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SDA: Self-Defeating Austerity

by afew Fri Nov 30th, 2012 at 08:22:01 AM EST

This title heads up a new report from economic institutes OFCE (France), ECLM (Denmark), and IMK (Germany).

iAGS, independent Annual Growth Survey 2013

The independent Annual Growth Survey (iAGS) brings together a group of internationally competitive economists from three European economic institutes to provide an independent alternative to the Annual Growth Survey (AGS) published by the European Commission. iAGS 2013 focuses on the Eurozone economic outlook and on the sustainability of public finances until 2032. This first report advocates delaying and spreading fiscal consolidation in due respect of current EU fiscal rules.

The report (pdf) does more than that. It starts out with a critique of SDA:

The failure of this strategy for reducing public imbalances by fiscal consolidation relies on a misconception about the functioning of economies, especially the underestimation of the multiplier effect. It is a fact, not a conjecture, that governments and European institutions have neglected the negative impact on activity of fiscal tightening and thought that they could reduce deficits quickly with only marginal effects on growth.

(...) As it is clear now, this strategy is deeply flawed. Eurozone countries and especially Southern European countries have undertaken ill-designed and precipitous consolidation. The austerity measures have reached a dimension that was never observed in the history of fiscal policy. The cumulative change in the fiscal stance for Greece from 2010 to 2012 amounts to 18 points of GDP. For Portugal, Spain and Italy, it has reached respectively 7.5, 6.5 and 4.8 points of GDP. The consolidation has rapidly become synchronized leading to negative spillovers over the whole euro area, amplifying its first-round effects. The reduction in economic growth in turn makes sustainability of public debt ever less likely. Thus austerity has been clearly self-defeating as the path of reduction of public deficits has been by far disappointing regarding the initial targets defined by member states and the Commission.

and goes on to argue that current policy makes recovery impossible, leading to medium and long-term depression of the European economy. In doing so, it includes country surveys of Germany, France, Italy, Spain, Portugal, Ireland and Greece. It also considers the social consequences, particularly for youth.

Then it goes on:

Complex as it is, the euro crisis is, at heart, a balance of payments crisis.

From the overview on the OFCE site:

iAGS, independent Annual Growth Survey 2013

Rather than focus on public deficits the underlying cause of the crisis needs to be addressed. The euro area suffered primarily from a balance of payments crisis due to the build-up of current account imbalances between its members. When the financial flows needed to finance these imbalances dried up the crisis took hold in the form of a liquidity crisis. Attempts should have been made to adjust nominal wages and prices in a balanced way, with minimal harm to demand, output and employment. Instead salvation was sought in across-the-board austerity, forcing down demand, wages and prices by driving up unemployment.

The third section of the report concerns macroeconomic imbalances, under the headings:

  1. One-sided adjustment of current accounts and trade balances
  2. Unit labour costs, prices, competitiveness and distribution
  3. Policy implications

The latter begins:

The policy implications of the above analysis are straightforward. The adjustment burden needs to be spread much more evenly between deficit and surplus countries. The latter, most notably Germany and the Netherlands, need to pursue expansionary fiscal policies and take other appropriate steps to increase the pace of nominal wage and price growth. In the case of Germany the introduction of a minimum wage should be considered to underpin workers at the bottom end of the labour market, which have seen a major erosion of their purchasing power.

There are tough legal-political constraints on expansionary fiscal policy in Germany, given the debt brake recently enshrined in the country’s constitution – and seen as a model for the whole of Europe. Faced with this obstacle, an approach based on the concept of the balanced budget multiplier should be adopted: growth-promoting public investment in areas such as education, infrastructure and childcare should be expanded, funded by higher taxes on items and individuals where the negative impact on demand is lowest (i.e. taxes on high incomes and capital).

The report ends on a project for reducing government debt over 20 years instead of the current brutal short-term deflationary policies. There's also, in different parts of the report, full discussion of questions like the fiscal multiplier and unit labour costs. All in all, very worth looking at, and encouraging to see that there are economists ready to challenge the conventional wisdom, and do so in a fully-researched and -argued paper.

From the end of the overview:

iAGS, independent Annual Growth Survey 2013

A four-fold alternative strategy is thus necessary:

First, delaying and spreading the fiscal consolidation in due respect of current EU fiscal rules. Instead of austerity measures of nearly 100 billion euros for the whole euro area, a more balanced fiscal consolidation of 0.5 point of GDP, in accordance with treaties and fiscal compact, would give for the sole 2013 year a concrete margin for manoeuvre of more than 60 billion euros. This amount would substantially contrast with the vows of the June and October 2012 European Councils to devote (still unbudgeted) 120 billion euros until 2020 within the Employment and Growth Pact. By delaying and capping the path of consolidation, the average growth for the Eurozone between 2013 and 2017 may be improved by 0.7 point per year.

Second, it involves that the ECB fully acts as a lender of last resort for the Euro area countries in order to relieve MS from the panic pressure stemming from financial markets. For panic to cease, EU must have a credible plan made clear to its creditors.

Third, significantly increasing lending by the European Investment Bank as well as other measures (notably the use of structural funds and project bonds), so as to meaningfully advance the European Union growth agenda. Vows reported above have to be transformed into concrete investments.

Fourth, a close coordination of economic policies should aim at reducing current accounts imbalances. The adjustment should not only rely on deficit countries. Germany and the Netherlands should also take measures to reduce their surpluses.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Nov 30th, 2012 at 08:23:27 AM EST
Will it be taken Seriously™?

The institutes that worked on it are not lightweights. However, a chunk of the funding came from the Socialists & Democrats group at the EP, so careful consideration by the Barroso Commission or the conservatives in power across most of Europe is unlikely to follow.

Does this mean the S&D opposition is coming round to clearer rejection of current policy? Hmmm. That's a tough one.

I wouldn't mind betting Hollande won't be pushing a copy into Merkel's hands the next time they meet...

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Nov 30th, 2012 at 08:32:07 AM EST

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