Monday, February 27, 2012


"To say that Europe has a growth problem is an understatement. Almost four years since the outbreak of the global financial crisis, only a handful of EU countries (Austria, Belgium, Germany, Slovakia, Sweden and Poland) have seen their economic output return above pre-crisis levels. In all the others, output is still below its peak in 2008 – in some cases dramatically so. Greece, Ireland and Latvia have endured catastrophic declines. But even in Italy, Spain and the UK, where the downturns have been less dramatic, output has already taken longer to return to pre-crisis levels than it did during the Great Depression of the 1930s. If this were not bad enough, many economies contracted in the final quarter of 2011 and will fall back into recession in 2012. How to explain this debacle?

Ask European policy-makers what their growth strategy for the region is, and chances are they will identify two ingredients. First, they will say, countries across the EU must push through structural reforms to improve the supply-side performance of their economies. Labour markets must be reformed; goods and services markets opened to greater competition; spending on research and development boosted; the EU’s single market deepened (notably in areas such as the digital economy); and so on. Second, they will argue, governments must restore confidence and lift ‘animal spirits’ in the private sector by consolidating their public finances. In combination, structural reforms and fiscal austerity will restore the region to long-term ‘competitiveness’, and consequently to economic growth.

The problem with this story is two-fold. The first is that supply-side reforms, though necessary over the medium to long term, are mostly irrelevant in the short term. Few observers doubt that EU countries, particularly those across southern Europe, would be well-advised to take supply-side reforms more seriously than they did under the Lisbon agenda. If they did, their productivity and living standards would rise over the medium to longer run. But to propose such reforms as an answer to Europe’s immediate growth problem is to miss the point: it is to provide a long-term (supply-side) answer to a short-term (demand-side) problem. Deepening the EU’s single market is a perfectly sound idea. But it will do nothing to offset the immediate impact of private-sector ‘deleveraging’ on demand.

If the first prong of Europe’s growth strategy is beside the point in the short term, the second is positively damaging. For the past two years, policy-makers across Europe seem to have persuaded themselves that fiscal consolidation will boost growth. Jean-Claude Trichet, for one, repeatedly dismissed claims that budgetary austerity would depress growth, arguing that “confidence-inspiring measures will foster and not hamper recovery”. Similar claims were made by other policy-makers, inside and outside the eurozone. The trouble is that these assertions had little evidence to support them. As a careful study conducted by the IMF concluded in 2010, “fiscal consolidations typically lower growth in the short term”. In other words, their net effect on demand is contractionary, rather than expansionary....

The short-term problem for Europe, then, is that demand across much of the region is chronically weak – and that fiscal policy is making matters worse. In balance sheet recessions, when households and firms cut spending and become net savers, governments must step into the breach by borrowing and spending. People who worry about the resulting deterioration of public finances should remember three things. First, large fiscal deficits are merely the counterpart of the increase in net savings among households and firms. Second, in balance sheet recessions fiscal deficits do not ‘crowd out’ private spending. And third, if governments cut spending when the private sector is ‘deleveraging’, activity will contract (unless foreigners come to the rescue by borrowing and spending more themselves).

The case against Europe’s growth strategy, then, is that it is all supply and no demand. There is no question that structural reforms are urgently needed to boost long-term growth. But fiscal policy is being tightened too rapidly. Europe has turned what should have been a marathon into a sprint. Governments are cutting public spending before private-sector balance sheets have been repaired. The result is that the more certain EU countries do to balance their budgets, the more output contracts. Fiscal virtue, in short, has become an economic vice. Not only does it risk pushing economic output in countries such as Spain the way of Greece, Ireland and Latvia. But it also risks discrediting much-needed structural reforms by associating them in voters’ minds with collapsing activity and rising job losses".

Philip Whyte, "Europe's Growth Strategy: All supply and no demand." Centre for European Reform. 27 February 2012, in

"Madmen in Authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."

Lord Keynes. The General Theory of Employment, Interest and Money. Chapter twenty-four.

The self-evident validity (at least it is self-evident to me) of Philip Whyte's essay is unfortunately, not in the least self-evident to the mad mandarins who command Europe's fiscal and monetary policy at the moment. To them the current crisis is a time for Europe's fiscal house to be put in order. Damn the employment torpedoes, 'full steam ahead'. Et cetera. Hence the ultra-nonchalance over the fact that most of the Eurozone and indeed most of the European Union will be facing another recession this year. Whereas the USA, who has been an extreme laggard as it relates to restoring its fiscal balance, will probably post for the first time in years, higher growth numbers than any of the countries of the EU. Of course to our modern day Brunning's, this fact has absolutely no importance whatsoever. Indeed, we have most recently seen European Commissioner Rehn, insisting upon punishing almost any country which he deems to be out of step with the current masochistic fiscal game-plan that Brussels has come up with. As Jean Pisani-Ferry, no stranger to the ways of Brussels, commented on to-day:

"Economic history teaches us that financial crises have long lasting, if not permanent, negative effects . Most European countries have already lost several percentage points of GDP and it seems wise to expect the second recession to do the same. Mr Rehn has good reasons to require action. However, demanding adherence to the 2013 targets has two major drawbacks.

First, immediate austerity measures would aggravate the recession. Recent research suggests that the short-run negative effects of austerity measures tend to be higher than we previously thought. Though most European governments have structural problems with their budgets, that does not call for impairing all automatic stabilisers in a recession year.

A second drawback of imposing immediate action is the form that this would almost certainly take. Closing a gap on short notice is not compatible with smart consolidation. The most effective way to achieve a dramatic result by next year would be to just raise existing taxes – with all the adverse consequences on potential output and no effects on the effectiveness of public spending....

Mr Rehn’s involvement in the budgetary policies of individual member states is motivated by their effects on other members. Attention has recently been focused on the negative effects of excess borrowing. However, in this era of major private deleveraging, the positives should also be considered.

This means minimum additional austerity over and above what is already planned in countries under direct financial stress and for no additional austerity at all in countries that do not face an immediate threat of losing access to the financial markets. Provided credible structural measures are implemented, this stance would be consistent with the EU treaty and budgetary sustainability. And it would certainly be better for the economy of the eurozone"

Either the Eurozone countries learn from their past mistakes in obsessing over non-existent inflation and concentrate on the dangers of low to no-growth and permanent high-unemployment. As Martin Wolf, Lord Skidelsky among many others have insistently noted, the current debt levels in almost all the European Union countries are quite manageable provided that the economies in question return to pre-2008 trend-growth rates, or better 2. Sans growth at all, or next to no growth, and the countries in question will soon enough follow Japan in having a 'lost decade' econmically speaking. With a concomitant effects on both Europe's place and standing in the world. Not only economically but in terms of pure machtpolitik

1. Jean Pisani-Ferry & Coen Teulings, "Eurozone countries must not be forced to meet deficit targets." The Financial Times. 27 February 2012, in

2. See Martin Wolf's many columns dealing with this topic in the Financial Times. For a recent example, see: Martin Wolf, "Europe is stuck on life support." The Financial Times. 31 January 2012, in See also: Lord Skidelsky, "Future Generations will curse us for cutting in a slump." The Financial Times.27 July 2010, in Finally, for an American perspective, see the strongly Keynesian, Nobel Prize economist Paul Krugman (who is perhaps the only reason whatsoever to read the ultra-tedious, American broadsheet, the New York Times) in a recent piece: Paul Krugman, "European Crisis Realities." The New York Times. 25 February 2012, in


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