Austerity alone is no solution

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May 10, 2012

Austerity alone is no solution

Anonymous Daily Star The Daily Star Thu May 10, 2012, 03:25 AM EDT

With France and Greece this weekend rejecting leaders who advocated austerity to solve the continent's financial crisis, a cynic might assume voters in these nations were simply picking politicians who said what they wanted to hear.

But it's not just voters who are questioning the economic recovery model proposed by outgoing President Nicolas Sarkozy of France and Prime Minister Lucas Papademos of Greece. In fact, a growing body of evidence indicates that a single-minded drive for spending cuts alone is having a negative effect on Europe's shakiest economies. Even European Central Bank President Mario Draghi, a noted deficit hawk, conceded as much April 25.

"We have a fiscal compact," Draghi said. "Right now, what is most present in my mind is that we have a growth compact."

Jean Claude-Juncker, the Luxembourg prime minister who chairs meetings of eurozone finance ministers, said this week: "Only if savings and growth go hand-in-hand, to form one European gesture, can the mistakes of the past be prevented."

These "mistakes of the past" were elucidated clearly in an International Monetary Fund study last fall that examined the effectiveness of fiscal austerity programs in 173 cases over 30 years. The IMF's researchers found when such measures curb the budget deficit by 1 percent of GDP, they also reduce real incomes by 0.6 percent and raise unemployment 0.5 percentage points.

In Greece, voters and politicians for years have flatly refused to acknowledge the seriousness of their financial straits. But in Ireland and Spain, fiscal responsibility was never much of a problem until burst housing bubbles sent both economies reeling -- and triggered strict eurozone mandates that both countries slash public spending. Unemployment has since skyrocketed in both countries.

A recent EU proposal to boost the European Central Bank's ability to finance infrastructure projects is a smart move, but massive public spending increases to stimulate Europe are neither necessary nor foolproof. Instead, labor laws that make firings difficult should be relaxed, and a culture that tolerates long breaks and frequent vacations should be more urgent about productivity.

But voters in the U.S. would do well to note that the so-called "expansionary fiscal contraction" -- a hypothetical economic boom brought about solely by cuts in spending and taxation -- has been proven a myth by Europe's failed fiscal experiments. This theory was promoted by Rep. Michele Bachmann, who said during her presidential campaign that tax cuts, spending cuts and a repeal of the health-care reform law would send unemployment plunging within three months, and by House Majority Leader Eric Cantor, R-Va., the self-described leader of a "cut-and-grow Congress."

Unsurprisingly, Mitt Romney endured intraparty criticism in February for admitting the economy would suffer "if all you're thinking about is just cutting spending." Such a statement may be impolitic, but it's also demonstrably true.