Will the End of Austerity Break Up the Eurozone?
The eurozone is turning away from stringent austerity policies and toward those that stimulate demand. President-elect Francois Hollande, the first socialist president since Mitterrand, plans to raise taxes on the rich to meet some of his growth objectives. However, without a credible debt reduction plan, Hollande risks a loss of confidence among investors and bondholders.
GROWTH AND AUSTERITY—A GLOBAL PROBLEM
The U.S. got certain things right these past years of recession, which is why we are in better shape than Europe now. And we got certain things wrong, which is why our recovery seems to have a serious vitamin deficiency.
In the “right” column, Americans did not go after federal deficits and budget overruns with no thought of the demand side of the economy. This included a large stimulus package and bailouts for American financial institutions with their backs to the wall.
The Europeans missed the stimulus component of policy; what they are now about to do is compensate for the error. In America’s “wrong” column, there is only one item: The stimulus measures put in place early in the Obama presidency were not sufficient, and economists who said so at the time should get more credit. This is precisely why the jobs numbers came out at the end of last week were disappointing.
THE NORTH vs. THE SOUTH
Until now Europe has lived by a Continent-wide economic policy fashioned by Germany, supported by France, the Netherlands, and other north European nations, and featuring austerity and structural reform as prescriptions for countries struggling with high sovereign debt, burst housing bubbles and wobbly banks, weak economies, and rising unemployment. Just for the record, unemployment across the European Union reached 10.9 percent last week—its highest since the euro was introduced in 1999. That is typical: It has been clear for ages that the policy mix in Europe was wrong, but no one would say the emperor had no clothes.
That is what is now changing. Ever since Hollande won the first round of polling three Sundays ago, senior officials across Europe have been lunging for the microphones to announce their belief in policies that offset austerity with demand-focused stimulus.
Late last week, Mario Draghi, president of the European Central Bank, asked Brussels to produce a 10-year plan for the euro with growth policies as its centerpiece. Part of what Draghi wants in the decade-long vision he proposes is what has been at issue since the Greek crisis nearly tipped over the E.U.’s common currency last autumn: more political integration so that economic and fiscal policies can be better managed throughout the E.U.
The next day Olli Rehn, the E.U.’s vice-president for economic affairs, echoed many of Draghi’s thoughts and added some of his own. The fiscal pact established last December can be applied flexibly, for instance. Spain, as a ready example among the desperadoes, can move its target for its deficit—it is now scheduled to drop to 3 percent of G.D.P. by next year—out a year to 2014. “The pact entails considerable scope for adjustment when it comes to application,” Rehn said in Brussels.
THE BALANCING ACT
What will Europe do now, then? I am looking for a new, improved version of the American strategy. It is already clear that Hollande, the Socialist victor in France, will fundamentally change the European conversation. We just do not know how, and we will not know until Hollande gets on a plane for Berlin to meet German Chancellor Angela Merkel.
The hard-edged policies Europe has had in place for the past several years—and which have now brought it close to depression—are Merkel’s baby. In the best of outcomes, Merkel’s discipline and reform can be combined with Hollande’s stimulus and flexibility to produce a healthy European policy that stretches out sovereign debt, improves demand in strong economies such as Germany’s, and thus induces growth in the ailing peripheral nations.
This does not mean a return to fiscal slovenliness. Neither does anyone expect a rethought policy in the E.U. to excuse the Greeks and others from existing commitments. Quite the opposite. The major international agencies—the International Monetary Fund, the E.C.B., and the E.U.—are all prepared to provide further funds; Christine Lagarde of the I.M.F. made this clear last week, and now Draghi and Rehn have spoken. But this will be on a disciplined basis.
The fundamental question is, Where does growth come from? Europe is concluding that it lost its bet on austerity alone and now expects a mix of policies — including stimulus to provide the growth needed to bring down debt levels and pay private creditors (even if terms are stretched out) – to get economies moving, and get Europeans back to work. Investment in public-sector projects is a time-honored place to begin.
Hollande’s big ideas so far include allowing the issue of common European bonds to finance large infrastructure projects (as opposed to financing debt repayment). He wants Draghi and the E.C.B. to ease interest rates. Last week Draghi disappointed many when he held the bank’s basic rate at 1 percent; under the circumstances, it ought to be lower. Hollande also proposes a tax on financial transactions, doubling the E.U.’s rescue facility to $1.3 trillion, and letting the fund borrow from the E.C.B. At home, Hollande wants to spend $28 billion on job-creating public investment this year and more than that in 2013.
This is the thinking of a moderate Socialist, and one hopes that markets do not swoon as if Marx himself had just been elected. Equally, the rating agencies will be highly misguided if they downgrade nations such as Spain, Italy, and Greece without giving a fundamentally new policy time to work.
The line from Berlin is that Merkel can accept much of Hollande’s program — a good sign for the markets — but will draw the line at any policy that causes European inflation to rise. Some analysts, such as Gideon Rachman at the Financial Times, think this cannot be done. His position is TINA, as the English nicknamed Margaret Thatcher: ‘There is no alternative’ to austerity. I disagree. Take inflation, for example: How great is the danger of inflation when you have a Continent-wide jobless rate of 11 percent—and in some countries rates of more than double that? Virtually nil. Inflation is not the perilous zone it can sometimes be.
In this sense, timing counts. A set of policies that may work under certain economic conditions may work calamitously under others. That is the lesson I draw from the elections in Europe. Sarkozy is the 11th European leader to lose his job over the direction Europe has taken. Depending on how coalition talks go in Athens, Prime Minister Lucas Papademos would make a dozen. In the best of outcomes, Americans will derive a lesson or two from Europe before drawing the curtain and pulling the voting lever next November.