Europe’s austerity disaster is not just a matter of reckless policy decisions by arrogant leaders in the EU, although that is ultimately where the buck stops. Many others have been involved in explicitly or implicitly, directly or indirectly, keeping the crisis going. Among them are assorted economists in various positions whose forecasts have reinforced the desires among political leaders: while the politicians want austerity to work, economists have predicted that it would work.
There is just one problem. Austerity does not work. While it has taken economists quite a while to begin to realize this, others have raised questions for some time now. Among them are business leaders: two years ago British corporate executives began expressing concern about the soundness of continuing EU-imposed austerity policies. The seeds of that doubt have grown, so much in fact that a few days ago Britain’s Chancellor of the Exchequer found it necessary to make a plea to business leaders to stay on board with Britain’s own austerity program. The Guardian reports:
George Osborne has asked business leaders to hold their nerve and continue backing the government’s austerity measures after the Bank of England gave the first signal since the financial crash of a sustained economic recovery. The chancellor told the CBI annual dinner on Wednesday night that the business community should ignore critics of his economic policy who advocate a stimulus package to spur growth and reduce unemployment. … His speech followed a series of forecasts from Threadneedle Street showing the UK recovery strengthening and inflation falling over the next three years. Sir Mervyn King said the outlook had improved, with growth likely to reach 0.5% in the second quarter of 2013, after the 0.3% registered in the first three months.
This is a good example of how the desires of politicians conspire with unrefined forecasts by economists. Anyone who reads a “strengthening recovery” into a 0.2 percent of GDP uptick in growth, from 0.3 to 0.5 percent, is either sloppy or desperate. Since the difference between 0.3 and 0.5 percent is little more than a margin-of-error change to GDP growth, I am inclined to conclude that at least some of the involved economists are sloppy.
One reason for this is that there have been forecasts of an improvement at the time of the announcement of every new austerity package in Europe over the past few years. I am planning a larger research paper to expose these errors; in the meantime, it is important to ask why economists think that the current austerity policies will have any other effect than the others that have been implemented since 2009.
More on that in a moment. It is important that we do not let the political leaders off the hook. I am firmly convinced that they are desperately looking for any sign that austerity is working – and that their desperation has reached such levels that they are inviting to a conspiracy of the desperate and the willing. It is interesting, namely, to see all the optimistic forecasts that are surfacing now. Politicians who should know better than most of us that austerity does not work, give a surprising amount of attention to those forecasts.
Their desperation is cynical yet understandable. Almost every political leader in Europe has invested his entire political career in supporting austerity. Now he is witnessing more and more critics lining up with The Liberty Bullhorn, pinning the unfolding social disaster on austerity advocates.
The obvious reaction should be to question austerity. After all, I cannot be the only one to ask how much farther the EU is willing to push its member states. For example, how much more can Greece take before the country explodes?
Europe’s leaders are no doubt aware of how close some parts of the continent are to social unrest. So long as austerity-minded politicians cannot provide people with an economic recovery, they know they are accountable for whatever happens.
As an alternative, they use forecasts of willing economists to convince people that the recovery is just about to happen, no matter how microscopic it might be. The Guardian again:
The modest improvement in output over recent months comes against a backdrop of rising unemployment, the lowest wage rises on record … According to the Office for National Statistics unemployment rose by 15,000 to 2.52m in the three months to the end of March. Wages were 0.8% higher in March than a year ago and only 0.4% better if bonuses are taken into consideration, which is the lowest rise in incomes since records began in 2001.
Again, calling this a “strengthening recovery” is clear signs of desperation. There were times when any growth under two percent set off alarm bells, among economists as well as politicians. Now, numbers a fraction as high are raised to the skies as signs of a “strengthening” recovery. From the Sydney Morning Herald:
The dogged recession across the eurozone has snared key economy France, with the latest EU figures released Wednesday [May 15] showing a full year-and-a-half of contraction as tens of millions languish in unemployment. In Brussels, French President Francois Hollande tipped ‘zero’ growth on the national level, blaming an EU-wide, German-led austerity trap — and hitting out at banks for holding back on lending as he and fellow leaders battle to unlock taxable assets hidden in offshore bank vaults or breathe life into training programmes for Europe’s disillusioned youth.
And his recipe is to take it all out in the form of higher taxes instead. Yep. That will really make things better… The fact of the matter is that France desperately needs a complete reversal of its economic policy, with long-term credibility to go with it. The same holds for the entire euro zone, which according to the Sydney Morning Herald is in deep trouble:
official figures showed a 0.2 per cent contraction between January and March, in the longest recession since the single currency bloc was established in 1999. EU data agency Eurostat said output across the 17 states that share the euro — which are home to 340 million people — fell by 1.0 per cent drop compared to the same quarter last year. France notably slid into recession with a 0.2 per cent quarter-on-quarter contraction, with unemployment already running at a 16-year high.
French president Hollande blamed the bad economic news…
on “the accumulation of austerity politics” and a “lack of liquidity” within the banking sector leading to a euro-wide loss of confidence. Fresh from winning France a two-year period of grace from the Commission to bring its public finances back within previously-understood EU targets, Hollande argued that nascent plans to divert state and private investment towards projects intended to get Europe’s youth working would make a difference.
In other words, more government programs on top of government programs that don’t work. If government was the answer, there would not be a crisis in Europe today.
Instead, as the Sydney Morning Herald reports, Europe is heading for yet more of the same, though some economists seem stubbornly unwilling to accept the permanent nature of the crisis:
Following a string of disappointing survey results in recent weeks, Ben May of London-based Capital Economics warned: “We doubt that the region is about to embark on a sustained recovery any time soon.” The latest official European Commission forecast for 2013 published earlier this month tipped a 0.4-per cent contraction, but May said that was way off course with “something closer to a two-per cent decline” likely. His firm’s pessimism was backed by Howard Archer of fellow London-based specialist analysts, IHS Global Insight. “We expect the eurozone to suffer gross domestic product (GDP) contraction of 0.7 per cent in 2013 with very gradual recovery only starting in the latter months of the year,” said Archer.
What reason does he have for expecting a recovery? This is the standard mistake that mainstream economists and econometricians make: they rely heavily on models that are inherently prone to draw the economy toward long-term full employment equilibrium. When they “inject” a change to economic activity, such as an austerity package, their model automatically makes the assumption that this sudden and uncharacteristic change – called a “shock” – will be absorbed and the economy will move on.
Every new austerity package is treated the same way, both by the econometricians who design the models and by the economists who provide the analytical framework. Their take on the European crisis is therefore a series of individual shocks, not a systemic re-shaping of the entire economy. As a result, they always predict a recovery and return to some long-term stable growth path.
To the best of my knowledge there is not a single macroeconomic model out there that has yet incorporated the systemic effects of austerity. Therefore, the economics profession will continue to make systemic forecasting mistakes – and advise politicians based on those mistakes.
Don’t get me wrong. I am not blaming economists for the errors that politicians end up making. But our profession must begin to recognize its almost chronic inability to deal with economic crises. Our forecasting methods can handle regular recessions but are frustratingly inept at dealing with situations that become inherently unstable, such as the current European disaster.
In fairness, I am not the only economist with an unequivocal criticism of austerity. On March 5, Joseph Stiglitz explained in Economywatch.com:
While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. Indeed, it will now take a decade or more to recover from the losses incurred by misguided austerity policies – a process that may eventually force Europe to let the euro die in order to save itself.
Strange conclusion. The euro is not the cause of the crisis. But Stiglitz is probably letting his ideological preferences get in the way of good economic judgment. Otherwise he would do the same analysis has I have and conclude that the crisis is caused by the welfare state.
That said, Stiglitz is eloquent in his criticism of austerity:
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60 percent, and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy. The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease.
Well said. But what alternative is Stiglitz proposing? Certainly not that the welfare state must go:
The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
I don’t know where Stiglitz gets his data but here are the debt/GDP ratios for Ireland and Spain in 2003-2008:
In terms of actual euros, the general government debt in Ireland shot up by almost 84 percent from 2003 to 2008. In other words, it was only thanks to strong growth in current-price GDP that the Irish did not see their debt ratio grow faster than it did. They were expanding their government as fast as they could, and certainly more than was healthy for the economy: in 2010 the debt-to-GDP ratio had reached 87 percent, i.e., close to double what it was two short years earlier.
The Spanish situation followed a similar pattern, though with less dramatic numbers than the Irish. The lesson to be learned from this is not that these economies could afford their big governments, but that their big governments survived only because there was enough current-price GDP growth to pay for them. As soon as GDP slacked off, the cost of the welfare state quickly became completely unbearable.
Stiglitz refuses to see this. He goes on to advocate even more government, without a hint of explanation of how the world’s already highest-taxed nations would be able to pay for that:
Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the United States; but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates). … There will also have to be Eurobonds, or an equivalent instrument.
More welfare state spending, more government, more debt, more of the same that brought about the crisis in the first place.
Instead of wanting more of the same and providing politicians with rosy outlooks, practitioners of economics should re-examine the results of their own contributions over the past few years. The ability of hundreds of millions of people to maintain their current standard of living, even support their families, depends on it.
Years of austerity and a bad economy have stirred up quite a bit of hostility in Europe against the EU. Political extremism is steadfastly gaining terrain. This is not surprising to anyone who is a regular reader of The Liberty Bullhorn, but it is news to the Eurocracy. And the resentment toward the EU has now grown to such proportions that it is beginning to seriously worry Europe’s political elite, especially one of the EU Commissioners.
More on that in a moment. First, let’s hear what a pale liberal in the European Parliament has to say about the same topic. From Euractiv:
The European Union should brace for “chaos” after the European elections a year from now if the surprise victories by renegade, anti-EU parties in recent Italian and British elections are any sign of what is to come, European liberal leader Graham Watson said. Watson, leader of the Alliance of Liberals and Democrats for Europe (ALDE), told journalists in Brussels that mounting euroscepticism could break the balance between the European People’s Party (EPP) and the Socialists and Democrats (S&D) in the European Parliament.
That is the least of his problems. His alliance ALDE has been behind the austerity policies that the EU has shoved down the throats of about 100 million Europeans. Those policies have the EU’s trademark all over them, so when people lose their jobs, lose their health care, see their college tuitions skyrocket; when they have to pay a lot more for food because the value-added tax has gone up; when young adults realize that they have no chance of ever attaining the standard of living that their parents have; well, where do Europe’s voters turn? To the liberals whose policies are destroying their lives?
Of course not. They turn to radical socialists as in Portugal, to old-fashioned hyper-statists as in France, to Nazis as in Greece or to complete nut jobs as in Italy. In short, they turn to anyone who gives a voice to ordinary people. The votes that went to Golden Dawn and other extreme parties were votes against a European political elite that no longer listens to those who feed them and give them legitimacy.
Back to Euractiv:
“The logic that has been behind the elephant marriage of the EPP and the S&D has always been the logic that between the two parties, they can guarantee having 62% of the MEPs, which is the co-decision majority,” said Watson. If the two main parties lose ground in the May 2014 elections and they get fewer than the 62% of the MEPs, or they are so close that they cannot guarantee a majority, politicians will face a more fractured European Parliament, leading to “chaos”. “Under those circumstances the two groups might work closer together to ensure that the European Union is governable,” said Watson.
Like this is the biggest of Europe’s problems. Greece is not governable, especially not after the EU’s austerity war on the country’s economy. Portugal is not governable. The Spanish government is walking a thin line without safety net between pleasing the Eurocracy and keeping the provinces from seceding. Italy is even more of a political chaos now than it was during the very turbulent 1970s.
But none of that matters when a Europhile liberal is worried about the future political composition of the only parliament in the free world that has no real legislative power.
Beppe Grillo’s surprise showing in the February parliamentary elections in Italy and the anti-EU UK Independence Party’s strong finish in recent British by-elections have eroded the power of the more traditional, Europe-focused political parties. Across Europe, fringe groups have seen a surge of support.
Please note how the UKIP is included as one of these “fringe groups”. This is revealing, as it shows how the EU Commission is becoming seriously worried about what the future might hold for them. One of its most ignorant members is from Sweden:
Earlier this year, the European Commission warned that political extremism was on the rise, spurred by a long economic crisis that has caused record-high unemployment and social exclusion on the continent. Support for far-right parties is growing, said EU Commissioner for Home Affairs Cecilia Malmström, urging European leaders to fight the rise of racist and populist rhetoric that pose a threat to the European project.
I knew her 20 years ago. She is a complete and utter political hack, totally willing to compromise with any value, any moral creed, any principle to climb the Eurocrat ladder. She wanted a top EU job already before Sweden was a formal member, and she has done absolutely everything in her power to get there. She has won one election, and one election only, and she did it based on a long list of promises of what she was going to accomplish as a member of the Swedish parliament. The second she got a chance to get on the track to become a Eurocrat, she walked away from her voters, her promises and her seat in the parliament.
This is the person who passes judgment on who people vote for.
Back to the Euractiv story:
If no strong action is taken, Malmström said, extreme political groups could gain wider support in the next European Parliament elections. “We need more European leaders to express their opposition to rising extremism. We must have the courage to stand up and protect our common European values. We must have all the courage to stand up for what we have agreed upon and protect our values that are now being challenged in many countries in Europe,” Malmström told a news conference on 28 January.
And who should they vote for, Ms. Malmström? Your kind? The kind who speaks out of both sides of their mouth? The kind who talks about “European values” and then forces governments in country after country to destroy the economic future of tens of millions of young people? The kind who thinks austerity is an abstract idea with no consequences in real people’s lives?
There is no doubt that the entire EU project is in deep trouble. But the reason is not that there are extremists marching on the horizon. The reason is that people like Cecilia Malmström have turned the idea of European unity into a political behemoth with career paths for those who are loyal to the bureaucracy and a democratic deficit that makes Russia look like a reliable democracy. The problems for the EU began the day when the EU Commission – including Ms. Malmström – decided to subjugate the Greeks by means of reckless spending cuts, destructive tax hikes and complete and utter disregard for the consequences of those policies for the man on the street.
Extremists like Golden Dawn are the consequence of the crisis, not its cause. And while we are at it, let me make crisp clear that the discussion here about political extremism has nothing to do with Britain’s new party, UKIP. They are by no means extremists. If anything, the UKIP is the ideological and moral disciples of Lady Thatcher: good, old-fashioned classical European conservatism at its best.
It’s been said that freedom is just another word for having nothing left to lose. While I disagree with the notion, I do believe it can explain to some degree why people make radical changes to how they vote in desperate economic times. If the so called democratic parties no longer listen to, let alone work for the best of, voters and taxpayers, then what does the middle-class family in Greece have left to lose if the Nazis take over? If the parties that claim to protect parliamentary democracy force an entire country through the fiscal grinds of austerity and destroy one quarter of that nation’s economy, then why should people expect life to become any worse if they put Hugo Chavez-style communists in power?
Yesterday I explained:
inflation-adjusted GDP growth is forecast to be 0.4 percent this year, though that will probably be adjusted downward in the next few months. EU institutions that publish economic forecasts have a tendency to downgrade their forecasts as the present catches up with the future. At the same time, total general government debt in the 27 EU countries is heading the other way: from 2010 to 2012 those countries added 1.4 trillion euros to their total debt. In terms of growth rates, EU-27 have added debt at frightening rates over the past few years: 2008: 6.1 percent; 2009: 12.8 percent; 2010: 12.3 percent; 2011: 6.7 percent; 2012: 6.7 percent. Due to an almost total absence of GDP growth, the ratio of debt to current-price GDP has grown at stunning rates…
In 2008 the debt-to-GDP ratio for the 27 EU member states was 62.3 percent. In 2012 it was 86.9 percent, rising steadily in open defiance of every conceivable austerity measure.
These numbers tell us clearly and indisputably that the European economy is in just as bad a shape as it was when the crisis broke out. More and more Europeans are beginning to realize this; today the Daily Telegraph reports:
Responding to this prolonged slump, the European Central Bank cut interest rates on Thursday. Having last acted 10 months ago, the ECB lowered its main rate by a quarter point to 0.5pc, while signalling it was prepared to go even further. “We remain ready to act if needed,” said the ECB President, Mario Draghi. The eurozone has now finally joined the Anglo-Saxon economies in arriving at “ultra-low” base rates. The Bank of England slashed its main interest rate to 0.5pc back in March 2009, in the immediate aftermath of the sub-prime crisis, soon after the US Federal Reserve went all the way down to 0-0.25pc at the end of 2008.
At these low interest rates, there is so much liquidity floating around in the economy that you could fill every mattress in Europe with ten-euro bills. Let us not forget that the purpose behind austerity is to end government borrowing and thus bring interest rates down. The lower interest rates would then encourage private entrepreneurs to invest more, and thus get the economy moving again. But the central banks have already done the job of cutting interest rates – they have in fact cut them to such levels that if any entrepreneur out there wants to invest, he can practically get free money to fund his project.
So why aren’t they investing? Easy: there is not enough demand for their products. Even a loan at virtually zero interest rate must be paid back, and it is actually not that easy to get hold of “free” money even in times of very low interest rates. After all, there is something call “credit risk” that the bank has to take into account.
Back to the Telegraph:
While eurozone rates were gradually reduced to 1pc in mid-2009, inflation-conscious Germany strongly resisted following the rate-slashing actions of other “leading” central banks. Under pressure from Berlin, the ECB actually raised rates a couple of times in 2011. Since the European economy renewed its nose-dive, though, rates have steadily been cut. With eurozone inflation at 1.2pc, its lowest since February 2010, ECB policy-makers argue they have “room” to cut.
It is ludicrous to believe that increased money supply in the midst of a recession will automatically cause inflation. If that extra liquidity is going to drive prices up, there must be some kind of transmission mechanism between the extra liquidity and the real sector where prices are set.
One such transmission mechanism is entitlements: if government uses newly printed money to pay for welfare checks, housing subsidies and similar cash entitlements, then the newly printed money will indeed fuel inflation. People will be able to go out and spend that new cash without there being any corresponding increase in production. Another transmission mechanism is cheap consumer loans, doled out with little or no regard for credit ratings.
Thus far there are no signs that any transmission mechanism from money to prices is active in the European economy. It is safe to write up the German worries about inflation to armchair theorizing.
A much more important variable to consider is unemployment, which the Telegraph mentions:
In March, the single currency region registered a jobless total of almost 20m people, a record 12.1pc of the working age population. This terrible composite figure hides, of course, a multitude of extremes. While Germany has unemployment of just 5.1pc, in Portugal some 17.5pc of the labour force isn’t working. In Spain and Greece, the figures are 26.7pc and 29.1pc.
Yet someone thought it was a great idea to create one and the same monetary policy for all these countries. And then they added a one-size-fits-all fiscal policy on top of that. Yep. But hey – the economists involved in developing this currency union all have degrees from prestigious schools, so they must have been right. Right…?
The fact of the matter is that the crisis is not over. It is becoming permanent. A major problem for the European economy in general is that it has suppressed private consumption to disturbingly low levels. Private consumption is the driving force of all economic activity – ultimately, all resources we produce will be directly used by consumers, or indirectly used toward their needs. As a result, when private consumption is reduced as share of GDP, it will inevitably pull down GDP growth as well.
Austerity policies are very effective in suppressing private consumption. Perhaps, therefore, it is not surprising that in a country like Spain the private-consumption share of GDP is around 55 percent, compared to approximately 70 percent in the U.S. economy. In the Irish economy the private consumption share is even lower: 45 percent.
The Greek share is high for a crisis country but falling steadily: it started at 72 percent in 2008 but is now 68 percent. This is a notable drop, as these shares are very stable over time. In actual (inflation-adjusted) numbers, the Greek economy has lost 34.5 billion euros worth of consumer spending in four short years. If the average private-sector job costs 50,000 euros to maintain (probably a high number by today’s standards), this means that the Greek economy has lost private consumption spending equal to 690,000 jobs. This accounts for the bulk of the 800,000 Greeks that have lost their jobs since 2008 (when almost 4.6 million Greeks had a job to go to). Even if many of them have been laid off from government jobs, the drastic drop in household spending has made it impossible for them to find a new job in the private sector.
Europe’s crisis started as a sub-prime crisis. Out-of-control government borrowing and credit downgradings of Europe’s most troubled welfare states added a serious escalation to the crisis. Austerity and weak private consumption vouch for a continuation of the crisis. It has been going on for such a long time now that I am convinced Europe will never come back from it. There will be exceptions – Britain among them – but the EU and common currency projects have their best days behind them.
Especially from an economic viewpoint.
The European economy is in bad shape. On May 3 the EU Observer reported:
The eurozone economy will contract by 0.4% in 2013, Economics commissioner Olli Rehn said Friday. Presenting the EU commission’s Spring Economic Forecasts, Rehn said that the bloc would return to growth in 2014 by a slower-than-expected 1.2%. Meanwhile, the average debt levels will hit 96% in 2013.
Looking at the 27 EU member states, things are looking almost as bad: inflation-adjusted GDP growth is forecast to be 0.4 percent this year, though that will probably be adjusted downward in the next few months. EU institutions that publish economic forecasts have a tendency to downgrade their forecasts as the present catches up with the future.
At the same time, total general government debt in the 27 EU countries is heading the other way: from 2010 to 2012 those countries added 1.4 trillion euros to their total debt. In terms of growth rates, EU-27 have added debt at frightening rates over the past few years:
2008: 6.1 percent
2009: 12.8 percent;
2010: 12.3 percent;
2011: 6.7 percent;
2012: 6.7 percent.
Due to an almost total absence of GDP growth, the ratio of debt to current-price GDP has grown at stunning rates:
To reinforce the persistent nature of the economic crisis, the EU Observer also reports:
France has moved centre stage in the crisis, after EU economic affairs commissioner Olli Rehn said that the country would fall into recession in 2013 and needs two more years to bring down its budget deficit. Presenting the Commission’s Spring Economic Forecasts on Friday (3 May), Commissioner Rehn described Paris’s forecasts, based on a mere 0.1 percent growth rate, as “overly optimistic.”
It is hard to see how France has ever been out of the Great Recession. From 2008 through 2012 the French economy averaged 0.06 percent in real GDP growth. During the same period of time its debt-to-GDP ratio went from 68.2 percent to 90.4 percent.
This explains why, as I reported recently, the French government is panicking over the prospect of more austerity. They know it has not worked for their southern neighbors and they are not going to stir up the same kind of political turmoil as those policies did in, e.g., Greece. The socialist French government knows that parties like Front National – often perceived, wrongly so, to be ideologically close to the Greek Nazis, Golden Dawn – as well as radical communists could make significant political gains if the French people were subjected to the same bone-crushing fiscal measures as the Mediterranean EU members have implemented.
The French resistance to more austerity caused the EU Commission recently to declare that the War of Austerity is over. It is not, of course, or else there would be a complete course change throughout southern Europe. Furthermore, the EU Commission would not be continuing to pressure Paris over balancing its budget in the midst of a recession. The EU Observer again:
The eurozone’s second largest economy would run deficits of 3.9 percent in 2013 and 4.2 percent in 2014, he said, calling on Francois Hollande’s government to draw up a “front loaded” package of cuts and labour market reforms to stop “persistent deterioration of French competitiveness.” For its part, Paris maintains that it will reduce its deficit to 2.9 percent in 2014, fractionally below the 3 percent limit in the EU’s Stability and Growth Pact. Hollande in March announced that an additional €20 billion worth of tax rises and €10 billion in spending cuts would be included in his budget plans but said no further cuts would be made.
Because if he tries, the socialist government is going to end up in real trouble. Many of the prime minister’s cabinet members are truly fearful of more austerity, for various reasons.
But wait, there’s more:
Crisis-hit Cyprus, which has now finalised a 10 billion bailout, is set to be worst hit by recession with an 8.7 percent fall in output. Meanwhile, the average national debt pile is expected to peak at 96 percent of GDP in 2014, with six countries – Belgium, Ireland, Greece, Italy, Cyprus and Portugal – having debts larger than their annual economic output. Rehn indicated that Spain would also be given an additional two years to bring its deficit down to the 3 percent threshold, while Slovenia would also need more time.
So long as Europe keeps its welfare state, it has no way out. The welfare state is what is driving Europe’s crisis today, and it will continue to do so for as long as the welfare state exists. Nothing is changing for the better. Europe is drowning in its entitlement-driven government debt. The continent is stuck, and the talk about austerity being over is politically motivated hot air.
I stand my my diagnosis: austerity policies exacerbated the financial crisis into a welfare state crisis and turned Europe into an economic wasteland. What used to be a thriving industrialized continent is now facing an endless future of industrial poverty.
Recently I have reported on the changing tone among Europe’s political leaders when it comes to austerity. The change came after the French government basically declared that it would not be able to unite around the same kind of job-destroying policies that the EU so viciously had forced upon France’s southern neighbors. But rather than admitting that their austerity policies have been a disaster for Europe, the Eurocrats simply shifted foot, declaring plainly that austerity had done its job.
Given the death of jobs and destruction of prosperity from the Aegean Sea to the Iberian peninsula, this is more than a little arrogant. It is political elitism coupled with a disdain for the lives of regular citizens.
It is, in one word, Eurotarianism.
If the EU Commission really cared about the citizens whose taxes are paying for their lavish lifestyle, they would pay a lot more attention to mundane things like, oh, the GDP growth rate of the euro zone. As technical and yawn-inspiring as that figure might be, it is still one of the best indicators of whether or not austerity is working. (Let’s not forget that Greece, Italy, Spain and Portugal are still enforcing austerity policies, despite the new words hot-airing out of the mouth of some Eurocrats.)
A good place for them to start learning about reality would be a recent article in Euractiv about the sluggish – to say the least – European economy:
The eurozone economy shows little sign of recovering before the year-end despite an easing of financial market conditions, European Central Bank Mario Draghi said … after interest rates were left at a record low. The ECB held its main rate at 0.75%, deferring any cut in borrowing costs … .
The common belief among parishioners of the Austrian school of economics is that so long as a government balances its budget a so called natural interest rate will emerge that will encourage entrepreneurs to invest and expand their production capacity. Regardless of the budgets of EU’s member states, if it was true that a low interest rate encourages investments, then a rate of 0.75 percent should have entrepreneurs all over Europe flocking to the banks.
Do you see that happening?
Neither does Euractiv, which reports that the ECB is also ready to keep interest rates down through its bond buying program:
The central bank has said it is ready to buy bonds of debt-strained governments such as Spain and Italy once they sign up to a European bailout programme with strict conditions, under a programme dubbed Outright Monetary Transactions (OMTs). So far no request has been made, but the announcement alone has calmed markets.
And is thereby keeping interest rates down. How surprising. The ECB has explicitly said that “we will use our money printers to churn out whatever trillions of euros it takes to buy every single treasury bond from Spain, Italy, Greece and Whateveristan, from now until Sweden freezes over”. When owners of even the junkiest of euro-denominated treasury bonds know that they can always get their money back, no matter how bad things get, then of course they will rest easier.
The problem is of course that at some point they will have had to print so much euros that owners of bonds outside the euro zone will want to secure the exchange rate of the currency. That becomes increasingly difficult if the ECB is going to flood the world with euros just to save its member states from the financial junk yard.
No one can say for sure when that point will come. Doomsday preachers have cast a spell on the U.S. dollar for years, yet it still stands relatively strong. That does not mean the doomsdayers are wrong – all it means is that we simply do not have enough examples of collapsing currencies to predict where either the Federal Reserve or the ECB will have printed too much money for their own good.
But long before we find that out, we will find out that the low interest rates the come with excessive money supply are not going to get the wheels turning in the economy. There is a very simple reason for that, which we will get to in a second. First, back to Euractiv:
Gloomy data this week indicated the eurozone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates. Recent survey evidence gave no sign of improvement towards the end of the year and the risks surrounding the euro area remain on the downside, Draghi said. He signalled the ECB would downgrade its GDP forecasts next month, describing “a picture of weaker economies”, and said inflation would remain above the ECB’s target for the rest of the year, before falling below two percent during in 2013.
It is interesting that inflation is above two percent in an economy – the euro zone – that is at a complete standstill when it comes to GDP. While we will have to wait for the micro data behind the inflation number to know exactly where it comes from, my bet is that it is caused by tax increases and terminated government subsidies in austerity-ridden countries. The private sector is always quick to pass on such explicit and implicit tax hikes, even in tough economic times.
Pricing in modern economies is typically done on a mark-up basis where producers and seller review prices about two times per year. (If your microeconomics professor told you anything else, then I’m sorry for the rude awakening…) This means that if we have austerity measures being put into place this spring with a direct effect on consumer prices, we will see repercussions in inflation data for the rest of the year.
That said, inflation above two percent and interest rates at rock-bottom levels is actually – according to standard economic theory – a good recipe for investments. You see consumer prices on a slow upbound trajectory, which tells you that if you lock in your costs today you have good reasons to expect profit margins in the future. At the same time, with very low interest rates you have good reasons to believe that you will lock in those low costs.
So why aren’t they investing?? Patience, my young padawan. Uncle Keynes will give you the answer in just a moment.
Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the eurozone, a mechanism that has been broken by the bloc’s debt crisis. The new bond purchase plan is the ECB’s designated tool but it can only be activated once a eurozone government requests help from the bloc’s rescue fund and accepts policy conditions and strict international supervision.
Which is technospeak for “more austerity”. Despite the hot air from Barroso, nothing has changed in the conditions that the ECB attaches to its bail-out program for debt-mired member states. Governments in already-suffering countries know that if they try to push more tax hikes and spending cuts on their citizens they will have an armed revolution on their hands – or be booted out of office in the next election and replaced by Nazis or “Bolivarian” communists. They obviously don’t want this to happen.
The problem for the ECB is that their bond-buying pledge has now calmed the markets, but the member states have not accepted the terms of the program. This means that in effect, the program is worthless. In order to avoid losing credibility the ECB is going to have to relax the conditions attached to the program, not now but in a year or two. The reason is that the countries in Europe’s dungeon of debt will not recover from their current crisis.
Why won’t they recover? Because their fiscal policies are still geared entirely toward balancing the budget in the midst of zero or negative growth and very high unemployment. With too few taxpayers and too many entitlement consumers indebted governments continue to run deficits – and therefore continue to try to close those gaps with the same policies that brought about the depression in the first place.
In order for those economies to start growing again the hopelessly indebted governments must give the private sector room to spend money. So long as consumers are pushed to the end of their finances by high taxes and unemployment they won’t spend. If they don’t spend there won’t be any demand for consumer products, services, houses, cars, food, clothes, haircuts, vacation travel services, books, plumbers, painters, carpenters, restaurants, recreational services like spas and gyms…
Which brings us back to why entrepreneurs are not taking advantage of virtually free money. They have no reason to believe that they will get their money back in the form of sales revenue.
People have cut their spending today, which according to the pastors of the Church of Mises and Menger means that they will increase spending by the exact same amount at 1:20PM on Monday. Keynes, however, had a more sober analysis. Here is how he opened Chapter 16 of his General Theory of Employment, Interest and Money:
An act of individual saving means — so to speak — a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand,— it is a net diminution of such demand. Moreover, the expectation of future consumption is so largely based on current experience of present consumption that a reduction in the latter is likely to depress the former, with the result that the act of saving will not merely depress the price of consumption-goods and leave the marginal efficiency of existing capital unaffected, but may actually tend to depress the latter also. In this event it may reduce present investment-demand as well as present consumption-demand.
Only Keynes can save Europe. It would take an enormous load of work, though, to allow his theory of effective demand to actually go to work in the European economy. While economically possible, I seriously doubt that there is enough political will power to allow that to happen. It would mean that those who have gained enormous political power both in the Eurocracy in general and among the austerity merchants, will have to take more than a few steps back.
I frankly don’t think this is politically possible. I am fairly certain that Europe has gone so far down the path of austerity and big government that it won’t ever come back again. But this message from Uncle Keynes could serve as an excellent reminder for American lawmakers to get their own house in order – the right way.
The Keynesian way.
After years of fiscal torture of country after country along the southern rim of Europe, the EU recently turned its attention to France. It was time for Paris to be subjugated. But unlike their southern neighbors, the French government got scared of the well-documented consequences of austerity and wanted no part of it. Since France is not as easy a pushover as Greece or Portugal, the Eurocrats in Brussels found themselves trying to bite off more than they could swallow.
In order not to look like losers, the EU Commission quickly decided to refurbish its agenda. All of a sudden the chair of the Commission, a Eurotarian by the name Jose Manuel Barroso, declared that…
the EU’s budget-slashing response to the economic crisis has run its course. Speaking in Brussels at a meeting of European think tanks, Barroso commented that “while I think this policy [austerity] is fundamentally right, I think it has reached its limits.”
In other words, Barroso and his cohorts of fiscal dictators now think they have destroyed enough jobs, raised enough taxes, starved the health care systems to a sufficient level of fiscal anorexia, and killed the future prospects for a satisfactory number of young people. Now they can leave the economic wasteland behind them as if nothing really happened.
Well, if things were at least that good. Even if the EU Commission would escape any accountability for what it has done to the livelihood of a hundred million Europeans – if all it would do from now on were leave the European economy alone, it might be possible to move the years of austerity into the annals of history. But that is not what is going to happen. As Barroso hinted, his commissioners have tasted blood and will not let go of their new-found instruments of power. They have become far too fond of their self-appointed role as supreme fiscal policy experts.
If they indeed stop shoving austerity down the throats of EU members, it will not be because they have become born-again libertarians who will leave the economy alone. Far from it. The alternative emerging from the hallways of the Eurocracy is almost as ridiculous as a continuation of austerity. From the EU Observer:
EU social commissioner Laszlo Andor has asked Germany to raise its wages in order to boost consumption and help other countries in the eurozone to export more. A shift from budget cuts and austerity towards economic stimulus is needed to help the southern euro-countries overcome the crisis, Andor told Sueddeutsche Zeitung in an interview published on Monday (29 April).
So now it is time to shift from one form of destructive incursions into the free-market economy, to another. Instead of raising taxes and cutting government spending to balance the budget of a member state, Mr. Andor and his fellow EU Commissioners now want to force private employers to pay their employees more.
The minimum wage is an attempt at making private businesses part of a government welfare program. It is a major issue here in the United States, but its effect on the labor market is even more intrusive in high-unemployment Europe. It has one of two effects:
- Some employers are discouraged from hiring more people, as the expected revenue increase from the work of that extra employee falls short of what the person would be compensated;
- Other employees will try to stay in business by raising their prices, thus passing the cost of the minimum wage on to their customers.
Either way, the end result is higher cost of living for consumers and fewer entry-level jobs for new job seekers, especially the young. For a good, in-depth study, see Mark Wilson’s recent Cato Institute Policy Analysis. Or continue to read and we will do a little experiment to show how ridiculous the minimum-wage regulation really is.
First, though, let’s hear more from Commissioner Andor:
“Saving alone does not create growth. That requires additional investment and demand,” he said. Andor, a left-wing economist from Hungary, also pleaded for countries like Spain, Italy and France to be given more time to bring their deficit in line with EU rules. If not, he warned, all these countries will just pile on more debt.
The only right thing to do is to eliminate the Stability and Growth Pact altogether, and thereby do away with the legal mandate that EU member states must balance their government budgets. But relaxing its enforcement is a step in the right direction. Mr. Andor is also correct in that the European economy needs more demand. But after having made that observation, Mr. Andor resorts to traditional statist thinking, namely that government can somehow dictate the course of the economy. He should have learned from the EU Commission’s attempts at dictating a balanced budget in, e.g., Greece. But no:
He advocated a minimum wage in Germany – a demand also being made by the Socialist-Green opposition – explaining that it would help raise overall wages and boost consumption in the EU’s largest economy. ”Belgium and France have been complaining about German wage dumping,” Andor added. If Germany continues to keep the wages low and have high export surpluses, the commissioner warned, “the currency union will drift apart. Cohesion is already half lost.”
The currency union was a mistake in the first place. The euro zone is not an optimal currency area as defined by widely accepted economic theory. But more importantly, it was constructed in such a way that the currency union was isolated from fiscal policy and any other policy area with implications for the performance of the economy.
This macroeconomic artifact assumes that the real and monetary sectors of the economy never interact, that money somehow plays an isolated role in the economy. But modern economies are far too complex for any such isolation to take place. Even such simple things as credit cards break down the barriers between real and monetary economic sectors. People’s demand for money is closely tied to their consumption – a part of the real sector – and thanks to the existence of credit the banking system is actually part of creating money supply. Their part of the money supply is entirely driven by demand and credit ratings, which mandates a monetary policy that goes in lockstep with fiscal policy.
Under the currency union such coordination has been impossible. But as soon as things went rough in Greece, Spain, Portugal and Italy the European Central Bank quickly abandoned its independence decree and began interacting very closely with the fiscal-policy authority, the EU Commission. This is strong evidence of the construction flaw that was built in to the currency union. If it had been designed properly from the get-go, the current crisis would not have been nearly as bad.
That was a tangent, albeit an important one. It hints at a systemic error in the entire European construct that has made life worse for almost half-a-billion people. More on that in a later article, though; time now to return to Commissioner Andor’s demand for higher minimum wages in Germany:
Germany’s central bank, the Bundesbank, warned in February against raising wages too quickly, as companies would fire people and invest less. Dramatically increasing wages would only temporarily boost consumer demand, it argued, and in the long run, real incomes and consumer spending would actually decrease.
Correct. Consider the following experiment as an illustration of why a minimum wage is a bad idea in the first place, and raising it is about as bad as introducing it in the first place.
Suppose you have just opened a coffee shop and you have hired six people. Your business is making just enough money to pay the bills, so you are not paying yourself anything. You can only afford to pay your employees minimum wage. They all work 40 hours per week at $7.25 per hour, which puts your weekly employee cost (excluding payroll taxes) at $1,740.
One day EU Commissioner Laszlo Andor and his minimum-wage posse ride through town. When the dust settles you are left with a wage bill of $8.50 per hour, per employee. Suddenly, your costs went up by $300 per week.
How do you come up with that money? You could raise your prices, but the neighborhood is fairly competitive. Besides, you know your patrons are pretty price sensitive, and as a new business you want to encourage them to come back. You do not want to alienate them by suddenly raising prices.
You have two alternatives. You can reduce everyone’s work week from 40 to 33 hours and bring your wage costs down to $1,700, about where they were before the minimum-wage increase. You can also fire one employee and achieve almost the exact same cost cut.
Either way, the harsh reality of doing business will force you to contribute to the job destruction that always follows in the footsteps of a rising minimum wage. As bleak an outlook as this might be, at least it is based on sound economic analysis. It provides, in a very simple setting, the microeconomic foundation for the Bundesbank’s concerns regarding demands for a higher minimum wage in Germany.
There is only one way out of Europe’s crisis, and that is to get government out of taxing and regulating the private sector – and to structurally reform away the welfare state. Mr. Andor’s alternative to austerity may look good at first glance, but its consequences down the road are going to be solidly negative. Unfortunately, it also illustrates the statist mindset that has the EU Commission in a tight grip.
First you send your tanks in and pound away at schools, hospitals and private businesses. When people are laid off and flock to unemployment offices you direct your bombardment at those instead. When the unemployed and homeless former middle-class citizens go scavenging for food in dumpsters behind McDonald’s, you hammer away at them with yet another round of big-caliber fiscal ammunition. Then you tell everyone that this invasion may be a bit hard on them right now, but at some point, somewhere in the long run, their lives will get better.
When people still defy your fiscal army you keep fighting them until they have lost a quarter of their income and their jobs and their entire country has been transformed from a relatively prosperous European nation to an economic wasteland.
You keep going until your austerity storm troopers have wreaked havoc and destruction on country after country and reached the outskirts of Paris. Then, but only then, do you pause and try to brush off the image of a fiscal imperialist. From the EU Observer:
European Commission chief Jose Manuel Barroso on Monday (22 April) indicated that the EU’s budget-slashing response to the economic crisis has run its course. Speaking in Brussels at a meeting of European think tanks, Barroso commented that “while I think this policy [austerity] is fundamentally right, I think it has reached its limits.”
Of course. When austerity robbed the Greeks of 25 percent of their GDP, they got what they deserved. When Spain is risking regional secession and political and economic disintegration, and when Portugal is simmering at the point of civil unrest, that is all right and good in Barroso’s playbook.
In reality, what really concerns Barroso is the presence of public opinion in the way of his fiscal tanks. The EU Observer again:
In a reference to rising public discontent at the severity of spending cuts and tax rises, he noted that “a policy to be successful not only has to be properly designed, it has to have a minimum of political and social support.” ”We have to have tailor-made solutions for each country, we cannot apply a one size fits all programme to the European countries,” he added.
What exactly does this mean? Different combinations of tax hikes and spending cuts depending on what country you are in? More tax hikes in Portugal and more spending cuts in France? Do note that Barroso still believes in austerity – his only reason for not charging ahead to conquer France is that the French prime minister’s cabinet is not united in the desire to greet the invading austerity army at the border.
In the words of the EU Observer:
Barroso’s remarks are a further sign that Brussels is ready to give the likes of France, Spain and Italy more time to force through unpopular economic reforms to reduce their budget deficits. For his part, speaking at the same event, EU Council President Herman Van Rompuy conceded the economic crisis is “lasting too long. He added that “patience is understandably wearing thin and a renewed sense of urgency is setting in.” He underlined the need to “move faster on the reforms with the biggest immediate growth impact.”
The problem with Barroso and van Rompuy is that they have absolutely no idea of what really gets an economy going, nor do they have an interest in learning about it. Their only goal is in expanding their own power, and they have discovered that austerity is a formidable tool that can conveniently be applied to further that goal. Right now they are hesitant because France is a big chunk of real estate to bite off, and French politicians are a bit less inclined to bow their heads to the new fiscal masters than they were in Athens, Rome, Madrid and Lisbon.
As the EU Observer notes, the critics of the EU’s fiscal invaders have just been given more ammunition to use in the defense of their national fiscal sovereignty, as the EU Commission’s own economic forecasts…
make grim reading, especially for countries on the Mediterranean rim, which have been among the worst hit by the eurozone’s economic crisis. … Portugal and Spain saw their deficits swell to 6.4 percent and 10.6 percent of GDP, respectively, while Greece’ deficit rose to 10 percent. The ongoing recession also forced up average EU government debt levels to 90.6 percent, well above the 60 percent threshold set out in the EU’s Stability and Growth Pact.
In other words, the countries that have been subjected to austerity the longest, are the ones with the biggest deficit and GDP growth problems. Austerity is sold as a recipe for smaller deficits and stronger economic growth, yet the outcome is the exact opposite.
I have only one thing to say to my many European readers: don’t let yourselves be fooled by what Barroso says about austerity reaching its limits. He has stopped his barrage for now because you are paying attention. Once you let your guard down and look the other way, his fiscal stukas will be taking aim at your country again before you know what hit you.
There is a new viewpoint emerging in the debate over the future of the EU and the so called European project. Panic is setting in over the stagnant European economy, and at the national level a wave of EU criticism is growing to a political tsunami. Sweden and Denmark have long had EU-skeptical movements, and in last year’s Greek parliamentary election almost 40 percent of the voters chose political parties that are more or less critical of Greece’s EU membership. Britain already has an established EU-critical party, the dynamic UKIP, and last Thursday I discussed the newly minted German equivalent, “Alternative fur Deutschland”.
These new voices are outlets for a public opinion that is completely antithetical to the europhoria that dominated the ’90s and the first decade of this century. But with the Great Recession many member states of the EU took a very hard beating, suddenly finding themselves trapped with a combination of large budget deficits and sky-high unemployment.
No serious analyst would ever have suggested that this was not possible under the EU and the currency union, but the pro-EU politicians who created, endorsed or furthered the European Union over the past 20 years did their best to give Europe’s voters and taxpayers the impression that the days of toil and spartan living were gone. If only Europe would create its currency union, the entire continent would become the land of milk and honey.
Today, the milk has gone sour and the honey is stale. And more European leaders seem to be waking up with a bad case of political hangover. The latest example is a high-ranking former French politician by the name of Hubert Vedrine, who has some straight talk to deliver on Europe via Euractiv:
The European Union will never receive enough public support for federalism and so should abandon the idea of a United States-inspired superstate, says the influential French Socialist former minister Hubert Védrine. Germans will never foot the bill and other Europeans will not accept the loss of sovereignty that a supranational state would entail, Védrine told EurActiv.fr on the margins of the Organisation for Econonic Co-operation and Development’s New World Forum in Paris.
Before we get to the core of his criticism, let us note that the EU is, never has been and never will be a European version of the United States. This is a misunderstanding based on ignorance or carelessness: the United States of America is a federation built by states, with direct elections of the legislative and executive functions at the federal level. In the EU, on the other hand, voters have no influence at all over the executive branch – the EU Commission – and only partial influence over the legislative branch, which is split between the Council of Ministers and the European Parliament.
The European Union lacks the separation of powers that is so critical to the constitutional republic of the United States. The best way to characterize the EU is that it is modeled after a traditional, European nation state with centralized powers. It has not yet become a formal nation state, but that is only because the member states preceded the EU. Anyone who wants to gauge how far the EU is going in terms of power grabbing need only look at its bail-out system for the member states: even if we count the so called “Stimulus bill”, a.k.a., the American Recovery and Reinvestment Act, the United States government has never invaded the finances of the states in the way the EU has effectively seized control over member-state budgets.
With this in mind, let us get back to Euractiv and Mr. Vedrine:
“I do not believe for a second in a supranational vision, where the nation-states transfer their competencies to a higher level and where the states will be reduced to regions. The European people will never accept that. To start with Germany.” “The federal leap means nothing,” Védrine said. “Let’s abandon this perspective – this will discourage the 0.01% of the people who are federalist – and let us not compare ourselves to the United States,” he said.
This is a good point. Europe’s history is so different from the history of the United States that the two cannot and should not be compared at the continental level. But I think Mr. Vedrine is missing one point when it comes to the EU project, namely the deficit in terms of democracy and enumeration of powers. The EU is expanding its control over member states in a way that was never intended or envisioned by those who formulated the Maastricht/Lisbon Treaty. Their view was one of an EU that would work as some sort of “facilitator” for European integration. They failed miserably in this way, in good part because they went much too far in their eagerness to institutionalize that same integration process. But at least they did not create a system for the EU to run the budgets of member states.
Today’s EU leaders are equally uninterested in comparing themselves to the United States. Their view is, again, one of a traditional European nation state with centralized powers, no checks and balances and minimal popular influence. Even though any observer of U.S. politics could point to several hot topics in today’s American politics where the federal government is reaching too far in its own ambition to expand its powers, it is also clear that the separation of powers (“checks and balances”) works to mitigate or neutralize such power grabs. The current struggle between the states and U.S. Congress over Obamacare is one of many examples of how this checks-and-balances is working.
A skeptical French voice, joining the new Alternative fur Deutschland and the UKIP, is a positive addition to the debate over Europe’s political and economic future. However, unless there is a dramatic change of course away from austerity, centralized budget control and unchecked power grabs by the EU Commission, it is highly unlikely that things are going to get better.
Germany now has its own anti-EU party, a counterpart to Britain’s increasingly influential United Kingdom Independence Party. Before we learn more about them, though, let us first listen briefly to UKIP chairman Nigel Farage as he tells it as it is to EU Commissioner Olli Rehn:
And now for a report from Russia Today on the new Alternative fur Deutschland, Germany’s anti-EU party that could present the established Europhiles with a real challenge:
Austerity is spreading its ever darker shadow over Europe. It has now grown to such proportions that it is beginning to really scare members of Europe’s political elite. Among the deeply concerned are members of the French prime minister’s cabinet. This is big news that few seems to notice. One who does, though, is Ambrose Evans-Pritchard, sharp-eyed editor with The Telegraph:
French president Francois Hollande is facing an anti-austerity revolt from his own ministers as he pushes through a fresh round of tax rises and austerity to meet EU deficit targets. Three cabinet members have launched a joint push for a drastic policy change, warning that [spending] cuts have become self-defeating and are driving the country into a recessionary spiral.
And these are no small words coming out of the French cabinet:
“Its high time we opened a debate on these policies, which are leading the EU towards a debacle. If budget measures are killing growth, it is dangerous and absurd,” said industry minister Arnaud Montebourg. “What is the point of fiscal consolidation if the economy goes to the dogs. Budget discipline is one thing, cutting to death is another,” he said.
See I told you so. But where have the French been over the past five years when Greece has been sinking into the dungeon of austerity, mass unemployment, poverty, economic despair and political extremism? What did the French do to help Spain avoid bone-crushing austerity that has turned middle-class Spaniards into food scavengers? Did a single leading French socialist lift as much as an eyebrow when Portugal was almost torn apart by social unrest following EU-imposed austerity?
Evans-Pritchard does not bring up this European context, but his analysis of the French socialist austerity revolt is nevertheless worth listening to:
Mr Hollande will on Wednesday unveil another round of belt-tightening worth €12bn, even though Paris is already carrying out the harshest fiscal squeeze since the Second World War and France may already be in a triple-dip recession. The cuts are hard to reconcile with Mr Hollande’s campaign pledge last year to end austerity. They have set off furious criticism across the French Left. “Austerity is no longer tenable in Europe today with millions of unemployed,” said social economy minister Benoît Hamon.
So Mr. Hollande has shifted foot. His original plan was to “end austerity” by having government spend more, not less, while still raising taxes through the roof. That alternative does about as much damage down the road as austerity, especially if at the same time you are trying to balance the government budget.
And at the end of the day, the balanced budget is all that matters. It is the pillar upon which Germany has built its unrelenting campaign against “undisciplined” euro-zone members. The doctrine of the balanced budget was one of the cornerstones of the EU constitution – originally turned into constitutional mandate in Article 104c of the Maastricht Treaty of 1992 – and has since been elevated to religious doctrine. No one in Europe questions the economic logic in, so to speak, putting the balanced budget before the horse.
Not even the French who break ranks with the austerity-touting consensus. However, they actually don’t have to, because the nature of the austerity measures is such that it really does not deviate much from the standard European doctrine of maxing out the size of government:
Almost all the austerity measures will come from tax rises, pension fees and a “green’ levy, rather than spending cuts. The state sector will climb to a record 56.9pc of GDP this year as the economic contraction eats into the private sector. Public spending has reached Scandinavian levels … Critics say the French tax squeeze is not even helping to curb borrowing. France is at growing risk of a debt trap as the slump itself erodes tax revenues. Public debt will jump to 94pc of GDP next year, a drastic upward revision from 90.5pc.
Spending cuts would have made no real difference. Look at Greece, Portugal, Spain and Cyprus. The problem is the over-arching focus on balancing the budget in a recession.
Evidently, as Evans-Pritchard reports, the bad shape of the European economy, after years of unrelenting spending cuts and tax increases, is so bad that the political elite is beginning to panic:
A report prepared for EMU finance ministers over the weekend by the Breugel forum in Brussels said the eurozone’s crisis strategy is a failure, a nexus of confused policies that cut against each other. Fiscal overkill is stopping the banks returning to health, while foot-dragging on the EU bank union is perpetuating the credit crunch in the Club Med bloc. Sky-high unemployment is eroding job skills and “undermining Europe’s long-term growth potential”. Low growth is making it “much tougher for hard-hit economies in southern Europe to recover competititveness and regain control of their public finances”.
This is a good, first look at Europe’s deep structural problems. Austerity is not a structurally oriented policy, but it interacts with a lot of structural features of the European economy that, taken together, conspire to trap the economy in perpetual stagnation. One of those structural features is the system of excessively rigid labor laws. By interfering with the need of businesses to make flexible adjustments of their work force, Europe’s hire-and-fire laws significantly raise the cost of doing business, especially for smaller firms.
As a result, Europe’s work force is not working up to its potential. Tens of millions of workers get stuck in jobs that do not produce optimally, and tens of millions of others get stuck in unemployment. One symptom of this is low labor productivity, which the Breugel Forum notes in its report about Europe’s labor productivity:
Since 2007, the EU15 has taken a productivity holiday, while productivity has increased rapidly in the US (Figure 3). In terms of total factor productivity, both the EU15 and EU12 lag behind Japan. Even economically stronger countries, such as Germany, lag behind the US, and the evolution in the United Kingdom does not differ markedly from that of continental economies. Some hard-hit countries, such as Ireland, Spain and Latvia, have apparently recorded outstanding labour productivity performances since 2007, but most of these gains have been due to compositional changes, such as the shrinkage of low-productivity construction and low value-added services, and the total factor productivity developments in these countries were weak.
By making it excessively costly for businesses to downsize in tough times, Europe’s governments cause a phenomenon called “labor hoarding”, the effects of which the Breugel Forum report explain well:
Labour hoarding can partly explain the initial response to the shock of the recession. Employment contracted by five percent between 2007 and 2010 in the US, while in several European countries the employment shock was of limited magnitude. Public policies, such as Kurzarbeit, a scheme financed by the German government to support part-time work and keep workers employed, were one factor behind this response. Firms also hoarded labour, expecting a rebound and thereby limiting the initial rise in unemployment. Five years on, however, the productivity setback has become permanent, contributing to lower potential output. This cannot be regarded as a cyclical phenomenon anymore. In the short run, weak productivity performance can be related to insufficient demand through the so-called productivity cycle. But the weak cyclical position of the economy cannot explain sustained poor productivity.
It is good that some Europeans with access to the “big stage” are beginning to look deeper into what is really happening to the deeply troubled European economy. However, so long as they do not realize that the welfare state is the root cause of the problems, they will not be able to prescribe a medicine that could actually cure the patient.
The lack of insight into Europe’s ailment will drive the continent straight into the economic wasteland. As tepid as the American recovery is, it offers an infinitely better platform for the future than what the Old World could ever come up with.