Europe: Le terrible échec de la politique d’austérité économique

For months, I have been arguing that economic austerity in time of severe economic downturn is highly counter-productive. The last thing the economy of a country needs when a country is going through a recessionary cycle (or experiencing a contraction of its economic activities like in many European countries) is a drastic reduction of public spending. The reason for that is very simple: when the economy is in a recessionary cycle, an influx of spending (even deficit spending) is a must to boost and trigger economic growth, consumption, create jobs, and restart the economic engines against. Once those economic engines are restarted, then an increase in taxes (on the highest brackets) and progressive cuts in spending (spending in non-economic growth sectors) can be established again. Cutting spending when spending is needed the most is like depriving a patient of a blood transfusion when that patient is heavily hemorrhaging from every orifice, which would ultimately lead to the death of the patient.

Well, European countries of the eurozone such as France, Ireland, Spain, Italy, Portugal, and i add to them the U.K (I am not even going to talk about Greece in this post. My position on Greece has been clearly stated in previous posts here and specially here) have been engaged in drastic  reductions of their public spending since the beginning of this crisis. These are the infamous austerity policy packages that most eurozone countries (and the U.K) have put in place to calm down financial markets. The result is an economic growth close to zero in almost all the eurozone (and the U.K). The economic forecast for 2013 and 2014 if the same policies are followed is even worse–i.e., an economic growth around 0% leading to a long lasting recession, high unemployment, and even higher public deficits. These countries fundamentally misunderstood the demands of the financial markets. What markets (across the globe) have demanded since the beginning of the euroze crisis is not an immediate and a drastic reduction of public deficits, but credible plans and policies for generating positive economic growth again. Most markets have already factored in and digested the fact that the eurozone countries have high deficits and those deficits won’t be reduced anytime soon, and the debt won’t be repaid in the foreseeable future. There is nothing that can be done about that in the short-term, and worrying about balancing budgets and cutting spending during a recession is an economic suicide.

This fundamental misunderstanding of the crisis led most European political leaders (best example of this misguided strategy is David Cameron and Nicolas Sarkozy) to engage in crafting crazy austerity packages to reduce the yield on government bonds and securities (which means in everyday language, borrowing money at a lower interest rate). And in doing so, these political leaders sacrificed long-term economic growth for short-term financial gain and an ephemeral stability. At the end, they pretty much got nothing (most eurozone countries lost their triple-A rating–except Germany–and most eurozone banks are in a bad financial situation). This strategy would only lead to the deepening of the economic downturn on the short-term, and turning it into a long-term economic stagnation.

This is what has been happening in the eurozone countries (and England), and the data recently released by the IMF, OECD, and the Government Growth & Development Center illustrate  that clearly. Countries engaged in cutting spending (what i call slash-and-burn-economics) and austerity policies are performing worse than countries that did not. In fact, the data show that countries that adopted austerity packages have worsened their economic situation.

For a better understanding of this, i yield the floor to Dr. Paul Krugman, Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and winner of the  Nobel Prize in Economics (aka Sveriges Riksbank Prize in Economic Sciences) for his work on New Trade Theory and New Economic Geography. Since the beginning of the crisis, Dr. Krugman has been writing a series of articles in the New Times explaining the origin(s) of the crisis and advocating for the soundest way of getting out of it. Needless to say that Dr. Krugman has been right on almost everything he has said.

January 22, 2012

Is Our Economy Healing?

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How goes the state of the union? Well, the state of the economy remains terrible. Three years after President Obama’s inauguration and two and a half years since the official end of the recession, unemployment remains painfully high.

But there are reasons to think that we’re finally on the (slow) road to better times. And we wouldn’t be on that road if Mr. Obama had given in to Republican demands that he slash spending, or the Federal Reserve had given in to Republican demands that it tighten money.

Why am I letting a bit of optimism break through the clouds? Recent economic data have been a bit better, but we’ve already had several false dawns on that front. More important, there’s evidence that the two great problems at the root of our slump — the housing bust and excessive private debt — are finally easing.

On housing: as everyone now knows (but oh, the abuse heaped on anyone pointing it out while it was happening!), we had a monstrous housing bubble between 2000 and 2006. Home prices soared, and there was clearly a lot of overbuilding. When the bubble burst, construction — which had been the economy’s main driver during the alleged “Bush boom” — plunged.

But the bubble began deflating almost six years ago; house prices are back to 2003 levels. And after a protracted slump in housing starts, America now looks seriously underprovided with houses, at least by historical standards.

So why aren’t people going out and buying? Because the depressed state of the economy leaves many people who would normally be buying homes either unable to afford them or too worried about job prospects to take the risk.

But the economy is depressed, in large part, because of the housing bust, which immediately suggests the possibility of a virtuous circle: an improving economy leads to a surge in home purchases, which leads to more construction, which strengthens the economy further, and so on. And if you squint hard at recent data, it looks as if something like that may be starting: home sales are up, unemployment claims are down, and builders’ confidence is rising.

Furthermore, the chances for a virtuous circle have been rising, because we’ve made significant progress on the debt front.

That’s not what you hear in public debate, of course, where all the focus is on rising government debt. But anyone who has looked seriously at how we got into this slump knows that private debt, especially household debt, was the real culprit: it was the explosion of household debt during the Bush years that set the stage for the crisis. And the good news is that this private debt has declined in dollar terms, and declined substantially as a percentage of G.D.P., since the end of 2008.

There are, of course, still big risks — above all, the risk that trouble in Europe could derail our own incipient recovery. And thereby hangs a tale — a tale told by a recent report from the McKinsey Global Institute.

The report tracks progress on “deleveraging,” the process of bringing down excessive debt levels. It documents substantial progress in the United States, which it contrasts with failure to make progress in Europe. And while the report doesn’t say this explicitly, it’s pretty clear why Europe is doing worse than we are: it’s because European policy makers have been afraid of the wrong things.

In particular, the European Central Bank has been worrying about inflation — even raising interest rates during 2011, only to reverse course later in the year — rather than worrying about how to sustain economic recovery. And fiscal austerity, which is supposed to limit the increase in government debt, has depressed the economy, making it impossible to achieve urgently needed reductions in private debt. The end result is that for all their moralizing about the evils of borrowing, the Europeans aren’t making any progress against excessive debt — whereas we are.

Back to the U.S. situation: my guarded optimism should not be taken as a statement that all is well. We have already suffered enormous, unnecessary damage because of an inadequate response to the slump. We have failed to provide significant mortgage relief, which could have moved us much more quickly to lower debt. And even if my hoped-for virtuous circle is getting under way, it will be years before we get to anything resembling full employment.

But things could have been worse; they would have been worse if we had followed the policies demanded by Mr. Obama’s opponents. For as I said at the beginning, Republicans have been demanding that the Fed stop trying to bring down interest rates and that federal spending be slashed immediately — which amounts to demanding that we emulate Europe’s failure.

And if this year’s election brings the wrong ideology to power, America’s nascent recovery might well be snuffed out.

January 26, 2012, 11:04 am

The Greater Depression

One thing everyone always says is that while this Lesser Depression may be bad, it’s nothing like the Great Depression.

But this is in part an America-centered view: we had a very bad Great Depression, and have done better than many other countries this time around. As Jonathan Portes at Not the Treasury View points out, the ongoing slump in Britain is now longer and deeper than the slump in the 1930s (the figure shows how far real GDP was below its previous peak in various British recessions; the red line is 1930-34, the black line the current slump):

I believe that when I began criticizing the Cameron government’s push for austerity, some right-leaning British papers demanded that I shut up. But the original critique of austerity is holding up pretty well, if you ask me.

January 28, 2012, 1:47 pm

The Worse-than Club

Further thoughts on the observation that the current British slump has now gone on longer than the slump of the 1930s. Is Britain unique?

No, it isn’t.

The NIESR has developed a monthly GDP series for Britain, which lets it use real-time data for the comparison. I can’t replicate that, but I can use the Maddison historical data and IMF data — including projections for 2012 and 2013 — to do some comparisons. When you do this for the UK, the worse-than pops right out (I use annual data; year zero is 1929 or 2007, and real GDP is expressed as a percentage of the pre-crisis peak in each case):

France and Germany are doing much better than in the early 1930s — but then France and Germany had terrible, deflationist policies in the early 1930s. (It was the Brüning deflation, not the Weimar inflation, that brought you-know-who to power).

With two of Europe’s big four economies doing worse than they did in the Great Depression, at least in terms of GDP — and that’s three of five if you count Spain — do you think the austerity advocates might consider that maybe, possibly, they’re on the wrong track?

January 29, 2012

The Austerity Debacle

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Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

O.K., about those caveats: On one side, British unemployment was much higher in the 1930s than it is now, because the British economy was depressed — mainly thanks to an ill-advised return to the gold standard — even before the Depression struck. On the other side, Britain had a notably mild Depression compared with the United States.

Even so, surpassing the track record of the 1930s shouldn’t be a tough challenge. Haven’t we learned a lot about economic management over the last 80 years? Yes, we have — but in Britain and elsewhere, the policy elite decided to throw that hard-won knowledge out the window, and rely on ideologically convenient wishful thinking instead.

Britain, in particular, was supposed to be a showcase for “expansionary austerity,” the notion that instead of increasing government spending to fight recessions, you should slash spending instead — and that this would lead to faster economic growth. “Those who argue that dealing with our deficit and promoting growth are somehow alternatives are wrong,” declared David Cameron, Britain’s prime minister. “You cannot put off the first in order to promote the second.”

How could the economy thrive when unemployment was already high, and government policies were directly reducing employment even further? Confidence! “I firmly believe,” declared Jean-Claude Trichet — at the time the president of the European Central Bank, and a strong advocate of the doctrine of expansionary austerity — “that in the current circumstances confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.”

Such invocations of the confidence fairy were never plausible; researchers at the International Monetary Fund and elsewhere quickly debunked the supposed evidence that spending cuts create jobs. Yet influential people on both sides of the Atlantic heaped praise on the prophets of austerity, Mr. Cameron in particular, because the doctrine of expansionary austerity dovetailed with their ideological agendas.

Thus in October 2010 David Broder, who virtually embodied conventional wisdom, praised Mr. Cameron for his boldness, and in particular for “brushing aside the warnings of economists that the sudden, severe medicine could cut short Britain’s economic recovery and throw the nation back into recession.” He then called on President Obama to “do a Cameron” and pursue “a radical rollback of the welfare state now.”

Strange to say, however, those warnings from economists proved all too accurate. And we’re quite fortunate that Mr. Obama did not, in fact, do a Cameron.

Which is not to say that all is well with U.S. policy. True, the federal government has avoided all-out austerity. But state and local governments, which must run more or less balanced budgets, have slashed spending and employment as federal aid runs out — and this has been a major drag on the overall economy. Without those spending cuts, we might already have been on the road to self-sustaining growth; as it is, recovery still hangs in the balance.

And we may get tipped in the wrong direction by Continental Europe, where austerity policies are having the same effect as in Britain, with many signs pointing to recession this year.

The infuriating thing about this tragedy is that it was completely unnecessary. Half a century ago, any economist — or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” — could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.

February 19, 2012

Pain Without Gain

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Last week the European Commission confirmed what everyone suspected: the economies it surveys are shrinking, not growing. It’s not an official recession yet, but the only real question is how deep the downturn will be.

And this downturn is hitting nations that have never recovered from the last recession. For all America’s troubles, its gross domestic product has finally surpassed its pre-crisis peak; Europe’s has not. And some nations are suffering Great Depression-level pain: Greece and Ireland have had double-digit declines in output, Spain has 23 percent unemployment, Britain’s slump has now gone on longer than its slump in the 1930s.

Worse yet, European leaders — and quite a few influential players here — are still wedded to the economic doctrine responsible for this disaster.

For things didn’t have to be this bad. Greece would have been in deep trouble no matter what policy decisions were taken, and the same is true, to a lesser extent, of other nations around Europe’s periphery. But matters were made far worse than necessary by the way Europe’s leaders, and more broadly its policy elite, substituted moralizing for analysis, fantasies for the lessons of history.

Specifically, in early 2010 austerity economics — the insistence that governments should slash spending even in the face of high unemployment — became all the rage in European capitals. The doctrine asserted that the direct negative effects of spending cuts on employment would be offset by changes in “confidence,” that savage spending cuts would lead to a surge in consumer and business spending, while nations failing to make such cuts would see capital flight and soaring interest rates. If this sounds to you like something Herbert Hoover might have said, you’re right: It does and he did.

Now the results are in — and they’re exactly what three generations’ worth of economic analysis and all the lessons of history should have told you would happen. The confidence fairy has failed to show up: none of the countries slashing spending have seen the predicted private-sector surge. Instead, the depressing effects of fiscal austerity have been reinforced by falling private spending.

Furthermore, bond markets keep refusing to cooperate. Even austerity’s star pupils, countries that, like Portugal and Ireland, have done everything that was demanded of them, still face sky-high borrowing costs. Why? Because spending cuts have deeply depressed their economies, undermining their tax bases to such an extent that the ratio of debt to G.D.P., the standard indicator of fiscal progress, is getting worse rather than better.

Meanwhile, countries that didn’t jump on the austerity train — most notably, Japan and the United States — continue to have very low borrowing costs, defying the dire predictions of fiscal hawks.

Now, not everything has gone wrong. Late last year Spanish and Italian borrowing costs shot up, threatening a general financial meltdown. Those costs have now subsided, amid general sighs of relief. But this good news was actually a triumph of anti-austerity: Mario Draghi, the new president of the European Central Bank, brushed aside the inflation-worriers and engineered a large expansion of credit, which was just what the doctor ordered.

So what will it take to convince the Pain Caucus, the people on both sides of the Atlantic who insist that we can cut our way to prosperity, that they are wrong?

After all, the usual suspects were quick to pronounce the idea of fiscal stimulus dead for all time after President Obama’s efforts failed to produce a quick fall in unemployment — even though many economists warned in advance that the stimulus was too small. Yet as far as I can tell, austerity is still considered responsible and necessary despite its catastrophic failure in practice.

The point is that we could actually do a lot to help our economies simply by reversing the destructive austerity of the last two years. That’s true even in America, which has avoided full-fledged austerity at the federal level but has seen big spending and employment cuts at the state and local level. Remember all the fuss about whether there were enough “shovel ready” projects to make large-scale stimulus feasible? Well, never mind: all the federal government needs to do to give the economy a big boost is provide aid to lower-level governments, allowing these governments to rehire the hundreds of thousands of schoolteachers they have laid off and restart the building and maintenance projects they have canceled.

Look, I understand why influential people are reluctant to admit that policy ideas they thought reflected deep wisdom actually amounted to utter, destructive folly. But it’s time to put delusional beliefs about the virtues of austerity in a depressed economy behind us.

  1. March 2, 2012 at 3:59 am

    those european countries benifited from a bias with white people why is the United states AA while China is triple BBB.
    Europe may be under a lot of debt but it does have most of the know how so in a way Europe cannot fail

    • March 6, 2012 at 4:51 pm

      It’s not about the failure of Europe as a political institution. It’s about in what shape you are going to come out of this crisis. And more importantly, it’s about the counter-productive effects of the austerity policies followed by many euzone countries, and how long this recession can last. What we see in the data–and this is a fact, not an opinion–is that austerity policies have not led to good economic recoveries.

  2. February 23, 2012 at 2:43 pm

    From what I have read about this crisis, the structural features of the international monetary system are to blame, the bank have gotten away with murder, it’s got to be the biggest theft in human history under our very noses (Ocean 11 style). Governments have pumped billions in insolvent banks (they got it all wrong from the beginning by mistaking an insolvency issue with a liquidity one!). Now of course, all this money has to be recuperated somehow and austerity is the only way, future generations will be robbed even before they’re born, countries are broke. Second, the European countries crisis: the EU has a lot to do with this, it is not just about economy, it’s about how to reform the EU such that similar things won’t have the same impact (indeed, some have called for doing away with the EU alltogether. This would be a mistake in my opinion but some reforms are definitely needed).

    • February 23, 2012 at 4:20 pm

      There are problems with the international financial system. No one would argue the opposite. However, recapitalizing some banks was necessary–more than necessary it was vital and it had to be done. As for the eurozone crisis, we published several posts on this topic. Policies that advocate austerity during recessionary cycles are rarely successful; and from a pure economic perspective, they are idiotic(and it is almost a red herring to compare public/state debt as private debt. They are not the same. A state is not like a family that needs to pay its bills otherwise it goes bankrupt). Despite that, we see them being implemented across the eurozone as if they are the sole remedy. You need first to get the economy going–i.e., stop the recessionary cycle first–then you can start reducing deficit spending. European countries got that sequence all wrong; they favored reducing deficit while the economy is still in a recessionary cycle, which would only regenerate more recession.

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