GIPS club (Greece, Italy, Portugal, and Spain).
  • Italy, so far, is getting away with it…

References

Giavazzi, Francesco (2010), “The “stimulus debate” and the golden rule of mountain climbing”, VoxEU.org, 22 July.

IMF (2010), "Navigating the Fiscal Challenges Ahead", Fiscal Monitor Series, 14 May.

Manasse,  Paolo (2010), “Budget cuts across Europe: Coordination or diktat?”, VoxEU.org, 24 July. 


[1] In practice, nothwithstanding the small numer of observations, I regress the size of adjustment planned for 2010-15 on the following economic “fundamentals” in 2009: the primary balance/GDP ratio, the debt/GDP ratio, the appreciation of the real exchage rate since 2005, the current-account balance/GDP ratio, and the unemployment rate. In the first specification I include a dummy variable for Greece, and in the sencond I do not. The excess adjustment reported in Figure 1 for each country is simply the difference between the country ‘s actual and predicted adjustments, under he two specifications.

 

[2] By construction, these country specific counterfactual adjustments sum up to the Europe-wide cuts, 4.2% of the Eurozone’s GDP.

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Topics:  Europe's nations and regions

Tags:  Germany, Greece, Fiscal crisis, Eurozone crisis, budget cuts

Professor of Macroeconomics and International Economic Policy, University of Bologna

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