A Dutch Auction?

For those unfamiliar with the concept of a Dutch auction, it is one in which the auctioneer begins with a high asking price which is lowered until a participant bids for the auctioneer’s price or a predetermined reserve price is reached. Much the same is happening with the European Union’s budget deficit limit as various member states threaten to flout the rules, lead by the Dutch.

Despite being one of the Eurozone’s keenest proponents of budget deficit limits at prior European summits, the Netherlands have decided to make no attempt to rein in its projected 2013 budget deficit under the agreed limit of 3% of GDP. The Dutch economy shrank by roughly 1% in 2012 and is expected to contract a further 0.5% in 2013. The Netherlands’ budget deficit is also expected to be 3.3% of GDP in 2013. The 3.3% budget deficit is mainly due to the nationalisation this month of failing bancassurer SNS Reaal in which the Dutch government provided a €1.1 billion bridge loan and €1.9 billion recapitalization. This projection has influenced the Government’s decision not to pursue further austerity measures, such as budget cuts or tax rises, to meet the 3% limit. However they will likely back further austerity measures in 2014 when the budget deficit is estimated to be 3.4% of GDP.

The government’s decision not to pursue further austerity measures this year is largely due to the Dutch economy being hit by a drop in consumer spending. Household spending has dropped to the same level as in 2001, house prices are falling and contributing to a less liquid housing market, real wages have fallen, and value-added tax has been increased from 19% to 21%. Unemployment has also risen to 6.4% and pension funds have announced premium increases to meet their coverage ratios.

EU coming down on its member states

A secondary reason is that the Dutch government is a coalition of centre-right Liberal and centre-left Labour parties and is effectively governing with a minority as they do not have a majority in the Dutch upper house Senate. They are therefore not keen to institute budget cuts and tax raises in the Netherlands, especially as the country has experienced three such periods since 2010, which decreased government spending by €46 billion or 7.1% of GDP.

Theoretically, the European budget commissioner can impose penalties on countries that violate the agreed limit. However, the Dutch believe that they will not be fined this year as they have taken effective action against their long-term structural budget deficit. The only country to request a delay in meeting the 3% budget deficit limit, and who have not received EU economic aid, is France. Portugal, Greece and Spain have all received one year delays to comply with the limit. However there are many other EU countries seeking delays to implementing the budget deficit limit.

On a bigger picture, some say that the worsening outlook in the Netherlands suggests a policy of growth through austerity is failing. In my opinion, austerity measures are not going to bring the European economies out of the crisis – it’s akin to giving cigarettes to a lung cancer patient. Austerity means lower real incomes, pensions, and minimum wages, and this translates into less income from consumption and less economic activity. This leads to a vicious cycle of a higher budget deficit and higher taxes. The EU and its member states should not be attempting to curb their budgets – that is for when the Eurozone is on a true upswing in the boom/bust cycle. Instead they should be focusing all their efforts on reducing unemployment, which would raise productivity, European competitiveness, and overall incomes, translating into a healthier budget deficit, higher consumption, and higher economic growth.