As a further round of economic crisis unfolds, many European social democrats seem frozen like a hare in a car’s headlights. They have nothing new to say about how to deal with fiscal deficits – except that the cuts must not occur all at once and that the most vulnerable must be shielded. Otherwise, economists on all sides appear to accept that public deficits must either be slashed or that the EU will be faced with a massive sovereign debt crisis. Nor, fearing inflation, do they favour monetising the deficits. But either deficit reduction or a sovereign debt crisis means further recession, at the cost of education, health, pensions and other building blocks of the European social model.
There is a way out. Europe can grow its way out of crisis. More growth means both a fall in government spending and a dramatic increase in tax receipts. Growth can provide the renewed infrastructure, energy saving technology and alternatives to fossil fuel so badly needed. Moreover – it can be financed. But a launching growth-based strategy requires political courage. If Europe’s social model is to survive, social democrats will need to find the courage to challenge the conventional orthodoxy of increased public savings.
Even the US is worried about the deficit hysteria sweeping the EU and its deflationary impact – not just in Europe but for the world economy. [1. See http://www.nytimes.com/2010/05/31/business/global/31deflation.html?scp=3&sq=europe&st=cse] First it was Ireland where draconian spending cuts have led to an estimated 9% annual fall in GDP this year and resulted in widening the budget deficit. Then Greece, where an EU-IMF imposed deficit reduction plan of 10 percentage points over two years has led to a forecast fall in GDP of 20%.
Today it’s Spain and Italy which have recently announced €15bn and €25bn respectively in austerity measures. Portugal has accelerated its budget reduction programme to get from 9% in 2009 to below 3% by 2013, to about 2.5% a year. [2. See http://www.ibtimes.com/articles/22922/20100509/portugal-promises-eu-to-cut-budget-deficit-more-in-2010.htm] In France, where the budget deficit is 8% – well below Britain’s – President Sarkozy is under pressure to follow Ms Merkel’s budget balancing act. Lest anybody forget, in 2009 Ms Merkel committed Germany to a permanently balanced annual budget after 2016, the so-called ‘debt-brake’ law, which means extra budgetary cuts amounting to €10bn per annum. [3. See http://www.spiegel.de/international/germany/0,1518,696760,00.html]
As though all this fiscal tightening were not bad enough, the OECD has recommended monetary tightening as a precaution against inflation. [4. See http://www.guardian.co.uk/business/2010/may/26/oecd-backs-coalition-spending-cuts] Both the Bank of England (BoE) and the ECB are thought to be considering raising interest rates at the end of 2010, despite the fact that the ECB forecasts that the Eurozone will contract by 4.6% this year and that in June inflation fell 0.1% compared to a year ago, the lowest inflation rate since 1953.
What does all this mean for growth? Take the Eurozone-16 countries alone: their average current deficit in 2010 is about 7% of GDP, and it will probably be 8% next year. The current aim is to bring this figure within the 3% limit by 2013, i.e. to make budgetary savings of 5% over two years. If we assume a (small) government multiplier of 1.5 and that its impact is distributed evenly over the three years following 2013, this would mean a 2.5% annual loss in growth until 2016. But average Eurozone growth since 2001 has only been just above 1% per annum, so we can expect deficit cutting to lower future growth.
In short, Europe’s pro-cyclical budget cutting will, at worst, prolong the slump turning it into a 1930s style depression. At best, it will produce Japanese-style stagnation, a ‘lost decade’. Whichever of these outcomes occurs, the economic and social costs will be high. Growth elsewhere in the world will be affected – this is what the quick European tour by Messrs Geithner and Summers is about. Prolonged unemployment means that a whole generation will remain jobless, and even when recovery takes place, they will enter the labour market without the skills they would otherwise have acquired and thus with little bargaining power. Many industries will decline, and some will disappear altogether, as will the wider communities which they helped support. Income and wealth inequalities will grow.
Perhaps most disturbing is that Europe’s ‘social model’ will be so deeply damaged by lack of public finance that it will in effect cease to exist, or else become a patchwork of support programmes for the ‘deserving poor’ (those in work) as in the Anglo-Saxon countries. The deficit cutters are burying Social Europe.
Why such pessimism?
Why has it come to this? The answer lies partly in the power of the financial sector, and partly in the near universal acceptance of neoliberal economic ideology. Like Britain and America, Europe has poured vast sums (in excess of a trillion euros) into bailing out its banking sector. Doubtless this was correct at the time. But as the recent sovereign debt crisis has shown very clearly, the very same financial markets that governments bailed out have raised sovereign borrowing costs to exorbitant levels for Greece and others while making fistfuls of money short-selling the weaker countries’ Eurobonds.
Although there has been fresh impetus for greater regulation of financial markets – led to their credit by France and Germany – there has been no corresponding change in ideology. The orthodox ideology is not so much monetarist or even Austrian – it is quite simply the ‘common sense’ notion of bankers and shopkeepers alike that an economy’s budget is no different from the family budget. They assert that a sound budget, whether private or national, must balance. [5. See http://blogs.euobserver.com/irvin/2010/04/13/why-sound-money-is-unsound/]
Both Friedman and Keynes would have agreed that the financial crisis required the banks to be bailed out – which the EU has done generously. Where Keynes disagreed with the prevailing orthodoxy during the Great Depression was on the question of balancing the budget. Keynes argued famously that when the private sector was rebuilding its saving, government must spend more; otherwise, aggregate demand would fall leading to falling output, employment and tax revenue.
Some of Ms Merkel’s slightly more sophisticated followers (eg, George Osborne in the UK) would argue that more state spending leads, via inflation or increased borrowing, to higher interest rates which ‘crowd out’ private sector investment. Unfortunately, for this argument to be true, one would need to show that ‘full’ crowding out takes place, something which according to this theory can only happen at the natural rate of unemployment. Since the ‘natural’ unemployment is unknowable, the argument fails.
As for Keynesian economics, despite the near Depression of 2007-09, many of Ms Merkel’s colleagues appear to remain blissfully ignorant of the subject. As Keynes explained in his ‘paradox of thrift’, although saving may be a good thing for individuals and businesses, the more a country tries to save, the more income falls and the less it can actually save. A good example of economic illiteracy is the oxymoronic title of a recent piece published by two journalists in the influential magazine, Der Spiegel, ‘European austerity is the first step to recovery’. [6. See http://www.spiegel.de/international/europe/0,1518,697098,00.html] As the Berliner Zeitung put it, the end result of this sort of nonsense is that: ‘Europe will save its way into the next recession’. [7. See http://www.spiegel.de/international/europe/0,1518,697098,00.html]
Growing out of Crisis
There are three components to avoiding further meltdown: growth, funding and recognizing that finance is a public good.
Take growth. As Keynes warned, under current circumstances, private capitalists loose their ‘animal spirits’, their will to invest, so the state must ‘socialise’ investment – at least for a time. What and where to build is hardly a problem: everything from social housing to a new, green infrastructure is needed. Nor is there anything very radical about doing so: the two main ‘Keynesian’ countries driving the world economy at the moment are the United States and China. The US ‘fiscal stimulus’ package – cumulatively some 4% of GDP since 2008 – is far greater than anything the EU has done.
How is this to be funded? First, tax reform is needed – most urgently, in the most unequal countries such as Greece, Portugal and the UK. It has been shown, for example, that Britain’s structural deficit could be largely plugged by redistributive tax measures designed to rebalance the growing gap between the highest and lowest income deciles. [8. See ‘In place of cuts’; http://www.compassonline.org.uk/news/item.asp?n=6164] Moreover, there is now ample evidence that reducing inequality would reduce the high social costs which inequality entails. [9. See for example Wilkinson, R G and K Pickett (2009) The Spirit Level: why more equal societies almost always do better, London: Penguin Books.]
Secondly, while awaiting reform of the Eurozone’s fiscal and monetary arrangements, the European Bank for Reconstruction and Development (EBRD) can be used much more actively to fund infrastructure and energy projects. After all, the EBRD (unlike the ECB or non-existent Euro-Treasury) can borrow actively on international markets.
A further tool is quantitative easing (QE): the ECB has already used this means to finance an earlier round of bank bailouts. The typical objection that unsterilised QE would be inflationary simply doesn’t stand up to scrutiny. With core inflation below 1% (and actually native is some Eurozone states), the greatest danger facing Europe is deflation, not inflation. Equally, there is no longer any reason why the EU should not introduce a Tobin Tax. A 0.1% tax on euro forex transactions (€1 per €1000) would bring in €220bn per annum, just over twice the value of the EU budget. [10. See http://blogs.euobserver.com/irvin/2010/02/20/the-eu-must-act-on-a-tobin-tax/]
Finally – and perhaps the most important point of all – we have come to a stage when the financial sector is simply too big and too unstable to be left to its own devices. Some want more regulation; others want to split up commercial and ‘casino’ banks (a new version of Glass-Steagal); still others favour ‘remutualisation’ and so forth. All these remedies should be tried. But the underlying point which social democrats need to make is that finance can no longer be left exclusively to private bankers. Big finance has become a public good and it is time to say so clearly.