The big news of the past week had nothing to do with the I.R.S. or Benghazi. It was the confirmation that, while the American economy continues to recover from the disastrous financial bust of 2008 and 2009, Europe remains mired in a seemingly endless slump.
On this side of the pond, the Congressional Budget Office announced that, with the economy expanding, tax revenues rising, and federal spending being restrained, the budget deficit is set to fall to about four per cent of Gross Domestic Product this year, and to 3.4 per cent next year. The latter figure is pretty close to the average for the past thirty years. At least for now, the great U.S. fiscal scare is over—not that you’d guess that from listening to the public debate in Washington. In Europe, things are going from bad to worse. New figures show that in the seventeen-member euro zone, G.D.P. has been contracting for six quarters in a row. The unemployment rate across the zone is 12.1 per cent, and an economic disaster that was once confined to the periphery of the continent is now striking at its core. France and Italy are both mired in recession, and even the mighty German economy is faltering badly.
Why the sharp divergence between the United States and Europe? When the Great Recession struck, U.S. policymakers did what mainstream textbooks recommend: they introduced monetary and fiscal-stimulus programs, which helped offset the retrenchments and job losses in the private sector. In Europe, austerity has been the order of the day, and it still is. Nearly five years after the financial crisis, governments are still trimming spending and cutting benefits in a vain attempt to bring down their budget deficits.
The big mystery isn’t why austerity has failed to work as advertised: anybody familiar with the concept of “aggregate demand” could explain that one. It is why an area with a population of more than three hundred million has stuck with a policy prescription that was discredited in the nineteen-twenties and thirties. The stock answer, which is that austerity is necessary to preserve the euro, doesn’t hold up. At this stage, austerity is the biggest threat to the euro. If the recession lasts for very much longer, political unrest is sure to mount, and the currency zone could well break up.
So why is this woebegone approach proving so sticky? Some of the answers can be found in a timely and suitably irreverent new book by Mark Blyth, a professor of political economy at Brown: “Austerity: The History of a Dangerous Idea.” Adopting a tone that is by turns bemused and outraged, Blyth traces the intellectual and political roots of austerity back to the Enlightenment, and the works of John Locke, David Hume, and Adam Smith. But he also provides a sharp analysis of Europe’s current predicament, explaining how an unholy alliance of financiers, central bankers, and German politicians foisted a draconian and unworkable policy on an unsuspecting populace.
The central fact about Europe’s “debt crisis” is that it largely originated in the private sector rather than the public sector. In 2007, Blyth reminds us, the ratio of net public debt to G.D.P. was just twelve per cent in Ireland and twenty-six per cent in Spain. In some places, such as Greece and Italy, the ratios were considerably higher. Over all, though, the euro zone was modestly indebted. Then came the financial crisis and the fateful decision to rescue many of the continent’s creaking banks, which had lent heavily into property bubbles and other speculative schemes. In Ireland, Spain, and other countries, bad bank debts were shifted onto the public sector’s balance sheet, which suddenly looked a lot less robust. But rather than recognizing the looming sovereign-debt crisis for what it was—an artifact of the speculative boom and bust in the financial sector—policymakers and commentators put the blame on public-sector profligacy.
“The result of all this opportunistic rebranding was the greatest bait-and-switch operation in modern history,” Blyth writes. “What were essentially private-sector debt problems were rechristened as ‘the Debt’ generated by ‘out-of-control’ public spending.”
The obvious alternative to rescuing the bad banks in the periphery countries was to let them go bust, but that was a risky option. As we saw in the United States after Lehman Brothers was allowed to fail, once one domino goes down the others get very shaky. Preventing a wholesale U.S. banking collapse took the Fed launching all sorts of emergency lending programs and Congress approving a seven-hundred-billion-dollar bailout. In Europe, such policies weren’t available. The E.C.B.’s charter didn’t provide for it acting as a lender of the last resort. And the European universal banks were simply too big to rescue. In 2008, Blyth recalls, the combined assets of the six largest U.S. banks came to sixty-one per cent of U.S. G.D.P. Compare that with Germany, where the biggest financial institutions (Deutsche Bank and Commerzbank) had assets equal to a hundred and fourteen per cent of German G.D.P., or France, where the three biggest banks (BNP Paribas, Société Générale, and Crédit Agricole) had assets equal to three hundred and sixteen per cent of France’s G.D.P.
With defaults and a wholesale bailout off the table, Europe was condemned to muddling through as best it could. Coming out of the first stage of the crisis, which lasted until the first half of 2011, it was saddled with a periphery—Greece, Ireland, Portugal—that had been bailed out but that was still sinking under enormous debts, and a financial system that was highly leveraged and loaded up with suspect government bonds. What the continent desperately needed was a return to growth-oriented policies of the sort adopted in the United States. Higher growth would have raised tax revenues, boosted job growth, and shored up the banks’ balance sheets. But largely due to the euro, Europe was stuck in an austerity vice.
Membership of the common currency prevented individual countries from printing money and devaluing their currencies, which is what the United States had done. Blyth notes:
If states cannot inflate their way out of trouble (no printing press) or devalue to do the same (non-sovereign currency), they can only default (which will blow up the banking system, so it’s not an option), which leaves internal deflation through prices and wages—austerity.
Theoretically, there is another option: fiscal stimulus in the form of tax cuts and more government spending. But that, too, is effectively ruled out. Under the terms of the euro zone’s comically misnamed Stability and Growth Pact, countries like France and Italy, which have budget deficits larger than three per cent of G.D.P., are legally obliged to cut spending, even though doing so is sure to depress the economy further, leading to lower tax revenues and bigger deficits. Meanwhile, member countries that have a budget surplus, particularly Germany, refuse to help their neighbors by introducing a stimulus.
It’s all quite mad, but that doesn’t mean it will end anytime soon. Indeed, about the only things that seem likely to change the situation are another blow up in the bond markets or a political revolution in a member state. So far, Mario Draghi, the Italian financier who took over as the chairman of the E.C.B. in 2011, has managed to prevent the first of these things from happening. And despite mass protests from Athens to Madrid, the pro-euro political establishment has held onto power.
Blyth rightly describes this whole sad story as an attempt to recreate a European version of the gold standard, the “barbarous relic” (Keynes) that helped bring about the Great Depression. But rather than confine himself to explaining and bemoaning the enduring appeal of austerity policies, Blyth explores their roots in the laissez-faire writings of Locke, Smith, and David Ricardo; the Treasury view of the nineteen-twenties; the Austrian business cycle theory of Friedrich Hayek and Joseph Schumpeter; the monetarism of Milton Friedman; the Washington Consensus of the I.M.F. and the World Bank; and the “expansionary austerity” school that emerged from Bocconi University, in Milan. With so much hinging on Germany, the discussion of postwar German ordoliberalism, which underpins Berlin’s hostility to expansionary policies, is particularly valuable.
As Blyth points out, German politicians influenced by ordoliberalism, such as Chancellor Angela Merkel and Wolfgang Schäuble, the finance minister, aren’t hostile to government activism in the same way conservatives in the United States and Britain are. To the contrary, they believe in a social market economy, where the state sets the rules, including the generous provision of entitlement benefits, and vigorously enforces them. But encouraged by Germany’s success in creating an export-led industrial juggernaut, they believe that everybody else, even much less efficient economies, such as Greece and Portugal, should copy them rather than rely on the crutch of easy money and deficit-financed stimulus programs.
That’s all very well if you are an official at the Bundesbank, or one of the parsimonious Swabian housewives beloved of Merkel, but it ignores a couple of things. First, it’s the very presence of weaker economies in the euro zone that keeps the value of the currency at competitive levels, greatly helping German industry. If Greece and Portugal and other periphery countries dropped out, the euro would spike up, making Volkswagens and BMWs a lot more expensive. Second, it isn’t arithmetically possible for every country to turn into Germany and run a big trade surplus. On this, Blyth quotes Martin Wolff, of the Financial Times: “Is everybody supposed to run a current account surplus? And if so, with whom—Martians? And if everybody does indeed try to run a savings surplus, what else can be the outcome but a permanent global depression?”
For many parts of Europe, the depression is already here, and its cost is mounting. In Spain and Greece, the unemployment rate among some younger demographics is close to fifty per cent. Meanwhile, the calls on the Spanish and Greek governments to downsize their spending programs continue. Blyth, who grew up poor in the Scottish town of Dundee, discusses what this means in personal terms.
Probabilistically speaking, I am an as extreme example of intergenerational social mobility as you can find anywhere. What made it possible for me to become the man I am today is the very thing now blamed for creating the crisis itself: the state, more specifically, the so-called runaway, bloated, paternalist, out-of-control welfare state…
I was never hungry. My grandmother’s pension plus free school meals took care of that. I never lacked shelter because of social housing. The schools I attended were free and actually acted as ladders of mobility for those randomly given the skills in the genetic lottery of life to climb them.
So what bothers me on a deep personal level is that if austerity is seen as the only way forward, then not only is it unfair to the current generation of “workers bailing bankers,” but the next “me” may not happen.
Is that laying it on a bit thick? Perhaps. Blyth’s larger point, though, is valid. Ultimately, economics cannot be divorced from morality and ethics. Austerity’s failure isn’t just a matter of disappointing G.D.P. figures and missed deficit targets. It’s a human calamity, and one that could have been avoided.