The medicine is unproven, but the patients are in a desperate condition.The European Union is attempting to solve its debt crisis with a severe dose of austerity. On Tuesday (21 June), the UK became the latest EU member state to impose a tough package of spending cuts and tax rises aimed at reducing its budget deficit. 

George Osborne, the UK’s finance minister, presented the package as an unfortunate but unavoidable step if the country was to maintain investors’ faith in its public finances and restore growth. The argument is a familiar one: the UK is following a path pursued also by Germany, Portugal, Spain, Denmark and Italy, all of which have already announced austerity measures.

These deficit-cutting moves have been welcomed by Jean-Claude Trichet, the president of the European Central Bank, who is arguing that budgetary consolidation is an essential prerequisite for financial stability, and, in turn, growth.

The EU’s drive towards budget consolidation is, however, taking place at an uneven pace in different member states.

France’s government is notably lagging behind. It has been criticised by both the European Commission and the International Monetary Fund this month for failing to show sufficient commitment to budgetary rigour.

The official explanation for France’s reluctance to impose deeper austerity measures is that growth requires high public investment. Rapid consolidation of its finances would increase unemployment, so harming economic recovery, the government argues. Nicolas Sarkozy, France’s president, said earlier this month: “If we add austerity to austerity, we are going into recession.” A rival explanation is that Sarkozy will be seeking re-election in 2012.

Nevertheless, Sarkozy’s concerns are shared by many of Europe’s centre-left parties and trade unions, and by László Andor, the European commissioner for economic and social affairs.

Barack Obama, the US president, warned in a letter to EU leaders last week that excessive spending cuts by governments could lead to “renewed hardships and recession”. Obama will be repeating this message at this weekend’s meeting of leaders from the G20 group of industrialised and emerging economies in Toronto.

The EU’s unpatented medicine has a peculiar provenance. The main impetus for austerity measures is the need to send a strong signal to the financial markets, in the wake of the eurozone’s sovereign-debt crisis, that EU governments are serious about reducing their deficits and will be able to repay their loans from international investors.

Recent evidence from the markets suggests, however, that this all-consuming desire to satisfy investors could drag countries into a downward spiral of cuts to public spending, wages and pensions that lower disposable incomes and so reduce domestic demand. The announcement of austerity packages by Spain and Portugal in May had only a modest impact on how they were perceived by the markets. Moody’s, a credit rating agency, cut Greece’s credit rating to junk status this month, despite the country’s vigorous efforts to cut spending.

Governments are faced with a dilemma. If they fail to take action to cut their deficits, markets will drive up the cost of borrowing to unaffordable levels, thereby ruining their attempts to get their public finances in order, as the Greek experience shows. But doing nothing runs the risk that investors will dump government bonds.

The challenge therefore is to find the right balance: trimming public expenditure on unnecessary subsidies or tax breaks, while avoiding deep cuts to purchasing power that will hold back domestic demand.

The debate about timing should not be taken as an excuse by any national government to duck the obligation to carry out structural (non-cyclical) reforms. Nonetheless, the rush to austerity can be overdone. As the EU’s senior figures head to the G20, they have to ponder the difficult question that will be posed there: if everyone embraces the new gospel of austerity, where will demand-led growth come from?

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