Bad medicine

By R.A. | WASHINGTON

HERE'S some news:

Recession-plagued Spain unveiled new austerity measures on Wednesday designed to slash 65 billion euros from the public deficit by 2014 as Prime Minister Mariano Rajoy yielded to EU pressure to try to avoid a full state bailout.

The conservative leader announced a 3-point hike in the main rate of Value Added Tax on goods and services to 21 percent and cuts in unemployment benefits and civil service pay and perks in a speech interrupted by jeers and boos from the opposition...

"This is a clear demonstration of the macroeconomic conditionality that we had to accept in exchange for the banking aid and in exchange for more time to cut the deficit to 3 percent," said Santiago Sanchez Guiu, economist at the Carlos III university in Madrid.

Spain has been given a little more deficit leeway this year and until 2014 to cut its budget gap to 3% of GDP. There has also been an agreement to provide aid to Spanish banks from the euro-zone's emergency rescue fund (which also looks a bit of a raw deal for Spain).

No one will accuse Spain of having a model government budget, but its crisis is not fundamentally about lax budgeting. In 2007, Spain was running a bigger overall budget surplus and a smaller structural deficit than Germany. It's gross debt was just 36% of GDP to 65% in Germany. And as of last year, it still had a lower public debt level than the Germans. One can certainly argue that Spain's boom-time surplus should have been even larger to lean against the capital inflows it was enjoying, but ultimately that wouldn't have made much difference.

More important, this is incredibly counterproductive. The Spanish economy is imploding. Without the ability to offset these cuts with a very aggressive monetary policy, the multiplier on this austerity will be substantial. There can't be much confidence that this austerity plan will generate any fiscal improvement given the likely cyclical hit to revenues and the resulting impact on banks, which could well feed back into greater sovereign obligations. It's more economic pain for no fiscal gain.

But that doesn't matter, because this is best understood as another bank shot move toward a crisis solution. The aim is to demonstrate a willingness to suffer great enough to convince Germany you're worth sharing risks with. So far the Spanish are game. But a quarter of Spanish workers are unemployed, a number that has risen 4 percentage points over the past year. One wonders how much more they'll stand.