Why are we talking about austerity now when it’s worked so badly across the pond?
FROM POLITICO | JANUARY 29, 2015
The Europeans—some of them, anyway—are finally beginning to concede that austerity has gone awry. There’s less growth, more structural unemployment, little bank lending and economic contraction. And now, of course, we have a political backlash in the person of Alexis Tsipras, the leader of Greece’s Syriza party, who upon winning the prime ministership last Sunday declared grandly (and probably over-optimistically) that Greece will now “leave behind the austerity that ruined it.”
So with all the evidence in, why in the world is the United States poised to embrace its own economics of austerity?
After a somewhat hawkish monthly Fed report described economic growth as “solid” (December’s term was “moderate”), the buzz is about when the Federal Reserve will begin to increase short-term interest rates, which have remained at zero since the onset of the financial crisis more than six years ago. Before that the Fed wound down its quantitative easing program of monthly bond buying. As overall U.S. economic data have improved and the labor market has stabilized, the Fed decided late last year that aggressive and unprecedented monetary measures were no longer required.
The rationale for the Fed to raise rates is that economic growth is humming along at about 3 percent while the official unemployment rate is well below 6 percent. The hawks at the Fed—those who believe that rates should be raised now rather than later on the assumption that where there is growth and a statistically tighter labor market there will soon be inflation—think that it is best to act before inflation starts rather than after.
Yet this “getting ahead of the curve” approach assumes that there is a curve to get ahead of. There is one glaring problem with this logic: There is absolutely no discernible wage growth or inflation, and with oil and energy prices plummeting, even the conspiracy theorists who believe that inflation is hidden or underreported will have a hard time finding it.
Again, the lesson of Europe is instructive.
Greece’s Syriza Party struck a deeply resonant chord throughout parts of Europe that have seen years of economic contraction and stagnation and blame austerity politics. The recent massive move by the European Central Bank steered by Mario Draghi to undertake its own version of quantitative easing was further proof that austerity policies are giving way to spending and stimulus.
Even some European economic officials realize that, judging from the experience of southern Europe, austerity has succeeded not in restoring fiscal sanity but in crippling economic activity. Spain, Italy, Greece, as well as some of the countries of central and eastern Europe took the direction of Germany and the northern powers and slashed spending and focused on reducing debt. The result was less of just about everything—except unemployment. There was a lot more of that.
It could be argued that austerity did yield some results in the United Kingdom and the Baltic States, but the former was never in the doldrums in anyway comparable to the southern states, and the Baltics were willing to pay a high economic price in return for the buffer provided by the European Union against an ever-threatening Russia.
Austerity is first and foremost an economic philosophy. And economic theories of how the world should work can be remarkably resistant in the face of real-world evidence to the contrary. The dangerous power of immutable theory has underpinned the entire theory of austerity in Europe, with ambiguous results at best.
The theory behind austerity is fairly simple: The economic problems of the Eurozone and the United States stem from an excess of debt invested unproductively in assets. Too much government spending directly or indirectly made its way into unproductive assets such as real estate or consumer spending or over-generous safety nets. That was bad enough, but for advocates of austerity, too much debt is the main enemy and reducing debt is the main goal. Debt is seen as the Damoclean sword hanging over an economy, constraining options, limiting growth, and sucking vital capital out of the system to service that debt. And then, if and when governments try to devalue their currency to pay off the debt, creditors pay the price.
Austerity then demanded that countries bring their debt down to an acceptable level relative to GDP. That was and is the theory, that too high a debt-to-GDP ratio imposes a burden on growth and imperils economic health. And that theory had no greater proponents than the Germans, who demanded that debt-laden countries such as Greece, Spain and Portugal drastically curtail public spending, generate more tax revenue, and pay down their debt.
That is precisely what happened. Dictated largely by Germany, but supported by the conservative government in Great Britain and other countries such as the Netherlands, austerity saw deep cuts to government spending in heavily indebted countries of southern Europe. No one had any illusions about how painful such policies would be, with unemployment in Greece and Spain well exceeding 25 percent officially, and economic contraction causing further pain.