For years, finance and prime ministers of many EU governments, the EU Commission, most Conservative parties (also some of those calling themselves social-democrat or Labour) and most of the international economics press (among the The Wall Street Journal, the Economist, the Financial Times) have seen budget consolidation not only as a necessary evil to get interest rates down, but also as the means towards growth, mostly in addition with “structural” measures, i.e. liberalizations of goods and labor and capital markets.
Empirical evidence does not bear this out: the prolonged very deep recession in Greece, the financial crisis in virtuous Spain and Ireland, the recessionary trends in the Eurozone and the EU as a whole – all these give credence to those who stressed that during a deep recession further budget consolidation is self-defeating and creates a vicious circle between lower government revenues, higher expenditures and lower GDP.
But: very recently, the IMF and some of the media have started to recognize this and have called for “growth cum consolidation”.
While this – late – recognition that if every country consolidates, demand is lacking and unemployment increases, thus GDP falls, the prescriptions of official bodies IMF and EU, OECD and World Bank fall short of the task ahead.
The “extremists”, the so-called “expansionary fiscal contractionists (my own wording, KB)” believe that austerity in itself will promote the next expansion. The more measured economists at the above institutions recognize that the severity and speed of downward budgetary adjustment has (negative) effects on growth, and propose to supplement this with “growth-enhancing structural reforms”, i.e. more labor mobility, less labor protection, more competition, more product market liberalization, etc. In other word, they believe in a “defensive” strategy, thereby increasing the competitiveness (by lowering the costs) of country X vis-à-vis the rest of the world.
But again, evidence that in a deep recession this is all it takes to obtain growth, is scarce, if it exists at all.
What is needed, in addition, is an “active” growth strategy that encourages and finances innovation, education, research and development, and infrastructure, both material (transport, energy and communication networks) and immaterial (social cohesion, diffusion of technical innovations and inventions, start-up institutions, etc.)
Active encouragement to take up employment, to produce higher-value services and products and to lay the foundations for future growth – all these are essential. Regulatory changes which have no or little budgetary costs are important in order to stimulate investment.
And then, of course, the balance between the (eventually necessary) budget consolidation measures and offensive, active growth measures – in other words their effect on total demand – will be important. This was discussed, with pretty weak results, at the recent EU Summit last week. There, once again, the balance was tilted towards austerity – with the rationale that first credible austerity must be on track (see the new pact) as a pre-condition for future growth measures. It is not implausible that the strong commitment of the 25 member states towards austerity enabled the ECB to come up with another half trillion Euros in long-term cheap loans to banks.
The frightening results for Greece (-7% GDP, 22% unemployment rate, 50% youth unemployment) have been recognized by the EU family. The troika now is actively thinking about activating some of the structural and cohesion fund moneys which are due to Greece but have not been disbursed because of – mainly Greek – delays and inabilities, prematurely, i.e. fashion a “growth dividend” amid the requested deep austerity. This – unfortunate – example does show that some people in Brussels and Washington, D.C. do recognize that the reliance on defensive measures only will drive Greece into a deep and depressing negative spiral, with grave consequences for the social cohesion of the country and the acceptance and viability of the state.
But: Why does it take such a stark case as Greece to come up with at least a semblance of a sensible growth program? Why can this way of thinking not become EU mainstream? The dangers of a deep and long-drawn-out policy-engineered depression for the whole Eurozone and the EU are very high.