Europe argues over spending cuts
The President of the European Central Bank, Jean-Claude Trichet, who presides over this new orthodoxy, warned that "postponing cuts in the public sector... could be very dangerous".
For some countries like Greece, the Republic of Ireland and Spain, the age of austerity is well and truly here. For others like Germany, France and Italy the icy winds of prudence will only start blowing next year.
The conversion to budget-cutting was driven by fear. Countries with large budget deficits were haunted by what happened in Greece. There a country which had lied about its finances was turned on by the markets. They pushed the cost of servicing Greek debt so high that the country had to be bailed out by the EU and the IMF. Greece was in effect bankrupt and it shook the eurozone to its core. The future of the single currency, the euro, was seen to be at risk. Other countries with high deficits were encouraged and, in certain cases, muscled into announcing austerity programmes.
So in Greece public spending this year is down 40%. The Spanish are trying to reduce their budget deficit to 6% of GDP by next year. Ireland's economy has shrunk 10% as it struggles to tackle its deficit. The Italians will soon face austerity cuts put at 24bn euros (£20bn).
Not all European countries, however, share the same outlook. Firstly, there are the conviction cutters. Foremost amongst them is Germany, which is almost evangelical in its approach, telling other European countries they must not live beyond their means. The German Finance Minister, Wolfgang Schaeuble, warned that "governments should not become addicted to borrowing as a quick fix to stimulate demand".
Then there are those who became cutters out of necessity. Greece, Spain and Ireland saw the cost of raising money in the bond markets rise. They all knew how the script went. If the markets doubted their determination to slash their budgets the spreads in the bond markets would widen, their credit ratings would slide and it would become harder and harder to finance their debt.
Then there are reluctant cutters like France. President Sarkozy hated the very word "rigueur". Paris, longer than others, doubted the wisdom of cutting whilst recovery was so fragile. Now it stands ready to unveil its own 40bn-euro package of cuts. Why? France is on notice that its triple A credit rating could be lost unless it reduces its spending.
So austerity has arrived, but is it working?
Ireland was first up to take the medicine. It has been called the "poster boy" for deficit cutting. It has reduced spending, cut benefits and salaries with remarkably little resistance from the unions or the Irish people. The budget deficit has come down from 14.3% last year to 11% this year, but at a huge price. Public sector salaries have fallen by 13%. The economy has contracted. Unemployment is now 13.7%. Prices and rents are falling. Ireland is experiencing brutal deflation.
Its problems are deepened because it is still trying to sort out the bad debts inside its banks, particularly Anglo Irish. Some put the cost of recapitalising its banks as high as 50bn euros - that is almost a third of the size of the entire Irish economy.
A measure of how the pain hasn't worked is that some in Ireland are now debating whether there is a case of crying "enough" and defaulting on its debts.
In Greece the government has been much more rigorous in slashing spending than many thought possible. Officials from the IMF and the EU have been full of praise. Civil servants have seen salaries fall and perks disappear. But unemployment is rising sharply. Households and businesses remain deeply pessimistic. Few believe that despite all the hardship it can avoid defaulting down the road. Others believe the cuts have gone too far. Hans-Werner Sinn from the IFO Institute in Munich writes that "it is impossible to cut wages and prices by 30% without major riots".
In Spain public sector wages have been cut and infrastructure projects postponed or abandoned. Spain is cutting spending when unemployment among young people is running at 41.5%. Some say that reducing demand with so many out of work flies in the face of all conventional wisdom. There are some signs that the Spanish government is wobbling over the extent of its austerity package. It recently announced an extra 500m euros for infrastructure projects next year.
Despite all the measures taken the risk premiums for Ireland and Spain actually increased in August.
For France the challenge begins now. This week its reforms will be tested on the streets, when the unions protest against the plan to increase the retirement age from 60 to 62. President Sarkozy has said the changes are non-negotiable. But in France governments have buckled before in the face of street protest. The problem this time round is that investors will be watching for weak nerves. A concession on pension reform could indicate that the government will lack the will to enforce the 40bn-euro austerity package.
Theo Panos of Trafalgar Asset Managers said "austerity is the key and it is probably only in the third or fourth quarter that you will be able to see how the programmes are going".
In Europe growth is rising. Indeed it is rising faster than many predicted. But much of that is due to Germany. If demand for German exports were to slacken later in the year Europe's growth would fall away and then the key question would surface once again. Is it wise to cut spending when the economies are so weak? Only recently the economist Nouriel Roubini remarked that "there is a significant risk of double-dip recession in the US... and many European countries".
The people's verdict on austerity will soon be delivered. Europe's unions are planning a day of protest on 29 September. The union leaders have two arguments: that it is crazy to reduce spending at this time and that it is unfair to focus so many of the cuts on the public sector. Their argument is the problem started in the banks and has been transferred to the government's books and ministers are now passing it on to the public sector. Complaints of unfairness will dominate their banners.
So it may seem that the argument in Europe has been won by the cutters; austerity is in vogue. But, so far, deficit-cutting has not solved the problems and if growth slackens as the year fades governments will be under pressure to review their plans.
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