Austria: Island of Stability?

Franz Nauschnigg is the head of the European Affairs and International Financial Organizations Division at the ONB

Franz Nauschnigg

With Europe in crisis, Austria can count itself lucky. The country has outperformed the rest of the European Union in these economic hard times. The recession of 2009 was not as deep – Austria’s economy shrank by 3.9% of the Gross Domestic Product (GDP), compared to the EU average of -4.2%. And Austria’s return to growth was faster and stronger than in the rest of the EU, marking 2% of GDP in 2010 against the EU average of 1.8%.

How has this been so? Austria’s strong showing can be traced to three things: low budget deficits before the crisis, in turn enabling countercyclical fiscal policies, as well as successful management of the credit crisis in the Central European and South Eastern European (CESEE) region. 

A low annual budget deficit and modest state debt before the crisis allowed the Austrian government to counter the dawning recession with a bold fiscal stimulus. Infrastructure building put firms and people to work. Income tax cuts freed up consumer spending, as did cash-handouts to people willing to scrap their old cars and buy new ones. 

Not least, a €100 billion loan package to Austrian banks helped increase their capital and enabled them to resume lending. 

Yet despite these costly interventions, the state’s annual budget deficit remained lower than the EU average. Its high watermark was 4.6% of GDP in 2010, while the EU’s hit 6.4% that year. Therefore, Austria’s total public debt of 73.8% of GDP in 2011 remains significantly lower than the 86.5% average for the euro area, the EU average of 82.3%, and far lower than the U.S.’s 101% or Japan’s staggering 212%.

Finally, Austria’s activism at the European level helped stem the burgeoning financial crisis in CESEE that was threatening Austrian banks which have large exposures to the region. 

To recap, immediately after Icelandic banks collapsed in October 2008, financial contagion spread to Hungary. By early 2009, the entire CESEE region was confronted with rapid capital outflows, depreciating the countries’ currencies and thereby making it more costly for states and households to service their foreign debts. This put Austrian banks, with massive outstanding loans in the region, at risk. 

At this point, Austria stepped up its international effort. Intense lobbying and a strong Austrian-French coalition overcame German resistance in the European Council, paving the way to the decision in March 2009 to increase the EU balance of payments facility to €50 billion, and provide the IMF with €75 billion. 

Together with the later decision by the G20 group of rich and emerging economies to increase IMF funds to $750 billion, this stabilised the currency and bond markets. Investors were confident that the EU and the IMF now had enough funds to rescue the entire region, if necessary. In the end, only a fraction of those funds had to be spent. 

Crucially, Austria initiated private sector involvement that helped turn the crisis around. In the so-called Vienna Initiative, a group of Western and Eastern European banking supervisors, joined by the IMF and the European Bank for Reconstruction and Development, successfully lobbied the private sector to maintain its exposure in CESEE countries, preventing the panic-selling of bonds and currencies that would have driven up interest rates and made a default more likely. 

In the euro area as a whole, international cooperation has, up until now, been less successful. Following the crises that started in Greece in 2010, contagion has spread to Spain and Italy. 

We should learn from the successful response to the CESEE crisis in 2009. Now, as then, the EU, euro area and IMF must provide sufficient funds to cover all of Spain’s and Italy’s possible financing needs, including recapitalisation of  their banks. This would get credit flowing back into their starved economies. At the same time, a recast “Vienna Initiative” should convince private lenders to hold on to their Spanish and Italian bonds to keep interest rates down.

Markus Marterbauer (right) is the head of the economics department, and Sepp Zuckerstätter is a senior economist at the Austrian Chamber of Labour (AK)

Markus Marterbauer and Sepp Zuckerstätter 

The worldwide failure of banks and financial markets in 2008 led to the deepest economic crisis since the 1930s. In 2009, EU GDP dropped by more than 4% in real terms. By 2011, it still stood about 1% below its pre-crisis level.

Austria fared a little better during these years. By the end of 2011, Austrian GDP stood 1.3% above its 2008 level. Rates of unemployment (4% of the labour force) and youth unemployment (7%) are the lowest in the EU, far below the Union’s averages of 9.5% and 21.4%.

However, the total number of jobseekers is still 50,000 (or 0.5%) higher than it was in 2008. Therefore, tackling unemployment remains a major political task.

Still, it could have been worse. Successful labour market development in economic downturns is one characteristic of the Austrian economy, chiefly by tightening the labour supply:

Reducing employees’ working hours, rather than laying them off, maintains the long-term benefits of a stable employment relation when the economy picks up again.

Reductions in overtime and holiday accounts, programmes of educational leave, and shortened working hours helped dampen unemployment, especially in manufacturing. Guaranteed vocational training for young jobseekers helped to keep youth unemployment low.

In addition, stabilising demand was important for returning to economic growth. The single most important factor was the welfare state: During recessions, it steadies consumption because, confident that their basic needs are covered, Austrians use their savings to continue spending. Constant consumer demand and reduced savings in downturns, and increased savings in boom years are characteristic of the Austrian economy. Both help keep output and employment levels up.

In addition, higher wage increases, low inflation, a reduction of income tax rates, and higher transfers to families and pensioners in 2009 proved beneficial. That year, per capita wages after tax actually increased by nearly 3% in real terms compared to 2008.

Still, the financial crisis imposed huge costs on Austria, not only in terms of an increase in joblessness, but also in terms of rising public debt: The stock of public debt jumped from 62% to 72% of GDP because of the downturn.

Public debt levels are currently too high. High public debt causes unproductive interest expenditures. Therefore, debt reduction is a necessity. However, successful debt reduction crucially depends on sound economic development.

Here, there are at least three hopeful indicators. First, Austria has a very productive and competitive manufacturing industry, accounting for the country’s favourable trade balance. Second, Austria benefits from a well-educated workforce, and stable industrial relations within the social-partnership system, enabling long-term planning for companies.

And third, high per capita income and the huge wealth of private households provide favourable financing conditions for both private and public investments. Private wealth in Austria is nearly six times higher than public debt, although the distribution of income and wealth is increasingly uneven.

Currently, high volatility in financial markets and austerity policies across all EU member states are leading us into a new recession. This poses enormous problems for the Austrian economy. More than one third of total demand in Austria comes from abroad. The bulk of this stems from other EU countries. Without recovery in those countries this demand is sure to dampen.

But the most striking risk still lies with the financial sector. Banks all over the world are still struggling to stabilise their balance sheets. Given the high degree of uncertainty and distrust between banks, the exposure of Austrian banks to risk in Eastern Europe remains a major concern.

Yet Austria's economy and economic policy have proven well equipped to provide stability in times of crisis. With its adaptable and stable institutions, Austria should perform well in the period of economic headwinds that lies before us.

Marcus Scheiblecker is an expert on Austrian development and European economic policy at the Austrian Institute of Economic Research (WIFO)

Marcus Scheiblecker

Thanks to the lively demand for Austrian goods and services from outside Europe, the real effects of the ongoing debt crisis in the euro area have been contained – at least so far.

This year the Austrian economy will post a strong growth of around 3%.

Certainly, the reason for this is that Greece, Portugal, Ireland and Spain weigh relatively lightly in Austria’s foreign trade. These four countries together had a market share of just around 4% of total Austrian commodities exports in 2007. Due to the crisis, their share declined further to below 3% in 2010. In tourism, Austria’s main service export, the four countries make up less than 1% of all over-night stays in Austrian resorts.

Yet with the debt crisis still unfolding, the resilience of Austria’s economy could come under pressure. The Italian government has announced a substantial austerity package to calm its creditors, as ten-year yields on Italian bonds jumped dangerously beyond 7% in November. The new prime minister, Mario Monti, has set about balancing the fiscal budget within two years – from its current deficit of -4% of GDP. This will be an additional strain on the already stagnating Italian economy and could have a greater impact on Austria’s than it has been so far.

Italy is Austria’s second largest trading partner after Germany, with an export market share for commodities of around 8%. Moreover, 2.5% of all over-night stays are booked by Italian tourists, mostly in cities where spending tends to be higher than on the ski slope. The austerity programme, meanwhile, is sure to dampen Italians’ demand for Austrian products, as well as their taking chic weekend holidays in Vienna.

Another way that the negative effects of the debt crisis could be transmitted to Austria is the exposure of Austrian banks to financial distress abroad.

Whereas the amount of Greek, Portuguese and Irish sovereign bonds held by the Austrian banking system is relatively modest, Italian bonds make up a substantially larger part of their portfolio. If these have to be depreciated, this could endanger the capital structure of Austrian banks.

In fact, Italy’s troubles already seem to be crossing the border into Austria. In November, yields for Austrian sovereign bonds unexpectedly rose sharply from 2.6% to 3.8%. This happened despite the fact that Austria is one of the world’s richest nations, with a debt to GDP ratio that is lower than Germany’s, strong economic growth before and after the crisis, and the EU’s lowest unemployment rate.

The reason for the sudden spike in interest rates paid on Austrian debt, then, could be that markets are aware of the Italian economy’s importance for Austria. As Austrian firms lose business in Italy, lenders seem to fear that the Austrian state also may run into difficulty in servicing its debts, and are hence charging a risk premium.

A further reason could be that the reduced creditworthiness of Italian bonds held by Austrian banks increases the probability that they will have to be rescued by the government. Such a bailout would drive up Austria’s public debts, as well as their yields. While this is an extreme scenario, the shifting odds are enough to actually push up the yields on Austrian bonds.

Admittedly, if the crisis deepens in Italy, this will increase the impact on the Austrian economy. But, despite Italy’s relative importance, it is unlikely to be decisive; the Austrian business cycle – like Germany’s – is much more dependent on factors outside of Europe.

Over the past 10 years, growth in Austria was on average 1.25% higher than in Italy, but this year the difference will reach 2.5%, as the Austrian economy will grow by 3%, despite Italy’s meagre growth of 0.5%. For the next two years, the European Commission forecasts the growth gap to narrow again to 1%.

This means that, even with Italy in a mild recession, the Austrian economy should continue to grow.