Austria Watch: The election is over, economic challenges remain

The voters have spoken - now it's the parties' turn. Difficult coalition negotiations characterised by complex power and personnel politics lie ahead in the coming days, or rather weeks, as it is unlikely that a government will be formed quickly (which is unusual anyway). Particularly in the case of the election-winning party (right-wing FPÖ), the claim to power could block actual policy making for some time to come. For the time being, this outlook should not help to reduce the high level of uncertainty among domestic consumers and, above all, companies (reflected in weak private consumption and investment activity). A government participation of the first-placed FPÖ is possible, although not certain. Either way, there is (almost) no way around the second-placed conservative ÖVP (party of the current chancellor), which in the case of an FPÖ/ÖVP coalition would be seen as a stabilising element and in the case of an ÖVP/SPÖ (social democrats) coalition, possibly with a third partner (liberal Neos or Greens), would prevent significant U-turns in the direction of (even more location-negative) economic policy. Radical shifts in economic policy are therefore not on the horizon, especially as past FPÖ government participations at federal level have not led to any such U-turns, which have no tradition in Austria anyway. Austria will certainly be in the international spotlight in the coming days due to the election results, and in the short term this could also be marginally reflected in Austrian government bonds (slightly higher risk premium vs. Germany). However, we do not expect a significant and/or prolonged panic reaction on sovereign bond markets. After all, the FPÖ is an "established" governing party, has ministrable players and is already represented in parts of the state bureaucracy. In the medium and longer term, however, the election result and thus any FPÖ government participation should not have any (direct) influence on Austria's government bonds or the souvereign rating. In the end, the more important question for bond markets should be to what extent the prevailing structural and fiscal challenges (depending on the coalition consensus) will be addressed.

But no matter what the new government will ultimately look like: The economic policy challenges are greater than they have been for a long time. For the first time since 1975, this year's parliamentary elections took place in a year of recession (in terms of full-year GDP growth). At the same time, the growth gap compared to the euro area has never been so glaring. It is true that the 2008 (financial crisis) and 2013 (euro crisis) parliamentary elections also took place in a challenging environment. However, back then Austria's economic situation was more favourbale (the GFC recession was only reflected in 2009 full-year growth numbers). And more importantly, even if domestic business cycle dynamics were affected by these events, they were not originating from domestic/Austria specific problems. What is more, Austria also benefited from EU-wide or global support measures (economic stimulus packages during the financial crisis, measures to stabilise the euro area). This is different this time, as Austria will be among the laggards in the euro area when it comes to business cycle dynamics for the second year in a row this year. Since mid-2022, the growth gap compared to the euro area has widened to around 4%.

Austria: Business cycle dynamics in election years (parliament)*

* GDP real (% yoy); 2024 RBI/Raiffeisen Research forecast

Source: Eurostat, RBI/Raiffeisen Research

At the same time, the fiscal room for manoeuvre is virtually non-existent. The challenges of recent years (pandemic, energy price shock and high inflation) are long gone, yet there are hardly any recognisable efforts to reduce the (structural) budget deficit. This is now taking its toll. The fact that business cycle dynamics are developing less favourably than budgeted means that saving measures need to be implemented. Thus, there is only very limited scope for discretionary fiscal measures to stimulate the ailing economy. For a detailed view on Austria´s structural fiscal position, see also here: Wide Angle Shot: Austria soon top-notch AAA-rated sovereign again?

Disappointing business cycle dynamics, mounting structural challenges in combination with extremely limited fiscal room for manoeuvre is therefore representing the difficult economic & fiscal policy reality any new Austrian federal government is facing.

The "side effects" of the various crises are currently weighing on the Austrian economy, in particular the period of high (and clearly above euro area average) inflation that prevailed in 2022/23. Although Austrian inflation is more or less in line again with the overall euro area trend, the noticeable increase in the (consumer) price level of 18% remains. A unique feature of Austrian collective bargaining is the de-facto indexation of wage growth to past (last 12 month) consumer price inflation. As a result and unlike in the euro area, negotiated wages have risen to the same extent as consumer prices. This, in turn, led to an increase of unit labour costs of 21% since the beginning of 2022, while unit labour cost growth in the euro area amounted only to 15% (as in Germany) over the same period of time. However, this did not have a negative impact on Austrian exports in 2023, as the (wage) cost increases have been cushioned by falling profit margins (see here). Firstly, this is of course not a sustainable (export) strategy and the weak export performance ytd suggests that the strategy "exports at the expense of profits" cannot be repeated in 2024. And secondly, falling profits reduce the scope for investment. In the end this means that higher labour costs and ultimately inflation are weighing on investment avtivity, which would however be especially important in times of declining price competitiveness and various transformation challenges (e.g. automotive sector). More room for investment would also boost productivity growth in the medium term. To be sure, Austria is still a country with above euro area investment activity. Having said this, equipment investment in percentage of GDP is on a rather steep downward trend, which is a contrast to the behaviour of investment activity in the entire monetary union.

The issue of labour costs (including non-wage labour costs) is therefore certainly one that needs to be addressed by any new government. It will be necessary to reflect on (and possibly rethink) the current practice of whether inflation must represent the lower limit for wage agreements in every stage of the business cycle. The example of Germany in the early noughties has shown that a prudent wage policy that takes price competitiveness (or its restoration) into account can be part of the solution.

We also have to face up to uncomfortable truths when it comes to the labour market. Since the pandemic, we have seen a reduction in average weekly working time in Austria that is unrivalled anywhere in Europe, which can be attributed by and large to a boom in part-time employment, as has been outlined by us this spring (see here, German only). As a result, Austria has now the second highest part-time employment rate in Europe. This "home-made supply shortage" is negatively affecting the labour supply (not in terms of people employed but in terms of hours worked), which may not be a limiting factor these days in times of weak business cycle dynamics, but will be a limiting factor in the next upswing at the latest, which will then dampen economic activity. The switch from part-time to full-time must be more attractive when it comes to net wages. This is currently not the case and is the main reason why we have seen a noticeable part-time boom since the end of 2019. Especially against the background of the currently limited fiscal room for manoeuvre, there is no reason why "voluntary" part-time work (= full-time is possible but not desired), i.e. part-time work apart from necessary care obligations, should be incentivised by tax policy.

Apart from the challenges fiscsal policy is facing in the short-run, it is necessary to create sufficient buffers to leave room for discretionary measures in times of weak business cycle dynamics. The challenges the pension system is facing (statutory retirement age vs. rising life expectancy) has to be mentioned in this context, as well as a stronger limitation of public expenditure growth in general.

Nowhere else in the EU are companies as pessimistic when it comes to their own competitiveness (within the EU) as they are in Austria. The actual situation is probably (somewhat) better than the sentiment. Sooner or later, European industry will find its way back onto a growth path, and Austrian industry should also pick up in its wake ("rising tide lifts all boats"). What remains, however, are the structural problems. As a first step, it would be important to admit that we have lost our way a little and that a course correction is therefore necessary. After all, awareness of the need for (reform) measures alone creates confidence, something that industrial companies in particular currently do not have. And it is also clear that the longer one waits to make a course correction, the more drastic it will have to be. A very long and tough phase of coalition negotiations would therefore also be another step in the wrong direction.