Jeff Madrick writes: 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 U.K. 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 U.S. 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.
Madrick is right, of course, but the overriding problem is that Europe (not to mention the rest of the Western “democracies”) are run by conservative governments, and conservatives think that Keynes is the devil incarnate. That has always been a problem for depressed economies: they lurch to the right, only to prolong their miseries. Remember the Great Depression? It lasted 10 years because that’s how long it took liberals to defeat the right-wing ideologues who were in power from Europe to North America.
There are two kinds of people in the world; those who believe economists, and those who think they’re arrogant jackasses with their heads in a dark and smelly place. Surrendering the authority of a national government and its society to a greedy cabal of faceless bankers and speculators must appear to take a high degree of hubris, but what if these illusionists are also the bankers and speculators their measures are designed to protect? These debts are being magnified over and above the original insolvencies in order to protect the profits of the banks and the speculators who took on the bad loans. What the public needs is to learn the names of these benificiaries whose interests require the imposition of austerity measures on the rest of us.
But wait, many of those beneficiaries of the original social spending and borrowing are us. Everyone who has a pension plan is demanding that our plans’ investments are protected. I remember an article from 2007/8 that pointed out that one significant driver of the US mortgage crisis were the pension and hedge fund industries that needed the high interest rates of the subprime mortgages to sustain their incomes and pay-outs. If the bond holders of European government debt take a haircut, the shed locks will fall in many places that may surprise us. Perhaps the culprit of our troubles is the overarching idiocy of Mr Market, who seems to think robbing one hand to enrich the other is a viable program for eternity. Sorry, but in a finite world there comes a time when growth beget by borrowing and cheap energy must come up against the brick wall of physical limitations. The well goes dry; the mine has no more ore; the city has overbuilt into the farmland that sustained it.
As Mr Micawber noted, we cannot live on credit forever. Like the Grim Reaper, the debt collector can only be held at bay for a limited time. In the other related article here, Kenneth Rogoff wonders if growth can be sustained—perhaps we should be considering if sustaining it is even desirable.