What if the Germans are wrong?

This fact was examined last week in a paper by Simon Tilford, chief economist at the CER (full disclosure, the CER receives an annual grant from the parent company of the Irish Daily Mail, as well as from a shed-load of other big corporates such as Shell, Boeing and Diageo). Mr Tilford notes that eurozone policy-makers advocate in particular that Italy and Spain should emulate the Baltic States and Ireland. They argue that 'these four countries demonstrate that fiscal austerity, structural reforms and wage cuts can restore economies to growth and debt sustainability.' ... As Mr Tilford points out, Ireland and the Baltic States have all experienced economic Baltic maps wikidepressions: 'From peak to trough, the loss of output ranged from 13 percent in Ireland to 20 percent in Estonia, 24 percent in Latvia and 17 percent in Lithuania. Since the trough of the recession, the Estonian and Latvian economies have recovered about half of the lost output and the Lithuanian about one-third. For its part, the Irish economy has barely recovered at all and now faces the prospect of renewed recession. Domestic demand in each of these four economies has fallen even further than GDP. In 2011 domestic demand in Lithuania was 20 percent lower that in 2007. In Estonia the shortfall was 23 percent, and in Latvia a scarcely believable 28 percent. Over the same period, Irish domestic demand slumped by a quarter (and is still falling). In each case, the decline in GDP has been much shallower than the fall in domestic demand because of a large shift in the balance of trade.' And here comes the punch in the jaw to our Government’s fantasy of an export-led recovery: according to Mr Tilford, 'The improvement in external balances does not reflect export miracles, but a steep fall in imports in the face of the collapse in domestic demand. Countries that have experienced such enormous declines in domestic demand, and whose economic growth figures have been flattered by a collapse of imports (and hence improvement in trade balances) hardly provide a blueprint for others, let alone big countries. Spain and Italy could close their trade deficits if they engineered economic slumps of the order experienced by the Baltic countries and Ireland. But a collapse in demand in the EU's two big Southern European economies comparable to that experienced in the Baltic countries and Ireland would impose a huge demand shock on the European economy. Taken together, Italy and Spain account for around 30 percent of the eurozone economy, so a 25 percent fall in domestic demand in these two economies would translate into an eight percent fall in demand across the eurozone. The resulting slump across Europe would have a far-reaching impact on public finances, the region's banking sector and hence on investor confidence in both government finances and the banks. The impact on sovereign solvency in Spain and Italy and on the two countries' banking sectors would be devastating.'