Wednesday, 11 January 2012

Jeff Madrick on how austerity is killing Europe

Jeff Madrick: When it was announced that Ireland's national income virtually collapsed in the fall of 20011, it should have been a death blow to those confident that austerity economics works. Ireland had been held up as the first great hope of the austerity advocates.

[Reprinted from the New York Review of Books]On the last day of 2011, a headline in The Wall Street Journal read: “Spain Misses Deficit Target, Sets Cuts.” The cruel forces of poor economic logic were at work to welcome in the new year. The European Union has become a vicious circle of burgeoning debt leading to radical austerity measures, which in turn further weaken economic conditions and result in calls for still more damaging cuts in government spending and higher taxes. The European debt crisis began with Greece, and that nation remains the European Union’s most stricken economy. But it has spread inexorably to Ireland, Portugal, Italy, and Spain, and even threatens France and possibly the UK. It need not have done so. Rarely do we get so stark an example of bad — arguably even perverse — economic thinking in action.

Over the past two years, the severe 2009 recession, which started in the US but spread across Europe, have imperiled the finances of one European country after another. As a result, Portugal, Ireland, Spain and Italy are coming under pressure from the EU to cut government spending and raise taxes to reduce their deficits if they wanted to qualify for a bailout. All have done so. Ireland and Portugal sharply cut spending and still had to take tens of billions of euros to help meet financial obligations as of course did Greece. The European Central Bank bought the bonds of Italy and Spain. Britain’s Conservative government led the way in ruthless government cutbacks in 2010. France has adopted its own austerity package, and even Germany, the supposed economic leader of Europe, has planned to cut its deficit by a record 80 billion euros in 2014.

Proponents of austerity claim that as nations take control of their finances businesses become more convinced that interest rates will not rise and that growth will resume. Their reasoning has been abetted by the financial markets, which drove up rates on Greek debt and soon enough on the debt of nations like Portugal, Spain and Italy. Should these nations not be able to pay their debts, bond buyers wanted a high enough interest rate to compensate for the risk.

But this is pre-Great Depression economics. How could the EU so misread history and treat with contempt the teachings of John Maynard Keynes, who argued that during recessions governments must expand economies through spending and tax cuts, not the opposite? In practice, making large-scale budget cuts or raising taxes, as Keynes showed, will reduce demand for goods and services just when an increase is needed. Faltering sales will undermine the confidence of businesses far more than fiscal consolidation will embolden them. By ignoring this, European policy makers will deepen, not solve, the financial crisis and millions of people will suffer needlessly.

Indeed, austerity economics has not worked in one single case in Europe in the last two years. When David Cameron’s government imposed a first round of harsh spending cuts in 2010, it utterly failed to revive the British economy as promised. To the contrary, it probably cut a budding recovery short. Unemployment and the deficit as a percent of GDP remained high. Some pro-Conservative observers I met at the time assured me that the Cameron team, led by George Osborne, the Chancellor of the Exchequer, was pragmatic and would reverse course on austerity if it wasn’t working. Yet when growth basically ground to a halt in late 2011, the Cameron team only doubled down, making further cuts. We need more of the same medicine, they told their citizens, a record number of whom are unemployed. Britian is a hair’s breadth away from outright recession only two years after its last one.

In November, meanwhile, Spaniards voted out of office a once-popular Socialist government, in part for its failed austerity program of the past year. The Socialists had earlier presided over a boom and even built a budget surplus. But then the housing and banking crises struck and private Spanish banks ran amok. In response, in 2010 the Socialists sharply reversed an earlier stimulus policy, cut spending, and raised taxes to the tune of about 5 percent of GDP. Government debt is still not high in Spain, and interest rates have not risen the way they have in Italy. But economic growth stalled after these measures were implemented, because reduced public spending weakened the demand for goods and services, pure and simple. With Spain’s official unemployment rate now 21.5 percent, the Socialists lost the election badly—paradoxically pushing voters to elect a conservative leadership that is calling for more austerity. In Spain, recession is now inevitable.

And then there is Ireland. The recent experience of this once booming country should be deeply embarrassing to those who advocate austerity economics. For six months early last year, its national income started growing again after a couple of years of dramatic collapse following its own financial crisis. Ireland guaranteed all the debt of its over-aggressive failing banks to appease investors and then paid for it by cutting social spending sharply. Ireland’s leaders said with almost religious authority that this painful self-discipline was necessary to right the economy, and officials in Ireland and across Europe hailed the country’s brief rebound in 2011 as proof that it works. But then the Irish economy plunged in the third quarter of 2011 at its fastest rate ever. The upturn in the economy proved only temporary under the restraints of austerity economics. It may yet need another bailout.

Climbing out of the morass left by the financial crisis and now the European debt crisis would not be easy even if the right steps had been taken as they unfolded. While the American economy has gathered a little strength, recession in the peripheral nations and possibly Britain could take down France and other stronger nations—particularly in the absence of a coherent policy beyond austerity.

There is a far better solution. And it would not require the failure of the euro. The eurozone and perhaps the entire EU must act like a unified country, ready to recognize that it must take responsibility for the drastic social effects of rapid spending cuts. The US is no shining example of enlightened policies, but the European Central Bank must guarantee the debt of its members just like the Federal Reserve guarantees the debt of the US Treasury. It can then force restructuring of debt in these nations, with some private investors taking losses. A financially unified Eurozone must then issue bonds to raise the money to pay back debts but also to provide a social net for the people of nations that are cutting back their spending on social programs to meet their remaining financial commitments. (This is what the US does, for example, by sending Social Security checks and aid for the unemployment to every state in the union.) This can be accompanied by demands for reforms in nations like Greece where taxes must now be collected more efficiently and unusually excessive public spending stopped.

Germany has the financial wherewithal to lead this rescue. But it is blocking the fiscal union from acting like a single nation with compassion for all Eurozone citizens. It is also refusing to underwrite a substantial new fiscal stimulus—good-old fashioned Keynesianism. Is this a new national arrogance? I hope not. So far, Germany is benefitting from the crisis as investors buy German bonds as safe havens from the turmoil. In fact, the failure to act will soon affect the German economy. It will take financial losses on its banks’ loans to the peripheral nations and its export markets will weaken. The bond buyers who are now gobbling up German debt, thus keeping rates low while they rise in Italy, Greece, Portugal, and Spain, will likely stop doing so.

The EU leaders must get over their obsession with eliminating deficits. They now want to reduce every country’s deficit to less than 0.5 percent. This is disaster. It will lead to very slow growth for a long time. Instead, they must use temporary deficits to restart growth. Rarely has policymaking been this poor. Sooner than later, the citizens of these nations will say, No more!, and political instability will result.
Jeff Madrick is senior fellow at the Roosevelt Institute and the Schwartz Center for Economic Policy Analysis. His latest book, Age of Greed, The Triumph of Finance and the Decline of America, 1970-Present, is published by Alfred A. Knopf. Jeff Madrick spoke at the 2011 FEPS/TASC Autumn Conference. This article was first published in the New York Review of Books; reprinted with kind permission.


Paul Hunt said...

Dontcha just love these Americans. The US is a federal state - with a never-ending battle about states' rights relative to those of the federal government; the EU is a union of sovereign states which have agreed by treaty to pool some sovereignty.

Perhaps P-E's new US friend might recall "No taxation without representation". Voters in Germany (and in other EZ creditor countries) will not consent to their governments dipping in to their pockets to provide a pecuniary expression of 'compassion' towards the PIIGS - and quite rightly and legitimately will not not consent - until some demonstable effective democratic control is exercised over how this money is spent.

Accompanying this by 'demands for reforms in nations like Greece where taxes must now be collected more efficiently and unusually excessive public spending stopped' just won't cut it. And quite rightly so. In Ireland, when the boom was starting to get boomier, the European Commission had the gall to mumble quietly to the government that it might apply the brake a little. The government told it where to get off - with huge popular support. Successive governments blew their trumpet about the Celtic Tiger miracle and its 'world-class' regulation - and this hubris really got on the wick of many Europeans. To top it all, Irish voters rejected the Lisbon Treaty and the concessions made to ensure its eventual ratification has made EU governance worse.

German voters aren't stupid. Fool me once shame on you; fool me twice shame on me. The Troika demanded meaningful structural reforms, not because that is their wont, but because they are necessary to counteract the impact of fiscal adjustment. The Government has whittled these proposed reforms down to almost nothing - largely under pressure from powerful narrow sectional economic interests. And the so-called 'progressive left' is a stout defender of many of these narrow sectional economic interests. A decade, or more, of stagnation is unfolding before our eyes. But Ireland is good at that; it has no end of historical experience.

Martin O'Dea said...

Hi Paul,
I am very surprised at your take on this article that I found logical and well intentioned. I am not sure that the thinking you are partaking in is not a little bit outdated now; where the kids of the piigs misbehaved and the mature big guys in Germany told us so.

The banks argument is particularly relevant for Ireland here (i.e. German banks etc lending money to Irish banks fuelling property bubble) but it is not just to show the complicity across the union but also to show that Ireland's (accepting that there is such a singular entity with a defined 'character'(I would prefer the five million people resident in this island etc. and a move from the solely nationalistic outlook to the peoples involved))particular three year history here has to be to the fore of our policy makers minds.

I found FF and Bertie era abhorrent for a whole litany of reasons, but I must admit (reluctantly) that I feel their mismanagement of the economy, real as it was, is now being exaggerated.

In truth, we had a property bubble, and we had 1 in 8 people employed in construction and 6 billion tax take from stamp duty in '07. Undoubtedly this was going to need a sore correction.

However, we had in the previous years; from the science and tech education concentration of the 60s and the ultra competitive leaving cert of the 80-90s as well as European membership, global cultural ties, strong work by IDA, and a whole bunch of other things generated a strong innovative (if mostly foreign, who are unbelieveably still here (if this was a crash of Irish industrial model)) high-tech and pharma and service led business infrastructure.

In an ideal world a strong government would have taken the property crash hit (medium in financial terms and big in psychology terms, and overseen a fall from 61 billion in revenue with 54 billions in spend down to something closer to 50 revenue and 55 spend for a number of years and those who left construction (particularly private) were re-educated and assisted in a massive employment push through public infrastructure and tech based endeavours. This would have included publi construction - - bear in mind that after contraction we still need houses built (mathematically we were building 90k to a 60 k demand (while I am not suggesting a few years of 30k would have smoothly resolved - what happened is clearly an exacerbated version of what could have).

Martin O'Dea said...

(part 2)
What FF and then FG and Lab have really done to inflict unbelievable damage to this particular 5 million over whom they have had the privilege to make policy has really occurred since '08. This is where the vast majority of decisions were made that lead to couples in the thirties with kids settled in schools and mortgages being maintained to unemployment a life-time of debt and emigration, and kids with severe diabetes having to forego a modern insulin pump that monitored sugar levels constantly and must have made a massive difference to parents and kids alike, and revert back to old fashioned model due to public service cuts. and so much more

The bank guarantee is still not appreciated for as massive an error and catastrophic a decision as it was (we don't fully know how culpable our euro colleagues were here), probably because it is difficult to believe anyone could make such a b...s of something. In my humble opinion this should be renounced and their act should be seen as criminal with whomever possibly Brian Cowen and the gentleman on 300k in Europe answering to a court of law and by such means have this 5 mill then distance themselves from this mass economic suicide.

Maybe even more infuriating is the decision to strangle our economy with the neo-liberal response to the neo-liberal nightmare - - AUSTERITY - - which if we succeed will ultimately lead to a manageable deficit of 1.2 billion in expenditure and 1 billion in revenue as we meander our way back to a third world country.

To believe that Germany is responsible and we should tow the line is wrong also in the context of the European project which either is or is not a monetary union with the political model to make that work, but more than that it leads to comments like 'we all partied' and other such perverse old fashioned catholic guilt type collective self-hate

The billions that are discussed are supposed to reflect the output of the economy, the truth is that the ouput of our economy was not destroyed by a property crash, it was destroyed by what came after; and this is a time when tech advances create the potential where we should be driving the output further and further towards long-lived, healthy, comfortable, nourished, engaged population

Paul Hunt said...


Many thanks for taking the time to engage. I fully agree that this 'one club' austerity policy is grinding, and will grind, the economy in to the ground. That is why the Troika demanded some meaningful structural reforms, but, with a focus on fiscal and banking issues, it probably didn't have sufficient sector-relevant expertise in its team, was forced to accept the half-arsed proposals advanced by the previous government and hasn't been strong enough in opposing the Government's efforts to whittle these down to almost nothing - apart from hosing some low-paid workers.

This last is just more evidence of the perpetuation of the convenient myth for capitalists that labour is the only factor of production and, therefore, that increases in productivity and efficiency may be secured only by cutting pay and making workers work harder and longer.

This is total balderdash. The real gains of structural reforms lie in the squeezing of monopoly profits, the removal of deadweight costs and in the elimination of inefficiencies in the sourcing and allocation of capital. Of course, potential efficiency gains in the work-place organisation of labour should be secured, but nominal wages should be maintained - to sustain aggregate consumption - until the cost base of the economy has been reduced.

But all of this would take some concerted effort, it would be difficult 'politically' and, while those who are comfortably ensconced - both on the left and the right - are able to maintain, if not enhance, their relative positions in the pecking order, why worry that the economy might stagnate for a decade or more?

Martin O'Dea said...

Ya, Paul that seems to be a fair assessment entirely, the contextualisations of these discussions are vital - there is almost no debate in Ireland on the notion of austerity as a policy, as opposed to a fact of life.
Much of this comes from the umbrella context - that
a) we can't do anything else because the troika are running us ,and
b) everything that goes wrong here is down to external factors and so we can;t really be shown at any point to have made policy errors.

I do think that reduction of costs are not really as defining an issue - as a growing export sector in global recession shows, but agree with you that the business owning media moguls aligned with the political classes reeling under the influence of pro-business policy advice; all push the agenda that wages are the root cause of all evils, (patent nonsense by fact and certainly by imploding domestic demand circumstance).
I further agree that professions such as law and medicine and other closed professions where the majority find themselves without recourse but to use these groups and who are massively unregulated, overly powerful and a real irritant to costs - but that has been the case for many decades and is more a reflection of a very divided society between haves and have nots than an economic reality.

I don't think that there are many politicians, or to be honest even businessmen in Ireland that sit at home over cauldrons plotting the next neo-liberal attempt to cajole power from the masses. The truth I feel is much more related to outdated mindsets, a lack of any thought and in some cases foundations that are set in the stone of the 19th and early 20th century. I fear that new approaches will come only with new voices at this time, one of the defining times, in Ireland's maturing. We can grown up as a nation and recover economically in 5-10 years or we can as you say wallow in our inability to be creative to set aside failed assumptions and put our people's welfare first. As I say I can only see the latter coming from a new departure, I can;t see that departure anywhere near the horizon!