Welcome to Austerity 2.0

Dana Reizniece-Ozola is Latvia’s Minister of Finance, and the former Minister of Economics (2014-2016)

Brexit“ and ”austerity“ are two of the most controversial subjects of recent times. Brexit is a political challenge stemming from an EU membership referendum; austerity is an economic challenge stemming from the political short-sightedness of pro-cyclical policies. But both phenomena have a direct effect on businesses and households across the European Union.

The Brexit vote, and Euroscepticism more generally, have come together with lengthy and hotly-disputed austerity policies in some countries to burden Europe’s economic revival by limiting the
influx of private money into the economy. The uncertainty caused by both Brexit and austerity is a key reason for the ineffectiveness of the European Central Bank’s quantitative easing policies. But how do Brexit and austerity interrelate? And what economic challenges can be expected from the referendum result?

One major impact relates to the EU’s multiannual financial framework (MFF) – for both the current (2014-2020) and next planning period. When Article 50 is invoked, the negotiations around and adoption of the 2021-2027 MFF will become more stressful and challenging than before. The withdrawal of Britain’s contribution will give greater power to net contributors and reduce the opportunities for net recipients. The decades of success stories that arise from EU funding is the primary argument for Structural Funds and the Cohesion Fund. The fundamental importance of an
influx of capital into smaller, peripheral economies is visible in the Baltic states, and elsewhere too. Ireland may, yet again, be one of the best examples. Small newcomers to the EU rely on financial assistance – help that would otherwise have to be found in national budgets or on international bond markets. This alternative would invariably create new pressures and calls for austerity, meaning spending cuts to long-term projects such as preventive healthcare or fixing structural unemployment.

Should the Brexit negotiations result in a swift removal of contributions from the UK, we may even see austerity pressures and a sudden need to redistribute fiscal capacity away from projects
financed under the 2014-2020 MFF. The current British input to the EU budget is substantial. With the European project on a less-than-stable footing at the moment and the economic recovery not
as fast as had been hoped, expecting ad hoc contributions from other member states to make up the missing funds resulting from Brexit appears to be wishful thinking.

Two other aspects are trade relations and financial market interdependence. Both could lead to prolonged or re-introduced austerity policies in EU countries. The operations of British financial service providers in other EU members (and vice-versa) will need to be addressed during the renegotiation process. The relocation of financial services and workers will bring shifts in tax revenue streams, and some countries could lose out. The high degree of mutual exposure to financial services, along with the economic uncertainty and currency fluctuations that the Brexit referendum has brought about, are set to cause damage to national budgets and limit the room for fiscal manoeuvring.

This is most evident for trade in goods and services. Austerity measures will have to be undertaken because of falling trade – not only real, but projected. The UK’s economy is closely tied to those
of other EU member states. Many of these countries – including my own – could suffer or are already suffering losses due to the result of the referendum and the depreciating pound sterling. Falling
export values and smaller tax revenues from exposed industries are already affecting planning for 2017 national budgets.

These are the current and most immediate consequences of Brexit for the macroeconomic situation and budgetary planning. Additional costs could come from possible infringements of the free
movement of labour and the resulting social expenses required for repatriated families.

So does Brexit mean a stricter and more prolonged period of austerity is necessary for Europe? The uncertainty of Brexit has already reduced private and public spending. But this won’t turn into a fully-fledged austerity in all EU member states if the situation is politically managed and economic uncertainty contained. The EU’s leadership may well need to find a way to implement, not only talk about, policies that will push Europe’s economy towards much stronger growth.