It’s not just Britain’s £6bn in cuts—deficit hysteria is sweeping the rest of the EU. First it was Ireland where draconian spending cuts have led to an estimated 9% annual fall in GDP this year and resulted in widening the budget deficit. Then Greece, where an EU-IMF imposed deficit reduction plan of 10 percentage points over two years has led to a forecast fall in GDP of 20%.
Today it’s Spain and Italy which have recently announced €15bn and €25bn respectively in austerity measures. Portugal has accelerated its budget reduction programme to get from 9% in 2009 to below 3% by 2013, or by about 2.5% a year.[1] In France, where the budget deficit is 8%—well below Britain’s—President Sarkozy is under pressure to follow Ms Merkel’s budget balancing act. Lest anybody forget, in 2009 Ms Merkel committed Germany to a permanently balanced annual budget after 2016, the so-called ‘debt-brake’ law, which means extra budgetary cuts amounting to €10bn per annum.[2]
A lost decade?
As though all this fiscal tightening were not bad enough, the OECD has recommended tightening monetary tightening as a precaution against inflation.[3] Both the Bank of England (BoE) and the ECB are thought to be considering raising interest rates at the end of 2010, despite the fact that the ECB forecasts that the Eurozone will contract by 4.6% this year and that in June inflation fell 0.1% compared to a year ago, the lowest inflation rate since 1953.
What does all this mean for growth? Take the Eurozone-16 countries alone; their average current deficit in 2010 is about 7% of GDP, and it will probably be 8% next year. The current aim is to bring this figure within the 3% limit by 2013; ie, to make budgetary savings of 5% over two years. If we assume a (small) government spending multiplier of 1.5 and that its impact is distributed evenly over the three years following 2013, this would mean a 2.5% annual loss in growth until 2016. But average Eurozone growth since 2001 has only been just above 1% per annum, so we can expect deficit cutting to lower future growth to near zero (or less).
In short, Europe’s pro-cyclical budget cutting will, at worst, prolong the slump turning it into a 1930s style depression. At best, it will produce Japanese-style stagnation, a ‘lost decade’. Whichever of these outcomes occurs, the economic and social costs will be high. Growth elsewhere in the world will be affected—this is what the quick European tour by Messrs Geithner and Summers is about. Prolonged unemployment means that a whole generation will remain jobless, and even when recovery takes place, they will enter the labour market without the skills they would otherwise have acquired and thus with little bargaining power. Many industries will decline, and some will disappear altogether, as will the wider communities which they helped support. Income and wealth inequalities will grow.
Perhaps most disturbing is that Europe’s ‘social model’ will be so deeply damaged by lack of public finance that it will in effect cease to exist, or else become a patchwork of support programmes for the ‘deserving poor’ (those in work) as in the Anglo-Saxon countries. The deficit cutters are burrying Social Europe.
Why?
Why has it come to this? The answer lies partly in the power of the financial sector, and partly in the near universal acceptance of neo-liberal ideology. Like Britain and America, Europe has poured in excess of a trillion euros into bailing out its banking sector. Doubtless this was correct at the time. But as the recent sovereign debt crisis has shown very clearly, the very same financial markets that governments bailed out have raised sovereign borrowing costs to exorbitant levels for Greece and others while making fistfuls of money short-selling their Eurobonds.
Although there has been fresh impetus for greater regulation of financial markets—led to their credit by France and Germany—there has been no corresponding change in ideology. The orthodox ideology is not so much monetarist or even Austrian—-it is quite simply the ‘common sense’ notion of bankers and shopkeepers alike that an economy’s budget is no different from the family budget. They assert that a sound budget, whether private or national, must balance.
As I have argued elsewhere, both Friedman and Keynes would have agreed that the financial crisis required the banks to be bailed out—which Europeans have done generously.[4] Where Keynes disagreed with the prevailing orthodoxy during the Great Depression was on the question of balancing the budget. Keynes argued famously that when the private sector was rebuilding its saving, government must spend more; otherwise, aggregate demand would fall leading to falling output, employment and tax revenue.
Some of Ms Merkel’s slightly more sophisticated followers (eg, George Osborne in the UK) would argue that more state spending leads (through inflation or increased borrowing) to higher interest rates which ‘crowd out’ private sector investment. Unfortunately, for this argument to be true, one would need to show that ‘full’ crowding out takes place, something which according to this theory can only happen at the natural rate of unemployment. Since the ‘natural’ unemployment is unknowable, the argument fails.
As for Keynesian economics, despite the near Depression of 2007-09 many of Ms Merkel’s colleagues appear to remain blissfully ignorant of the subject. As Keynes explained in his ‘paradox of thrift’, although saving may be a good thing for individuals and businesses, the more a country tries to save, the more income falls and the less it can actually save. A good example of economic illiteracy is the oxymoronic title of a recent piece published by two journalists in the influential magazine, Der Speigel, ‘European austerity is the first step to recovery’.[5] As the Berliner Zeitung put it, the end result of this sort of nonsense is that: ‘Europe will save its way into the next recession’.[6] A deeply pessimistic conclusion, but inescapable I’m afraid.
[1] See http://www.ibtimes.com/articles/22922/20100509/portugal-promises-eu-to-cut-budget-deficit-more-in-2010.htm
[2] See http://www.spiegel.de/international/germany/0,1518,696760,00.html
[3] See http://www.guardian.co.uk/business/2010/may/26/oecd-backs-coalition-spending-cuts
[4] See http://blogs.euobserver.com/irvin/2010/04/13/why-sound-money-is-unsound/
[5] See http://www.spiegel.de/international/europe/0,1518,697098,00.html
[6] See http://www.spiegel.de/international/europe/0,1518,697098,00.html
#1 by Eyjafjallajokull on May 29, 2010 - 11:45 pm
If the banks had not been bailed out, would the sovereign debt crisis have also occurred?
They should all have been denied government funds because they will be doing this again. This rotten system must be flushed clean or there will be another round in 2012, 2014 and so on. Is it really Keynesian? Throwing money at bankers to appease the gods, rather than focusing on employment? Why is the middleman necessary for government money to reach employers?
#2 by Jay han on May 30, 2010 - 1:51 am
email this to me
#3 by GWI on May 30, 2010 - 3:01 pm
@Jay Han: you’re welcome to cut & paste
#4 by ki on May 30, 2010 - 5:13 pm
No fear, we’re still a long way from introducing the 4 day school day due to lacking funds for educating our children like hawaii does.
http://abcnews.go.com/WN/hawaii-day-school-week-ease-recession-woes/story?id=8894574
But im sure Mr Geithner has only the best for europe at heart when he demands that we keep spending while his own country cuts back massively, only not on the national level. Listen to the US and reap the benefits by spurring US growth at europes expense.
#5 by french derek on May 30, 2010 - 5:34 pm
A helpful, if pessimistic article. However, I am confused as to what is actually happening now – though less so about the why.
Many economists argue that the way out of the current crisis (and we are still mired in economic trouble) is via Growth. The private sector, across the EU, is still struggling to regain stability, never mind growth: thus it would seem that Keynesian policies still have a place.
However, government spending plans take time to come to fruition (a time-lag of about 12 – 18 months, I guess). Keynesian-inspired spending projects (eg infrastructure of all sorts) should have been agreed long ago? Along with the cash to support such spending. Certainly this appears to be what happened here in France.
Another problem relates to the aggregation of nations – choosing, according to the measures selected, to see everyone as fitting the same frame of reference. Taking fiscal tightening of governmental spending as the sole reference leaves out the reality of other policies and their anticipated effects. Effects such as the loosening taxation on the private sector, on R&D, investment etc. And, of course, the committed Keynesian spending going to the private sector from government.
Your thoughts on my non-sense would be appreciated.
#6 by GWI on May 30, 2010 - 5:51 pm
@french derek:
Yes, I do think growth is the only answer, and I would personally favour what in the UK is called the Green New Deal—massive investment in green infrastructure and new energy sources. You are right to say there’s a timelag and that such a package should have been agreed long ago, but better late than never. How to finance it? Growth is to some degree self-financing (raising tax reciepts and lowering social exp), but this will need a combination of quantitative easing and tax reform so that the super-rich pay their share. Elsewhere on the blog I’ve argued strongly for some form of Tobin tax. Given the further damage the next round of inflation will inflict on our finances, the case for a Tobin tax must gradually become irresistible.
#7 by droom on May 31, 2010 - 12:37 pm
Georg Irvin is one of the best authors on this site.
In this article I miss a discussion of the reasoning behind the Maastricht 3% budget deficit norm, when it was put in force by the treaty of the same name. That might shed some light on the possible effect in variations of this “norm” on the euro and the economies of the 14 euro-countries.
Another one is that the article leaves out the political arguments. Why is Germany so adamant, so fanatic about cutting its budget to get back to the 3% norm. Well, the Germans have a shocking experience with enormous budget deficits in the 1920′s which gave rise to a huge economic crisis, and most of all, the rise of Hilter. They react now like a Pavlov dog: never again, so we must cut the budget! Not really smart, as you think through what mr. Irvien deos what the enormous risks are of growing unemployment, rising inflation, negative growth, etc. for the social and formeost the social fabric of EU countries. Right now, predictable is that these economic policies will give rise to – indeed – exactly that what Mrs Merkel c.s. fear most: the rise of right wing parties. It’s time to leave the Old Continent……
#8 by Peter Sain ley Berry on June 1, 2010 - 11:10 am
I think it would be useful to distinguish here between capital and revenue spending. Pressure on budgets so often sacrifices just those projects that would help to lead us all out of this mess. Long term investment projects – like for instance investment in energy efficiency – that show a return on capital should surely be funded. Indeed, they should be accelerated. It is careless and profligate revenue spending that is unsustainable. There is no such thing as a free lunch and we can’t go on simply buying our lunches on tick; at some point someone has to pay for them.
#9 by MB on June 1, 2010 - 2:06 pm
Article is missing the point: europe is on the brink of sovereign default. In May money markets dried up and bondmarkets almost died. This is Oct 2008 with a vengeance. Spending is not an option anymore. No one will lend Europe te money.
#10 by Jean-Baptiste Perrin on June 2, 2010 - 12:30 pm
@MB which means that Europe has to take the money where it is: in the banks. Peter said it better than me: there is no free lunch. And George is right, I believe, when he says that in time of crisis Keynesian policies are the better ones (while in normal times, they are clearly the worst). The solution is to refuse that the banks get away with grand larceny. They and their affiliated rating agencies (for the uninitiated, there is no such thing as an independent rating agency) need to pay for the damage they have contributed to cause. Yes, in good times, the countries of Europe have borrowed above what was reasonable. However, the proverbial droplet which made the pot overflow was caused by the banks and the rating agencies which required more money from state budgets to bail them out. Not taxing them (call it Tobin tax or anything else, who cares about the specific mechanism) and not regulating them would be a crime against the rest of humanity.
#11 by Ronald Gruenebaum on June 2, 2010 - 11:28 pm
You know, sometimes it’s enough to judge an article by its headline.
Europe is a geographical term, maybe a cultural conntations. It cannot be killed by a deficit or the related hysteria, whatever that is.
Given that journalists have only words as tools I wonder about the quality of this analysis. As I commented on other occasions, Mr Irvin is too much stuck in his small world of economic analysis which the brighter ones among us have already identified as an oxymoron.
#12 by Jean-Baptiste Perrin on June 3, 2010 - 12:29 pm
Nitpicking on vocabulary instead of addressing the arguments might sound clever, but it doesn’t help to convey your point, Ronald. And to nitpcik myself a bit, George Irvin is not a journalist, so you are guilty of the same.