European Debt Crisis Part XXIII

On Monday, Ollie Rehn, the dough-faced Finn who serves as the European Union economic and monetary affairs commissioner, briefed the European Parliament on the latest bad news about Europe's economy. Second-quarter growth fell to 0.2 percent in the Eurozone as a whole (compared to 0.8 percent in the first quarter). German quarter-to-quarter growth tumbled down from 1.3 percent to 0.1 percent. France's fell to zero. Eurozone manufacturing output contracted in August.

Rehn also admitted that a further slowdown is expected because of "higher oil prices in the first half of the year, and more recently, a less supportive external environment and - yes - the impact of the financial market turmoil." Curiously missing from this list is any mention of the true culprit: the insistence on stringent programs of fiscal austerity across the continent. Germany, for instance, continues to assert that countries' fiscal irresponsibility led to the euro crisis. At a panel discussion in Frankfurt yesterday, German finance minister Wolfgang Schauble said that the Eurozone crisis was caused by excessive public debt throughout the world. From this highly controversial axiom stems the theorem that fiscal retrenchment will calm market fears about sovereign debt and attract investment that will produce growth and jobs.

As a number of prominent economists have argued, there is no reason to believe in this theory of growth through fiscal contraction, or what New York Times economic columnist Paul Krugman has colorfully dubbed "the confidence fairy." No empirical evidence exists of economies growing because they went on an austerity diet. In all cases where a country cut spending, raised taxes, and still managed to enjoy an economic boom, exogenous factors (currency devaluations leading to a surge in exports, for example) played an essential part. In any case, the belief that the euro crisis was caused by fiscal indiscipline is only partially true. Greece may have gone under because its public debt was out of control, but in Ireland, the cause of the meltdown was reckless lending from private banks to private real-estate companies. In Portugal, the main problem was weak competitiveness leading to a decade of anemic growth.

Since fiscal laxity did not really cause the crisis, fiscal rectitude, in the absence of positive outside shocks, has not resolved it. The contraction in Greece led the economy to collapse. After shrinking 4.5 percent last year, it is set to plummet by another 5 percent or more this year. Ireland, which in 2011 returned to growth after three years of recession and austerity, has an unemployment rate of 14.4 percent. In 2007, before the crisis, it stood at 4.4 percent. Portugal, whose preemptive fiscal measures did not prevent it from becoming the third Eurozone member to be bailed out, announced an extremely ambitious program of spending cuts, tax hikes, and privatization this week. The Portuguese economy is expected to contract by 2.3 percent this year and a further 1.7 percent in 2012, before returning to growth (1.2 percent) in 2013. Skeptics might note that predictions made for Greece's growth path at the outset of its supervised austerity program proved far too optimistic.

But let us assume that there was no other way for these countries -- that since they lost the confidence of the bond market, they had no choice but to start cutting their public sector down to size. What about AAA countries like Germany and France, where growth seems now to be stalling, further undermining the prospects of their more beleaguered fellow members? Why were these countries, which in the London G-20 summit in 2009 pledged their renewed faith in Keynesianism and embarked on stimulus programs to kick-start their freefalling economies, so quick to forget and so hasty to pull back from expansionary policies? Did they not read the data, collected comprehensively by economists Carmen Reinhart and Ken Rogoff, which said that recessions caused by banking crises take much longer to overcome?

The UK, an EU member that has not joined the euro, is an even starker example of the folly of overzealous fiscal retrenchment. In the June 2010 election, the Conservatives insisted that the level of British debt was dangerously high and that immediate, drastic cuts were necessary to save the country's credit rating. Labour argued that the Tories proposed to cut too far, too fast and that they would undermine the recovery. The Conservatives won the election, but recent data on faltering growth show that Labor won the argument, even though the pound has trended downward against the euro in the last 15 months.

This, then, is the situation now in the Eurozone. Growth is slowing down in some countries. For a number of them, this makes an already bad debt situation worse. And still Europe's top leaders insist on a recipe for addressing those debt problems that only seems to be making them worse.

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