Monday, November 24, 2014

After Austerity

NEW YORK – This year’s annual meeting of the International Monetary Fund made clear that Europe and the international community remain rudderless when it comes to economic policy. Financial leaders, from finance ministers to leaders of private financial institutions, reiterated the current mantra: the crisis countries have to get their houses in order, reduce their deficits, bring down their national debts, undertake structural reforms, and promote growth. Confidence, it was repeatedly said, needs to be restored.

It is a little precious to hear such pontifications from those who, at the helm of central banks, finance ministries, and private banks, steered the global financial system to the brink of ruin – and created the ongoing mess. Worse, seldom is it explained how to square the circle. How can confidence be restored as the crisis economies plunge into recession? How can growth be revived when austerity will almost surely mean a further decrease in aggregate demand, sending output and employment even lower?

This we should know by now: markets on their own are not stable. Not only do they repeatedly generate destabilizing asset bubbles, but, when demand weakens, forces that exacerbate the downturn come into play. Unemployment, and fear that it will spread, drives down wages, incomes, and consumption – and thus total demand. Decreased rates of household formation – young Americans, for example, are increasingly moving back in with their parents – depress housing prices, leading to still more foreclosures. States with balanced-budget frameworks are forced to cut spending as tax revenues fall – an automatic destabilizer that Europe seems mindlessly bent on adopting.

There are alternative strategies. Some countries, like Germany, have room for fiscal maneuver. Using it for investment would enhance long-term growth, with positive spillovers to the rest of Europe. A long-recognized principle is that balanced expansion of taxes and spending stimulates the economy; if the program is well designed (taxes at the top, combined with spending on education), the increase in GDP and employment can be significant.

Europe as a whole is not in bad fiscal shape; its debt-to-GDP ratio compares favorably with that of the United States. If each US state were totally responsible for its own budget, including paying all unemployment benefits, America, too, would be in fiscal crisis. The lesson is obvious:  the whole is more than the sum of its parts. If Europe – particularly the European Central Bank – were to borrow, and re-lend the proceeds, the costs of servicing Europe’s debt would fall, creating room for the kinds of expenditure that would promote growth and employment.

There are already institutions within Europe, such as the European Investment Bank, that could help finance needed investments in the cash-starved economies. The EIB should expand its lending. There need to be increased funds available to support small and medium-size enterprises – the main source of job creation in all economies – which is especially important, given that credit contraction by banks hits these enterprises especially hard.

Europe’s single-minded focus on austerity is a result of a misdiagnosis of its problems. Greece overspent, but Spain and Ireland had fiscal surpluses and low debt-to-GDP ratios before the crisis. Giving lectures about fiscal prudence is beside the point. Taking the lectures seriously –  even adopting tight budget frameworks – can be counterproductive. Regardless of whether Europe’s problems are temporary or fundamental – the eurozone, for example, is far from an “optimal” currency area, and tax competition in a free-trade and free-migration area can erode a viable state – austerity will make matters worse.

The consequences of Europe’s rush to austerity will be long-lasting and possibly severe. If the euro survives, it will come at the price of high unemployment and enormous suffering, especially in the crisis countries. And the crisis itself almost surely will spread. Firewalls won’t work, if kerosene is simultaneously thrown on the fire, as Europe seems committed to doing: there is no example of a large economy – and Europe is the world’s largest – recovering as a result of austerity.

As a result, society’s most valuable asset, its human capital, is being wasted and even destroyed. Young people who are long deprived of a decent job – and youth unemployment in some countries is approaching or exceeding 50%, and has been unacceptably high since 2008 – become alienated. When they eventually find work, it will be at a much lower wage. Normally, youth is a time when skills get built up; now, it is a time when they atrophy.

So many economies are vulnerable to natural disasters – earthquakes, floods, typhoons, hurricanes, tsunamis – that adding a man-made disaster is all the more tragic. But that is what Europe is doing. Indeed, its leaders’ willful ignorance of the lessons of the past is criminal.

The pain that Europe, especially its poor and young, is suffering is unnecessary. Fortunately, there is an alternative. But delay in grasping it will be very costly, and Europe is running out of time.

Read more from our "Austerity and its Discontents" Focal Point.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (25)

    Please login or register to post a comment

    1. CommentedH Gerken

      "Europe’s single-minded focus on austerity is a result of a misdiagnosis of its problems." - this is not a fiscal crisis, it is a behavioural crisis on the greek side. Carrot and stick. we were too permissive in the past and took their word. According to the EU treaties no other nations should take the debt of the other. The treaties are broken. Either the rules are accepted of they could go bust. No one has remorse with financial fraudsters who don't get real but blame others.

    2. CommentedStephen Pain

      I believe we should look to W. Edwards Deming who aside from his anti-humanist approach - was sound in terms of manufacturing. One can save a huge amount and pay off the debts by reducing waste throughout the system. There is tremendous waste. Secondly, if one goes for quality rather than quantity, then one can reduce the trade deficit. On top of this, since many countries are seeking a green future - why the hell are they advertising a future with bigger and faster cars - why not bicycles? So Deming is one key figure. Another is E. F. Schumacher. In China they are currently building like there is no tomorrow - bigger and bigger buildings - and aiming for the sky - yet they cannot build a motor car that meets international standards? Why is that? They need to stop and think about their direction and take an initiative to rethink and reform their society to understand that the American Dream has led to a waste land. Why not see what you have? Value that? It is not a question of austerity - it is a question of vision and recognizing that happiness is not waste. With regard to the theories of economics - well it is like someone going down to the races - except billions of lives are at stake. It would be much better to stay home and think what exactly is going on? The rocket science of recent years has disguised debt - if the US has a sovereign debt ranging from 60 to 200 trillion US dollars - why do we hear its bond traders and credit rating companies baying against the Eurozone? Why do they seek to get Germany which has had a rather sensible and prudent economy that is export led, with good service to manufacturing ratio, tight control over credit and property market, to go against its successful approach? I find such baying and advice coming from a country that has bankrupted itself as they say... a bit rich.

    3. CommentedOliver R

      Although you are right in saying that Europe's hell bent focus on austerity is damaging the continent, this is a mantra which has been repeated for months if not years now, and appears to be falling on deaf ears, due to the intrasigence of Mrs Merkel. The crunch point will be after the Greek elections next month, when a left wing coalition hostile to the bail out could conceivably gain power. It will be interesting to see if at this point Mrs Merkel finally repents and loosens the noose of austerity, or if she sticks to the course, jettisoning Greece from the Euro. My money would be on the latter.

    4. CommentedYoshimichi Moriyama

      @Aldo Dias, perhaps I am not answering you but I want to tell you something. I am not sure what exactly I want to tell you. I'm not kidding. I'm serious.
      Stephen Hawking talks about the universe after the Big Bang, not before it. Frankly, as I am ashamed to tell this, I am always curious what the universe was like before the Bang. What would Hawking say? He might say, "I am not asking a scientific question."
      Scientists were asking in the 17th century(was it the 18th?) what was being lost in the chemical process of combustion. They did not know they were looking in a wrong direction for an answer. They began to ask in the next century what was the chemical process of combustion.
      They were asking a right question now, for nothing is lost in the process.
      We have a lot of problems, high employment rates, the aging population, stagnation, huge income disparity, soaring prices of some commodities...These are economic problems, but they are also social and political and cultural problems.
      Aren't we asking too much? If economics had a tongue to speak with, it might say, "Aldo, you are greedy, asking a question like what the univers was like before the Bang. Don't expect too much of me."

        CommentedAldo Dias

        hahaha Yoshimichi Moriyama, you absolutely answered my question. And in the best, most enlightening way possible, because you answered a question I did not know I had.

        Good wishes to you sir!

    5. CommentedTad Furtado

      Aldo - see my reply to your comment below Mr. Genilloud's. I put it in the wrong place, it seems. Have a great day.

        CommentedAldo Dias

        Tad, I appreciate your comment. However, and if I am to be a bit more serious and "drop the attitude", as the expression goes, I'd argue that a slightly finer analysis is required; I don't think the PIIGS generalization is a good one because the various countries have very different problems, economically and even politically/morally. Since we were talking about my country, the problem has been Government debt, and especially how its service was structured, leaving too much of a burden for future polítical cycles, not even generations, and a lack of organization of the business sector, that stemmed from the country's past of paternalist state coorporativism that was not adequately "cured" by the consulate of the current President, Anibal Cavaco Silva, who in favor of appearing worldly and sophisticated and a model student of free trade was lax in his negotiations regarding eu trade relations with asian economies, in the late 80 and early 90, who at the time where direct portuguese competitors by salary and industry, namely textiles. So what should have been a period of great economic organization and structuring didn't happen. Instead payments were made and businesses liquidated. We were to live off the domestic service sector. Of course this ended up meaning non transactionable services. We invested in this to the tune of 4% a year.

        But now that has all forcibly stopped. And probably this was why the majority of the country welcomed the Troika intervention. The sitting prime minister actually won the elections on a completely pro-troika, liberalization policy. "If there were no Troika, we would propose the same measures". People even knew that when he said that we must make the state more effecient he meant making healthcare and social security more expensive. The same went for jobs, though unlike popular belief it is incredibly easy to fire people in Portugal.

        But Tad, you sound like a man more knowleadgeable and inteligent than myself, so tell me: how can the economy possibly adjust itself when businesses are, for cultural reasons that I don't think are in abstract good or bad, totally dependant on bank loans for treasury operations, much less investment needed to reorient the economy towards exports.

        How can Portuguese banks, which were never shown to have problems - far from it, they did not permite housing bubbles to form like in Spain or Ireland, nor invest any significant amount in risky complex operations or PIIGS sovereign debt other than, in the months leading to the bailout, Portuguese, unlike German banks, and who maintained personal credit very low - be made to reduce lending to 120%, less than any other banks in europe? Starving over consumption makes sense. Starving the private-sector's ability to adapt and face the challenges before it seems like callous and short-minded. Still regarding exports, and this really is my main point, doesn't German historically high superavids endanger the monetary union, and the adequacy of the monetary policy, as much as deficits?

        Moreover, how can our exports increase as much as expected by the Troika if suddenly all of our trading partners are adopting unnecessary recessionary policy. The best thing Germany could do for Europe is increase the wages of its wokers. That would give its partners at least a fighting chance, a glimmer of hope.

        Finally, regarding the Troika plan, it was badly acessed, didn't take into account the business sector's dependence on banks for its standard operations, and it wrongly acessed transport companies and energy deficits. Unable to go to foreign markets, this massive coorporations are sucking out 40 billion euros of the economy over the Troika plan's execution. This is causing businesses that have orders to still go bankrupt and generate mass and unexpected unemployment.

        I very much look forward to hearing from you, or anyone else.

    6. CommentedJimmy Van de Putte

      I call this "focus-inversion" , and hierarchical info filtering".I have seen this many times before in my departement ( Defense) and these are all "management-f*ckups" (mind the expression) , These issues will only be contained when we drasticly change our way of thinking- analyzing , structure , education and function of management in a whole! I am writing an essay on my vision and analyses of these dynamic processes which result in poor decision making, .... nice and comforting to see that I get supporting articles even from a NP-winner see that

    7. CommentedYoshimichi Moriyama

      "there is no example of a large economy recovering as a result of austerity." Japanese economy is a large one. It is the third largest. On the other hand, the Japanese have twice as big debts as their GDP and the government has already spent a lot of money, trying to stimulate. The result was more debts but still stagnant economy. I wonder what advice Prof. Stiglitz would give to a Japanese prime minister.

      The professor should make sure of the name of the prime minister if he does. We have a new prime minister every monday morning in Japan.

    8. CommentedMark Pitts

      Stiglitz’s policy recommendations always share two traits: (1) they relate to the world he wishes existed, rather than the world as it is, and (2) they always boil down to income redistribution.
      In this case, he recommends that Europe act like the US despite the overwhelming differences. The US has fiscal unity, the EU does not. The US enjoys political unity, the EU does not. The countries making up the EU are sovereign nations; they are not like US states.
      Yes, New York may agree to send federal money to Mississippi in times of crisis, but New York also has a say in and shares federal fiscal policy with Mississippi. If however, New York had no federal control, or if wages & pensions in Mississippi were better than in New York (as is the case with Greece and Germany in many cases), there would no doubt be a significant resistance to such transfers.
      In the end, Stiglitz’s recommendation is that that the rich northern European countries transfer income to the south. But why are they more obligated to do so than China, the US, the oil-exporting states, or any other country that has the wherewithal to make such transfers?

        CommentedAldo Dias

        Because, Mark Pitts, its in their interest to. Germany is in a political, monetary and economic union where it has enjoyed a de facto german currency for 10 years. this currency has proven too expensive for southern european economies. Its a question of what came first, fiscal irresponsibility that led to wage increases and lack of competitiveness or lack of competitiveness due to a too strong a currency that created the political pressure to maintain living standards through debt.

        Moreover, Germany new exactly what was going on in Greece, it was done with the involvement of major german banks - who seem to be impeccably hygienic in their domestic operations but are the first to through money at bubbles and "toxic assets" outside their boarders, be it new york or greece.

        Germany needs to increase its wages. And it will do so. Angela Merkel does not want to go down in history as the grimm reaper of europe and the euro. And so she must pay. Tsipras knows this. German callousness and eastern german disdain for other societies and other democracies has escalated the matter from a political and economic problem to the national dignity of a people. And while private sector greeks virtually don't pay taxes - although i don't see any proposals to advance money specifically for the modernization of the greek fiscal machine - the greeks are a very proud people and the european establishment has chosen the wrong country to humiliate out of the euro.

    9. CommentedTad Furtado

      Single minded focus on austerity?

      Is this an alternate universe being discussed? Because austerity isn't happening. Feel free to review the OECD data and point out which nations are adopting truly tight budget frameworks:

      The nations ran up spending unsustainably and now that those levels have come off very slightly, we are supposed to consider this austerity? I understand the need to have governments act in a counter-cyclical manner, so I don't oppose new spending on infrastructure and other asset building projects, but let's not pretend that not doing so is some form of draconian budgeting and let's certainly not put ourselves deeper into the hole for politically connected crony capitalism projects. I'd prefer slower or no growth in that case.

        CommentedAldo Dias

        Since the statistics you provided failed to mention government expenditure in 2011 for one of the countries under intervention, Portugal, and since the program only started began in may 2011, I thought I'd enlighten you on the effeciency of the portuguese people at implementing this so called "austerity that isn't happening".

        To make it easier for you, here are the relevant items:

        Government deficit -3.6 in 2008, shot to -10.2 in 2009 because of the crisis, -9.8 in 2010 because of the crisis as well -4.2 at the end of 6 months of the financial assistance programme. From this I conclude that portugal's problem was a liquidity problem caused by the over compensation of the credit rating agencies following their big mess with lehman brothers and so on. Secondly, that the european consensus for fiscal stimulus was not supported by the ECB. Third, that there has been a massive dose of austerity.

        Moreover, government expenditure is now back to the levels before 2009. In parallel to all of this, the debt has shot up, thanks to the grevious conditions of the so called assistance. Which are being enforced as a premium on moral hazard. Its just prof of my southern lack of sophistication that my catholic nature jumps to the expression "pay for your sins" all too quickly.

    10. Commentedjames durante

      Wow--the last thing we need is more growth! Capitalism demands it, at any cost. "Grow or die!" It is the ideology of the cancer cell, as Abey put it.

      Nor do we need more jobs. Most people I know hate being at work; they work shit jobs for low wages and no benefits. Bully for you Stieglitz if you like being a Harvard professor or whatever it is you do.

      Young people don't need jobs or skills, unless those skills involve producing needed things or helping people directly.

      What seems to be needed is a managed slow down towards a steady state economy that provides basic needs and lots of leisure. Family time, ceremonies, creativity in arts and music, plenty of rest, good, healthy, basic foods...

      Get the cancer ideology out of your heads!

        CommentedTad Furtado

        Aldo - I appreciate your reply. That Portugal and other nations are running huge deficits is not in question. As for spending, the point I made in my comment was that these nations ran up spending during the early and mid 2000s in such a manner that looking at spending now compared to a few years ago is giving a false impressing of "austerity". Sure, it may be austere in contrast to full on recklessness, but if you compare spending over time relative to purchasing power, population and adjust to bring it all into current dollars, it is clear that Portugal and most of the other nations are not being asked to live on short change. Rather, they've been living too long on the backs of future generations and the level to which they have become accustomed has proven unsustainable - and thus the let down.

    11. CommentedIgor Noveski

      Agreed. I believe that increased gov spending is the only way out of a recession, but only base on thourough cost + benefit analysis. Gov spending needs to focus on infrastructure, energy, education, health care, i.e. sectors where there is high ROI, max bang for the buck.. Also, the corruption index and democratic index of crisis economies need to improve, as corruption and wasteful spending flourish in times of crisis.

    12. CommentedRob Underwood

      Austerity is one key part of the problem holding human capital back, especially young human capital. Another is rampant class-ism, which has long been an issue in Europe and is now on the rise (i.e., worsening) in the United States. We are cannibalizing all our futures by denying our young a present. We are doing this through both our unwillingness to spend and our unwillingness to evaluate talent based on merit, not pedigree. I wrote an essay about meritocracy, class, youth, and Occupy last week. It's available here -

    13. CommentedStéphane Genilloud

      The euro is indeed poorly adapted to the eurozone, and little can be done to improve that situation in the short term. But maybe there is a temporary mechanism that could open the door for south European countries either to stay in the euro, or to exit. That would be a twin-currency mechanism, and if I don't miss something, it might well be applicable: Spain can keep the euro while printing a small amount of pesetas (that it would use for filling the gap in its budget). More details here

    14. CommentedShiang Peow Foo

      The severe suffering and high unemployment may manifest into nationalism, which further destablizes Europe. We certainly living in interesting times!

        CommentedIgor Noveski

        Agreed. Nationalism breeds on the crisis. Growth and spending are needed now, in order to prevent a deeper social, cultural and ethnic divide in crisis economies.

    15. CommentedShiang Peow Foo

      "The lesson is obvious: the whole is more than the sum of its parts. If Europe – particularly the European Central Bank – were to borrow, and re-lend the proceeds, the costs of servicing Europe’s debt would fall, creating room for the kinds of expenditure that would promote growth and employment"

      Unlike U.S., EC is not a federal State hence comparison is not appropriate; EC does not have a unified political platform or share common military resources. How'd one expect that the whole is more than the sum of its parts? How to balance fairly the differences in social and military spendings among each parts?

    16. CommentedPaul A. Myers

      Along Stiglitz's lines, let us propose:

      (1) If Operation Twist has had some success with monetary policy in the US, why don't we have an Operation Twist for fiscal policy in Europe (and the US, too).

      What is Operation Twist for fiscal policy? Simple--spend short, reform long. So launch significant spending programs now to employ resources, while passing now future labor market, entitlement, and tax reforms necessary to balance future budgets and finance bond repayments as required to achieve desired debt/GDP ratios.

      If I am going to loan money to a government today for 5-10 years, I don't care if next year's budget is in deficit. I care if the funds are available 5-10 years from now when it comes time to pay back. A country needs to match future receipts with future obligations. To create current surpluses to fund future repayment requirements is simply nuts (or maybe German!).

      If I were President Hollande, I would take some spreadsheets to Berlin and twist up those current expenditures and then show how future cash flows out there 5-10 years can meet the repayment demands.

      Give the squareheads an elegant example of Cartesian Gallic philosophy!

      Achtung, maintenant, alors, all eyes towards the pragmatic!

    17. CommentedDaudel Sylvain

      Draft manifest to reinvent Capitalism
      From Shareholder Value to Humanity Value

      We are at a turning point in the history of capitalism. Its long-lasting positive impact on the wealth of nations, on the worldwide poverty reduction, on the well being of people is waning. Numerous warning signs have been identified, denounced, analyzed and explained. So far negative externalities have been denied, minimized, accepted or tolerated. Today, even the greatest defendants cannot but plead for a change. In the Financial Times, Lawrence Summers calls for "smart reinvention, not destruction ».

      This draft manifest is to contribute to the debate with some radical but non-destructive measures to preserve the goodness of the system and direct it towards benefits for humanity and not just illegitimate profits for a few. It is a draft manifest as it contains only four propositions and needs to be criticized, enhanced and transformed into practical and legal dispositions.

      The aim is to continue satisfying humanity present needs without compromising opportunities for future generations.

      1) Feeding shareholders is illegitimate when Companies accumulate wealth depleting the planet and harming humanity.

      2) Companies should prove they have a positive balance of obligations towards humanity before distributing dividends to shareholders. It is not sufficient to pay taxes because you have harmed the planet. Profits are only legitimate if you do more good than bad!

      3) Companies failing to prove their worth will be boycotted by humanity.

      4) Shareholders require quarterly reports, humanity demands quarterly reports.

      The value of a company is currently derived from its capacity (short term or expected in medium to long term) to distribute a remuneration to the capital it has had accessed to. Shareholder value is then the ultimate indicator of capitalism. Under its various names (EBITDA, Earning per share, PER, EVA...etc.) it expresses the successful functioning of any company and drives all activities and decisions of management. Our first proposal says that shareholders should not receive dividends just because the company is producing profits in the way they are accounted for today - forgetting or forgiving all externalities produced on our planet, on humanity.

      Along our history we have learned to understand and recognize externalities; we have developed methods to measure them; we have established standards and rules and incentives to respect and preserve these standards; we even have laws that have been designed to enforce these rules and taxes or sanctions for those who do not abide by the laws. The problem is that results have not followed and there is little progress. On the contrary, sanctions have just been integrated as the price to pay to continue damaging the environment and extracting profits to the detriment of humanity and future generations.

      From this observation stems our second proposal: sustainability is not just limiting the damage we are doing or paying a price to be forgiven. Sustainability should be repairing whatever damage we are producing, just like in everyday life. When you damage your neighbor's fence, she is entitled to have it repaired by you.

      Companies should contribute to repair the damage done. Before being allowed to announce any kind of profit that can be distributed to their constituents (shareholders) companies should prove that negative externalities have been compensated (through de-pollution, tree planting... whatever is good for the planet and humanity) and that the balance is positive or at least even. That opens a whole new field for productive employment, productive for the future, not just the short-term illegitimate enrichment of a few.

      Our third proposal is certainly the most radical and controversial. It says that companies will be boycotted by humanity if they fail to prove that they have a positive balance. The verb 'will' is not there by chance. It probably is the only incentive to produce the right decisions as it has a direct and devastating impact on the company's performance and ultimately its value.

      To be able to decide whether a boycott is necessary, we need transparency and that is the objective of the last proposal. Just like shareholders require quarterly reports to decide whether they continue to give their confidence to such or such company, humanity should get quarterly reports on the balance of damage and repair to decide whether boycott is or not in order.

      We understand that there are numerous aspects of this draft manifest that should be criticized, refined, enhanced, changed and we open it for general discussion in the hope that we indeed find ways to reinvent capitalism without destructing its benefits for humanity today and tomorrow.

      Sylvain Daudel

    18. CommentedPietro Donnini

      to save investment killing humans it's impossible...this is obvious but still too complex for actual economist (that are the real world crisis...): thank you, you are one of the few real economist on earth!