Tuesday, May 1, 2012

Austerity is Wrong

Austerity policies have proved to be wrong in Europe and efforts of the EU and the ECB to contain the crisis rather ineffective. L. Summers, a former US Treasury secretary wrote in FT (April 30): "Treating symptoms rather than, causes is usually a good way to make a patient worse". This is what is happening in Europe where the problem is growth, not excessive deficits. This is now becoming evident, even for the most orthodox defenders of fiscal rigour. Now that the ideological veil has dropped, more pragmatic solutions in favour of growth enhancing policies are being envisaged.

What went wrong in Europe? Increased austerity has not restored normal financial conditions, but has actually worsened access to financial markets. Public spending reduction reduces income, so the ability to repay debts. In fact, as happened in Greece, massive budget cuts have produced only limited reductions in deficits. This , in turn, reduces the growth potential if capital investments fall sharply and prospects to get the unemployed back to work are becoming more difficult. In Europe, due to economic integration, these effects are amplified. A recession in one country produces a fall in demand in others. Increase in savings and exports in one country have to be compensated by equal increase in spending and importing in others. Germany's performance has been achieved by becoming a huge net exporter but this would not have been possible without large scale borrowing and importing by Europe's peripheral countries. Peripheral countries will not be able to reduce their debt substantially if at the same time Germany pursues the same policies aiming at increasing its surplus.

Orthodox economists will argue that more spending in countries with large debt is pure madness. They are wrong: if demand falls and unemployment continues to raise, austerity measures will simply become ineffective and people will continue suffering. Obviously, savings can be achieved if they are undertaken wisely, for example to reduce waste of public money. But one thing is to reduce inefficiencies, another is to cut in basic services such as heath care and education which are vital for the well being of citizens.
Policies to increase public spending on investment would then make sense if they are coordinated at European level. The ECB is now pledging for a 'growth compact', being conscious that  its massive injection of liquidity at a very low interest for three years has not resolved the crisis. As the recession in the eurozone is likely to worsen, European leaders are determined to restore growth. But this can be pursued in different ways. Merkel and Draghi support growth initiatives through 'structural reforms',  an old euphemism which covers essentially wage cuts and less protection for workers.

F.Hollande, if he were elected president, has pledged for a large scale plan to finance trans-European infrastructure projects which will be financed through the emission of bonds by the European Investment Bank. This is a promising start, but may not be sufficient. We need certainly a common European commitment to growth based on efficiency measures to increase productivity but also on equity concerns to restore confidence and hope among the majority of men and women suffering from the dangerous spiral of recession nurtured by more austerity.

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