Will European governments reverse the austerity course that has done so much to damage their already enfeebled economies? With the revelation of mathematical errors in the work of two Harvard economists, Carmen Reinhart and Ken Rogoff – who had claimed to show that economic growth falls off a cliff once a country’s ratio of debt to GDP reaches 90 per cent – another of the intellectual underpinnings for the current strategy has been swept away. As foreseen by the majority of mainstream economists, eurozone countries’ debt positions continue to worsen rapidly despite wrenching austerity and there is no sign of a rebound in consumer and business confidence. Mass unemployment and chronically weak business investment is waking people up to the folly of synchronised austerity in a depressed economy, hastening what President Barroso has termed (in an unguarded moment) the ‘political limits of austerity’. Everything argues for a change of course, but it could be slow in coming.

The assertion that fiscal austerity would actually boost economic growth – made by another pair of Harvard economists, Alberto Alesina and Silvia Ardagna – was always highly questionable, as was the Reinhart and Rogoff thesis. But the European Commission and European governments (including the British one) latched onto the work of Alesina and Reinhart and Rogoff to provide intellectual support for austerity. Even as the body of evidence against Alesina’s research accumulated, European policy-makers were slow to reject it. When they eventually did, they continued to argue that it was still necessary to pursue fiscal austerity so as to prevent ratios of debt to GDP exceeding the magical level of 90 per cent of GDP, despite the fact that austerity was depressing growth and increasing countries’ debt ratios. The question marks over the soundness of Reinhart’s and Rogoff’s work on debt levels and economic growth are certainly embarrassing for European governments and the Commission, but it is unlikely to dispel the myths around austerity. 

On the face of it, things do seem to be changing. The Commission has given eurozone countries a bit more time to meet their fiscal targets. In particular, it is dealing cautiously with France, which has resisted cutting its deficit as quickly as demanded. The Commission is being careful to place as much stress on the need for structural reforms as austerity. But all this amounts to less than it seems. The decision to give countries a bit more time is simply an acknowledgement that deficits are higher than they were supposed to be because economies are weaker than the Commission expected them to be. It does not represent a significant change of strategy. The fiscal position across the eurozone remains contractionary despite the region’s economy being stuck in a depression. For their part, the Germans are actually tightening policy despite the country’s budget being in surplus and the German economy having stalled. There is still no acceptance that running a budget deficit in a recession is a perfectly sensible economic strategy or that structural reforms will only pay off economically in the long-term, and only then if accompanied by a recovery of business investment.

Why is a policy U-turn unlikely, at least for the time-being? Many policy-makers probably did (and some probably still do) believe that the current austerity strategy is the correct one. Politicians in a number of core eurozone countries like to say, ‘We did our homework, it’s time for others to do theirs.’ Theirs was always a very partial reading of the causes of the crisis, but it has obvious appeal to national vanity and has become central to the narrative of the crisis in these member-states. Many policy-makers never believed in austerity as a solution to the crisis, but went along with it because it was the only politically possible course. They acknowledged that it made little sense to institutionalise pro-cyclical fiscal policy in the form of the fiscal compact, but understood that it was necessary in order to keep the Germans and other core members on board and ensure they acquiesced in a more activist approach by the ECB. This latter policy has ensured that French borrowing costs have come down steadily despite frustration at the slow pace of fiscal consolidation under Hollande’s government. 

However, the eurozone needs a big change of direction, not just a bit more time for countries to meet their fiscal targets. The possibility of this happening depends to a large extent on Germany. How could they be brought around? One way would be for the French, Italians and Spanish to unite in an attempt to face down the German government. It is quite possible that it will eventually to come to this, but it would be a risky strategy to play in the run-up to a German general election. Such a manoeuvre could easily backfire and would certainly be seen as an aggressive move by many Germans. Another way would be to redouble efforts to persuade Germany of the risks that austerity poses to itself. After all, the German economy is slowing quickly under the combined impact of falling exports to the eurozone and a slowdown in exports to China. This is exposing the underlying weakness of the country’s economy: stagnant domestic demand. But the politics are formidably difficult. The Germans might modify their narrative and agree to take some steps to strengthen domestic demand in Germany. But they are unlikely to accept that austerity is self-defeating, not least because this would leave them having to acknowledge the need for far-reaching institutional reforms of the eurozone.

For example, if struggling member-states face high borrowing costs because investors treat them as if they are borrowing in a foreign currency (rather than because their economic policies lack credibility), this strengthens the arguments in favour of allowing the ECB to act as a fully-fledged lender of last resort, or in favour of a degree of risk mutualisation. The ECB’s promise to stand behind the debts of eurozone countries (its so-called Outright Monetary Transactions) has proved remarkably effective so far. But ultimately the central bank will have to put money on the line, which it cannot do at present unless countries promise to abide by strict conditionality. The evidence of the last five years strongly suggests that attempting to meet these conditions would prove very damaging economically and politically. 

But the German and other core eurozone governments understandably want to avoid having to try to sell such reforms to their sceptical electorates, for fear of turning their voters against the single currency. This is why it will continue to suit many policy-makers to argue that the crisis is all down to rule-breaking, and the responsibility of individual member-states. Despite the overwhelming weight of evidence, both empirical and theoretical, many politicians will continue to trot out Margaret Thatcher’s favourite line: there is no alternative – TINA.

Simon Tilford is chief economist at the Centre for European Reform.

Populists and extremists are on the rise across Europe. Even Germany is now seeing the rise of a eurosceptic party. The euro crisis is the reason for growing political risk in the eurozone. Or is it? True, populist parties are more important in several euro countries. But the reasons for this are manifold and it is hard to detect a Europe-wide trend. An end to the euro crisis would not guarantee a return to predictable two-camp politics.

What is populism? At the most basic level, a populist is someone who advocates measures that you do not like. For the right-wing press, populists are the people who call for higher taxes, more welfare and the protection of industries. For the left-wing media, it is people who oppose immigration, diversity and the EU.

What populists tend to have in common is that they contrast themselves with the political elites. "Populism is as much about style as it is about substance", says Tim Bale, politics professor at Queen Mary University in London and an expert on the subject. Populists usually claim that they alone represent the people while established political parties are portrayed as self-serving, aloof and corrupt. Populists dislike representative democracy and love referendums.

Applying this definition, the rise in populism in Europe predates the euro crisis by quite a few years. Think of Jörg Haider in Austria, Pim Fortuyn in the Netherlands, the Kaczynski brothers in Poland or Jean-Marie Le Pen in France.

Two trends have eroded people’s trust in public authority and thus helped the populists. First, globalisation, immigration and technological change are making life more complex. Centre-left parties can no longer credibly promise jobs and social security. The centre-right’s notions of stable families and individual responsibility sound barely credible. As old ideological divisions blur, mainstream parties on both sides promise to do 'whatever works'. Confused voters find the populists' clear, simplistic messages appealing.

Second, the spread of the internet and new media can help political upstarts to mobilise the masses. Many people nowadays trust the internet more than the mainstream media. And in their attempt to regain ratings, even serious broadcasters give colourful populists more air time than 'boring' centrists.

The euro crisis has not caused European populism but it is certainly fuelling it. In these vexing times, the simple solutions peddled by the populists are gaining traction in many eurozone countries. But each country has its idiosyncrasies.

Voters in some of the northern creditor countries got restive first. The eurosceptic and anti-immigration Freedom Party almost tripled its share in the Dutch election in 2010. One year later, the anti-bailout True Finns became the third largest party in the Finnish parliament. However, both parties seemed to have peaked already. In 2012, the Freedom Party's vote collapsed in the Dutch general elections, as did support for the True Finns in local elections.

Is it Germany's turn now? With the Alternative für Deutschland (AfD), a eurosceptic party will for the first time contest a general election in Germany in September. The AfD's main objective is for Germany to leave the euro, although the party supports other aspects of European integration. One opinion poll showed that almost a quarter of Germans would "in principle" consider voting for a eurosceptic party; but in another poll, only 3 per cent said they would choose AfD if elections took place now. The AfD’s leader, Bernd Lucke, a soft-spoken boyish-looking academic, is an odd sort of populist, although, like most of his European peers, he promises more direct democracy and an end to the politics of yore. However, since most of the party’s upper echelon consists of bespectacled professors and well-to-do businessmen, it appeals to middle-class centrist voters – who are overwhelmingly still happy with Angela Merkel and her euro policies.

In Germany, as in other North European countries, the main impact of the populists is that they throw well-rehearsed coalition politics into disarray. The AfD might not get the 5 per cent needed for parliamentary seats. But it might steal just enough votes from the (already suffering) Liberals to deprive Merkel of her natural coalition partner after September. Populists also have impact because mainstream politicians often feel compelled to usurp their ideas. Such tactics hardly ever work, partly because the populists can easily move to further extremes and partly because moderate voters (still a majority in all North European countries) resent politicians chasing the populist vote.

If populism in Northern Europe is destabilising but not disastrous, what about the south? In Greece and Italy, the populists are no longer fringe figures. In the Greek elections of May 2012, the hard-left Syriza party came first after promising Greeks an end to EU-imposed austerity; the neo-fascist Golden Dawn got 7 per cent, with a similar share going to another right-wing nationalist party (a re-run of the vote a month later lifted the centre-right New Democracy just above Syriza but otherwise changed little). In Italy’s election in February 2013, the anti-EU Five Star Movement of Beppe Grillo gained 25 per cent, a bigger slice than any other single party.

With unemployment now standing at 27 per cent in Greece, and Italy suffering its longest recession in two decades, how could people not have voted for populists? They could have. Spain also has 27 per cent unemployment and not a populist in sight. The Irish and Portuguese people have suffered tremendously in the euro crisis but they have not deserted the established parties.

Greece and Italy stand out because their political systems had become dysfunctional long before the economic crisis. Corruption and nepotism exist in most European countries – but not to the extent that used to prevail in Rome and Athens. It is therefore understandable that Greeks and Italians now refuse to back established parties that have done little for their respective countries in decades.

The deepest rift in Greek politics runs not between supporters and opponents of austerity but between those who have long benefited from a bloated public sector (protected by, and closely intertwined with, New Democracy and the other mainstream party, Pasok) and those in the private sector who have borne the brunt of austerity.  To them Syriza’s promises of free health care and school meals, generous social welfare and higher minimum wages look appealing. But many of them simply cannot stomach supporting the two traditional parties of power anymore.

Greece is also one of the few places where the crisis has boosted the extreme right. One reason is growing resentment of the million-odd immigrants who arrived during the good years. Another is the breakdown of law and order that has accompanied the Greek economic collapse. The state is in such disarray that many Greeks now welcome Golden Dawn’s black-shirted hoodlums bringing some ‘order’ to their neighbourhoods – even if that entails hundreds of immigrants ending up in hospital after brutal beatings.

In Italy, the right-wing Lega Nord got a measly 4 per cent in the 2013 election. It had become tainted by too many years in government. Italians rejected all established political parties in the last vote, irrespective of whether they were pro or anti-austerity. They did not vote for their erstwhile technocratic prime minister, Mario Monti, either. Monti's tax hikes and budget cuts did not win him many friends. But his approval ratings (once at a stellar 70 per cent) only collapsed once he stopped being a technocrat and entered the political fray as an election candidate.

The tragedy in Greece and Italy is that this much-overdue re-ordering and renewal of the political system comes at a time when both countries desperately need strong and stable governments. It might be years before that is a realistic prospect. Populists do have a habit of running out of steam. The closer they get to power, the more they come under pressure to present credible solutions and make compromises. At this point, they either become mainstream or they deflate. Until this happens, populism and political uncertainty will continue to make the euro crisis more combustible.

However, it is not certain that an end to austerity would make Greek and Italian politics predictable, nor that without further bailouts there would be no populism in Northern Europe. In an age where voters are both confused and easily malleable via the internet and social media, politics will not return to the staid two or three party systems of the post-war years. 

Katinka Barysch is deputy director of the Centre for European Reform.