The Pillars of Austerity are Crumbling… So What to do?
By Sean Garman
A few weeks back the academic pillars supporting austerity fiscal policy crumbled when three economists from the University of Massachusetts-Amherst identified significant flaws in the findings by Harvard economists Kenneth Rogoff and Carmen Reinhart that once the Debt to GDP ratio exceeds 90% economic growth dramatically declines. There are plenty of stories detailing their cock-up. This epic academic take-down raises important questions around the use of academic studies to justify already-determined economic policies, and what Europe is to do as this mighty intellectual pillar of austerity crumbles.
The first problem is to acknowledge is that the research has been hijacked to justify fiscal austerity. At this moment, policy-makers are fixated on fiscal imbalances and they latched onto this piece of research to justify their policies. I can only really blame policy-makers for this. Just like people don’t make investment decisions based on what a spreadsheet tells them, so too should policy-makers have the confidence in the logic of their argument that they do not need the outcome of one study to dictate their economic policies. In an effort to back their arguments up, too many political leaders latched onto any support to provide political cover. Now that pillar has been kicked away.
To be fair to both Rogoff and Reinhart, neither has said that there should be a “cut now” policy and both have been quite strongly in favour of further reform, at least in the US. Yet the relative scarcity of supply-side reform in Europe best demonstrates that politicians find it easier to cut spending than reforming public services. The courage of their convictions extends no further than having someone tell them what to do to provide political cover from any fallout.
Possibly, it also demonstrates that politicians prefer short-term fixes than structural changes that challenge the cultural norms of their societies.
Now we are in a catch-22. Many European countries (including Britain) are heavily reliant on the capital markets to fund recurring government expenditure and to rollover their existing debt stock, compounded by no prospect of sustainable surpluses in the near future. The capital markets are rightly concerned that if they lend money they will either not get it back or higher inflation may be used to erode the real value of their investment. Finally, leaders find it easier to cut spending than to enact micro reforms thereby restricting (or strangling) supply-side growth potential. All in all, this is a pretty messed up position that we find ourselves in. European leaders should have enacted micro reforms concurrently with medium-term fiscal austerity: thereby easing the supply-side of the economy to help boost sustainable economic growth while getting public finances in order to better manage, and eventually reduce, their debt burden.
Not to sound too pessimistic but this is not going to happen. The rhetoric of austerity, the relative scarcity of reforms and the one-size-fits-all fiscal and monetary policy are turning Europe inside out. If you have any better idea about how to get out of this hole, then we’d be glad to hear it!