No matter what deal politicians and policy makers reach on Greece current focus the continent’s economic future seems doomed in the medium term.
The just-concluded European Summit, ostensibly, sought to find ways to balance austerity with growth. Predictably, it ended focusing primarily on finding a deal to cut Greek debt.
In other words, the focus remains very, very short term. A deal on Greece might cheer the financial markets for now but will do very little for Europe in the long term.
Why? Because European policy makers have been focusing on all the wrong things, such as tightening government spending and reining in budget deficits at a time when economies are swooning. Yes, the region needs those belt-tightening cuts over the long term, but what it desperately needs right now is growth — and there is absolutely no plan for that.
For most of last year, Europe was on overdrive to enforce fiscal austerity plans. “Cut spending, raise taxes and bring government budgets into balance” was the constant refrain among European leaders, led by Germany’s Chancellor Angela Merkel.
One year on, those austerity cuts, especially by troubled countries such as Spain and Italy, have done precious little to boost growth— or rein in high public debt, which is what started the region’s crisis in the first place.
The focus, so far, has been on lowering that dreaded “debt-to-GDP” ratio. Debt-stricken governments, under duress, have slashed government spending and raised taxes. The result: lower economic activity, lower consumer demand, higher unemployment and rising discontent among businesses and households alike. In addition, with lower tax revenues, the ability of governments to repay their debts also decreases.
It’s also important to note that when gross domestic product (GDP), shrinks, the debt-to-GDP ratio also increases automatically because of a lower denominator. To bring the ratio down, more austerity is required, which further shrinks the economy, requiring more austerity ……you get the picture.
“Last year was one for fiscal hawks to celebrate as fiscal consolidation proceeded apace,” theEconomist noted recently. “In the eurozone, Germany, France, Spain and Italy all managed to reduce their structural budget deficits, the latter three thanks to austerity. All three are expected to reduce those deficits further this year.”
But it has come at a terrible price. Unemployment across the 17 nations that use the euro hit a euro-era high of 10.4 percent in 2011, even as recession fears grow across the region.
Several experts have been warning about exactly this situation since last year. Prominent among them was Nobel Prize-winning economist Paul Krugman who, in a recent blog post, noted that what is happening in Europe was “completely unnecessary”.
“Half a century ago, any economist — or for that matter, any undergraduate who had read Paul Samuelson’s textbook “Economics” could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.”
Now, the voices against further spending cuts are gaining traction. At the World Economic Forum in Davos, Switzerland, even the International Monetary Fund, which until recently had been advocating the need to cut debts, issued a warning that inappropriate spending cuts could strangle growth prospects in Europe.
At the same event, US Treasury Secretary Timothy Geithner also warned of the risk of a “recessionary” cycle. “There is a risk that every disappointment in growth will be met with an austerity that will feed the decline, and that is a cycle you have to arrest to solve financial crisis,” he said, according to a BBC report.
Finally, European leaders seem to be waking up to the problem. The recent EU summit at least introduced growth into the agenda for the first time— so far, the focus has only been on austerity.
Unfortunately, given their snail’s pace of reacting to the sovereign debt crisis, it seems highly unlikely they’ll do anything quickly on the growth front.
They may have started talking about growth but so far, that’s all it remains — talk. Clearly, sovereign debt crisis nothwithstanding, Europe has a much bigger problem on its hands
