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Europe’s Phony War: Austerians Vs. Deficitarians

Are European nations really well-advised to follow the alluring policy prescriptions of U.S.-based deficit boosters?

March 20, 2013

ECB President Mario DraghiCredit:

President Harry S Truman famously begged for a one-handed economist. He was tired of having his advisors always argue “on the one hand” and “on the other hand.” These days, there is no shortage of one-handed economists in Europe.

Indeed, a veritable war of the economists is raging over the choice between austerity and deficits in Europe. Both sides — the Austerians and the Deficitarians — promote their recipes as the one and only way out of the crisis (and back to growth).

The intellectual impasse is easily exploited politically. All over Europe, the political left and the unions have united under the banner of the Deficitarians, while parties on the right have fallen for the Austerians.

In the meantime, the debate over debt or discipline is what such dogmatic debates always are — truly academic. The Deficitarians are evidently right in arguing that belt tightening pushes a recessionary economy deeper still into recession.

To accept that, one does not have to read the collected works of Keynes. Fiscal policy should be countercyclical to the flow of business activity. It should be looser when the economy falters and tighter when the economy hums.

Economic theory thus suggests that governments should spend in the bad times and cut back in the good times. But what about political practice?

It is here where democratically elected governments falter. Almost nobody wants to, or is capable of, enforcing budget cuts upon their citizens as a matter of precaution.

The political logic is thus the precise opposite of the Keynesian economic logic: Only when the economy falters and puts budgets under pressure will governments slash spending. Pressure is needed to touch any expenditures, entitlements and expectations.

In contrast, running up deficits is politically easy because the bill for them will only come due in the future. That makes any act of fiscal consolidation politically difficult — because it does hurt in the present.

Public debt thus has a natural tendency to increase over time. That game continues until a major overhaul — mostly devaluation and inflation — or until markets gets scared and start doubting whether a government’s debt will actually be repaid.

That brings us to the beginning of the eurozone crisis, when capital markets lost their faith in the ability of Greece and other nations on the eurozone periphery to repay their debt.

Those who now plead for more debt to be issued in order to solve a debt crisis must also explain where that debt is supposed to come from. It clearly cannot come from the countries now in trouble. Markets just wouldn’t buy it.

It could only come through bigger transfers from Northern Europe to Southern Europe, or from the rest of the world to Europe. The first option is anathema for Germany and a few other EU nations. The second is pure utopia, except for piecemeal support with plenty of strings attached. Once again, political reality trumps economic theory.

Europe’s Deficitarians are essentially a U.S. import. Theirs is the campaign that Paul Krugman and other progressives across the Atlantic are waging offshore, as part of their battle against the Republicans’ U.S. budget plans.

But Francois Hollande’s government in France, and other nations such as Italy, that are fond of U.S. Deficitarians’ prescriptions ought to watch their backs.

Larry Summers, the former U.S. Treasury Secretary, Harvard President and fellow Krugmanite deficit booster, is now stabbing France’s government in the back, for not doing enough to reform its economy.

Of course, the French really ought to have known better in the first place. The economic and demographic reality of Europe — in particular that of Southern Europe — differs profoundly from that of the United States.

America is an entrepreneurial country with a diverse economic base and healthy demographic growth. Compare that to Europe. France hasn’t balanced its books since the 1970s and carries the heaviest of public sectors.

Italy is Europe’s Japan, stuck into economic stagnation and demographic decline. Spain’s pre-crisis economy was one big bubble of banking and real estate.

The United States today can thus afford more debt because it will be able to pay off more tomorrow. It still has major growth potential — and not just for reasons of population growth.

The dollar remains the global currency and, as a mature currency union, the United States can simply shoulder more debt than Europe’s crippled eurozone.

Those who want Europe to go for more debt today must therefore also explain how Europe will pay off that debt tomorrow. Short-term fiscal doping carries a long-term cost — and a clear trade-off: Whatever a country spends on debt servicing, it cannot spend on investment, innovation, education and the like.

And that erodes economic potential. Yesterday’s debt is a recurrent drain on tomorrow’s prosperity. As even the United States will learn eventually, there comes a time when these long-term costs outweigh the short-term benefits.

Many of Europe’s debt-ridden countries are past that turning point. Piling up more debt for the future will benefit those who are able to finance it. Properly understood, it is a form of regressive redistribution — shifting future prosperity to today’s rich who receive the interest payments on that debt.

In the final analysis, economic growth stems from innovation and productivity. Countries that score well on prosperity and job creation in the long run are not the countries with the highest public debt. Rather, they are the ones where prudent policy facilitates innovation and its transition into economic activity.

Europe’s stark reality is that it features more than 30 years of declining growth capacity, masked by increasing debt. The total Greek debt — governments, families and companies — stood at 92% of GDP in 1980. By 2010, at the advent of the euro crisis, it was 262% of the much bigger 2010 GDP.

In the same period total debt-to-GDP went from 190% to 310% in Italy, from 160% to 321% in France — and from 136% to 241% even in Germany. Everybody is pretty much tapped out.

Nobody can wave a magic wand, as much as Paul Krugman — the Princeton economist and New York Times columnist (and one of the few in the trade who, by Truman’s definition, is a one-handed economist) — might wish that the Germans could do.

Debt can turn into an addiction that becomes debilitating and unsustainable. In Europe, it has reached its last hour with the eurozone’s confidence crisis. The writing on the wall is there for all to see: More debt will not shorten the path towards new and real economic potential, but lengthen it instead.

Given the divergence between idealized economic prescriptions and sobering but undeniable political realities, this crisis is the lever to redress Europe’s derailed budgetary culture. And it is the tool to ensure a healthy economic legacy for the young generations.

In the crisis countries of Southern Europe, the current wave of austerity ought to be understood for what it really is: essentially the symptom of a failed system in emergency repair (albeit under peer pressure from fellow Europeans).

What is needed there at this juncture is a parallel strategy for investment, which will require European solidarity. What goes by the name of “austerity” in Mr. Krugman’s parlance is simply a reasonable and unavoidable requirement to maintain deficits within the boundaries of reason.

One can of course debate the economic validity of particular budget targets for any given country, but they too are essentially the expression of the politics of the euro crisis. Without common budget standards across the eurozone, there can be no common rescue strategy. The budget targets, no matter how arbitrary their percentage points may be, are the necessary means to a higher end.

Instead of fighting battles that have been long lost, we should direct our energies towards the where and how of budget savings. The path of least resistance is the well-trodden road of one-off measures and linear cuts.

Europe needs reforms that generate budget margins through effectiveness and efficiency. Savings should flow from structural reforms that enable economic growth, streamline the public sector and stabilize the welfare state.

That’s what at stake. The phony war between Austerians and Deficitarians is really just a big waste of time.

More on this topic


The political logic is the opposite of the Keynesian economic logic: Only when the economy fails and budgets are under pressure will governments make cuts.

Europe's Deficitarians are essentially a U.S. import. They are the brigades of Paul Krugman.

France and other nations enamoured with American deficit-spending theories ought to watch their back.

Larry Summers, a deficit booster, is now stabbing France's government in the back, for not doing enough to reform its economy.

Whatever a country spends on debt servicing due to incurring more debt, it cannot spend on investment, innovation and education.