Lorenzo Bini Smaghi: Reform denial poses bigger threat to democracy than austerity

[…] structural reforms are politically difficult to implement, in advanced economies, not only in Europe. They require measures that are generally opposed by lobbies, which defend the interests of insiders, in the labour, capital or goods and service markets. Such lobbies are strongly represented in parliament or in government. Structural reforms thus tend to be delayed as long as possible, at least until the financial markets continue to finance imbalances at sustainable rates.

When markets turn around, and start losing confidence, pressure mounts on the policy makers to implement measures aimed at reducing the excessive budget deficit so as to maintain market access. The longer governments wait, the tougher are the measures required to restore investors’ confidence. […]

There are several problems with this strategy. The first is that when market confidence is at stake, quick decisions are needed to restore stability. Under these circumstances, it’s politically easier to adopt fiscal measures, in particular on the revenue side. Selective expenditure cuts are more difficult to agree upon. Structural reforms are left for a second stage, as they require more time to be designed and negotiated with the social partners. […]

The second problem is that if the fiscal measures are successful in calming the markets, there is less pressure to implement the second leg of the programme. Structural reforms tend to be further delayed. The opposition of interest groups strengthens. The proposals for changes in the labour and goods markets are diluted.

The result of this strategy is that the adjustment takes place largely through restrictive budgetary measures, whose impact on growth is much more recessionary than expected. […]

No wonder citizens voted against this policy. But this policy is the result of their unwillingness – and that of their elected politicians – to implement a timely and more balanced adjustment package, either independently or through a programme negotiated with international institutions.

Austerity is the result of countries’ democratic decisions to wait until the last minute before acting, under the pressure of the markets, mainly by raising taxes rather than implementing long-waited reforms. Denying this, by claiming that austerity has been imposed on countries – rather than self-inflicted – and looking for scapegoats, is the biggest threat to democracies going forward.