Austria: Not Exactly a Miracle

There are two sets of reasons. One consists of the institutional and the policy framework. The other is the structure of the economy and the performance of the markets. The latter also contains the major weakness, which is the performance of the financial markets, as well as of the banks.

Let us first review the data, namely the performance of the Austrian economy since the beginning of the crisis in the second half of 2008. In terms of GDP per capita, Austria is among the most developed countries in the European Union (EU) and indeed, in the world. It experienced a sharp contraction in GDP growth of 3.8 percent in 2009, but has recovered over the following years. Last year, GDP growth slowed down markedly, as in most of the EU. Unimpressive growth is expected this year with acceleration next year, again in tune with the developments in the euro area and the EU. Overall, the economy has performed better and similarly to the better performing countries in the EU.

The effects of the recession and the slowdown of growth on employment and unemployment have been moderate as those on the fiscal balances and the public debt have. The latter has increased, in percent of GDP, by about 15 percentage points, i.e. from around 60 percent of GDP in 2007 to almost 75 percent in 2012. Still, this is not a dramatic increase and is smaller than one finds in most other developed economies. This is a combined effect of a lower growth rate and higher fiscal deficits, which reflect increased transfers and costs of the fragilities in the banking sector.

Consumption, however, has not declined throughout the whole crisis period while investment suffered its lone though sharp decline of almost 8 percent only in 2008. Nevertheless, overall recovery has been sluggish. Similarly, employment has continued to grow, though quite slowly, except for a drop of 1.5 percent in 2008. The unemployment rate increased at the height of the crisis, but has gone down basically to the pre-crisis level, which is quite low by any standard (4.2 according to Eurostat and 6.7 by national definition in 2011, with little change in 2012). More important is a relatively low unemployment rate among the young, while unemployment of the youth has increased sharply in many developed economies. Also, long-term unemployment is quite low, while the overall employment rate is again among the highest in the euro area and the EU.

The prospects going forward depend on external developments as Austria is a small, open economy and runs a surplus in its current account. Export of services and income from cross border investments are responsible for that surplus. During the crisis the trade balance of goods has deteriorated, which is, in fact, good for the more depressed euro and other economies, while Austria needs to have a buoyant services sector and good performance in its outward foreign investments. If those can be sustained, with sustained growth of domestic demand, the prospects in the next few years look favorable, certainly compared to most other developed European economies.

The Social Partnership

What explains this rather good performance? One reason is that Austria gave up on monetary policy a long time ago and adjusted its institutions and economic policy to that fact. This is important because it provides a useful comparison with other euro monetary union member states. A number of countries that are facing significant private and public debt problems have adopted the euro without adjusting their economic institutions and policies accordingly. Austria, however, relied on a Deutsche mark peg for a couple of decades before adopting the euro and adjusted its income and fiscal policies so that the hard peg and now monetary union could prove sustainable and indeed advantageous. The main institution on which it relies is that of the social partnership. The main policy is that of a countercyclical fiscal framework.

The key to the sustainability of a fixed exchange rate regime is that the development of income is checked in such a way that it does not ruin the competitiveness of the economy. That essentially means that growth of wages should be such that the cost competitiveness of the economy is sustained. This is primarily what social partnership is supposed to accomplish. Over the longer term that indeed seems to have been accomplished with the trade balance and the current account being mostly kept at sustainable levels. In a number of other euro member states, the adoption of common currency has led to growing trade and current account deficits due to, in part, loss of competitiveness because of rising labor costs as no effective institutions of income policy have been in existence.

Income policy is, of course, not everything. One striking difference between Austria and some other euro member states is in the growth of private debt. The level of private debt has been pretty stable in Austria, while it has increased significantly in many other especially southern European countries, but also in some new member states. The reason is again in part the decline of interest rates due to the membership in the euro currency union or of the exchange rate policy tied to euro. So, rather strong growth of the economy and of the incomes with often appreciating real exchange rate have led incentives to take on a lot of private debt. Thus household debt as well as corporate debt, often borrowed from abroad, has increased significantly. This has not happened in Austria. As it runs a current account surplus, it invests abroad, but at home growth of incomes has not been such as to lead to a fast increase in private debt. This means there was no overhang of either foreign or domestic private debt. In fact, in so far as financing has proven a problem, it has been as a consequence of significant investments abroad, some of which have been in countries that may have difficulties paying these debts back.

In addition to income and financial policy, long abstention from the use of monetary policy has led to a rather prudent fiscal policy. In this respect the adoption of the euro has been helpful because it has led to moderation in the reliance on fiscal deficits and on policies aimed to keep the public debt within the limit set by the Stability and Growth Pact (60 percent of GDP). Thus, in pre-crisis times when growth has been good, the policy of fiscal adjustment was followed with the aim of bringing the public debt down to the required level. This proved to be useful when the crisis erupted, because fiscal institutions have been put in place that made it possible for the fiscal deficit and the public debt not to explode. It was also possible not to adopt the policy of fiscal austerity that many other countries were forced to pursue. Fiscal policy has not been either the boon in good times nor the drag in bad times it is often made out to be.

The institutional framework has been developed that insured balanced development and the use of countercyclical policies in the time of crisis. That is one set of reasons why Austria has done well during the crisis.

Hub for the Region

The other is the state of the markets. As noted, the employment rate is high and unemployment and inactivity low or relatively low. Also, the corporate sector is rather diverse and does not depend on only a few exportable products. The services sector is also rather flexible and tradeable, i.e. it relies on high foreign demand. In this respect, it is important to note that the fall of the Iron Curtain and the opening up of the Eastern Europe and the Balkans has been quite favorable to Austrian financial and other services sectors. Austria is among the main investors in these countries and is also developing into a trade, transport and educational hub for these regions. The way these regions were growing before the crisis and relying on financial and other services from abroad, Austria was well placed to benefit from these developments. These advantages are for the most part enduring ones, so those should not end with this crisis or for some time until the process of catching up of less developed countries with the more developed countries in the EU and its neighboring continues. As a matter of fact, in the current crisis the Austrian labor market has proven attractive to countries that are going through a prolonged recession or depression, especially in the Balkans. The data is not altogether reliable, but the indication is that there has been significant inward mobility due to the still existing demand for labor by Austrian corporations.

The key weakness is in the financial market or, more specifically, in the banking sector. Austrian banks have expanded into neighboring markets, which are now facing problems honoring their foreign debts due to the prolonged recession and stagnation. Indeed, the Austrian authorities have had to spend considerable amounts of money to shore up the banks. This has also required support for continuous involvement in the financial markets in the neighboring states where Austrian banks play a very prominent role. The latter was achieved with the help of international financial institutions through the so-called Vienna Initiative, which required the banks to stay engaged in cross border financial activities. This has stabilized both the domestic and foreign financial markets and allowed for sustained effort to deal with banking sector weaknesses without the emergence of an additional financial crisis. There are still some persistent risks due to the growth of non-performing loans in the emerging European markets, but those have become more manageable.

Traditionally, Austrian financial markets have been rather volatile. They have also been the source of regional financial and economic instability. As a rule, these financial problems have originated in Vienna, not in the foreign financial markets. Similarly, this time around, most of the banks in Central and Eastern Europe and in the Balkans, where Austrian banks are involved, have not shown too many weaknesses during the crisis. That is in part because these financial markets have not had time to develop sufficiently so that household and corporate portfolios would prove unsustainable. So, even though losses have to be sustained, that should not put the whole banking sector at risk. And given that the Austrian economy is performing well under the circumstances and there is scope for fiscal support, it is probably the case—to the extent this can be known—that Austrian banks are on the mend and should come out of the crisis without a financial collapse.

That being said, the Austrian economy it is not a case of miraculous development. It is very developed, there is high welfare and social security, and its institutional and policy framework is appropriate to what the population wants and what is needed to keep the economy competitive. It has proven stable during the current crisis and even ready to benefit from the turnaround in the regional, European, and world economy, when it comes. But it cannot be expected to lead the recovery of the EU or the new wave of innovations if and when it comes. But there is no doubt that it has proven resilient and even successful due to its flexibility and good governance.