The announcement Wednesday by Germany’s chancellor, Angela Merkel, that her nation is ready to discuss economic stimulus to keep Greece in the eurozone is—if serious—a hugely important development. But the critical test will be what policies emerge from this announcement. After more than three years of unsuccessful efforts to tackle the problems in Greece and other countries through imposed austerity measures in return for bailout funds, observers might be forgiven for thinking there are no solutions to the continuing eurozone crisis. Yet the eurozone is not stuck between a rock and a hard place. The tragedy is that effective solutions are available, but the stronger European nations, led by Germany and the European Central Bank, seem incapable of adopting them, or perhaps even thinking clearly about them. The crisis is not purely a consequence of Greek intransigence, by any means.
As Greeks withdraw hundreds of millions of euros from their own banks, there may be little time to head off crisis. But the leaders of the eurozone have to begin with a clear-cut objective that is more than lip-service. Even fervent advocates of austerity economics—cutting government spending and increasing taxes to reduce government budget deficits—agree with those who advocate stimulus on one crucial point: that the threat of economic collapse in the eurozone—and of the end of the euro—can only be eliminated by renewed economic growth in the struggling countries.
The austerity camp argues that once enough government spending is cut, budget deficits as a proportion of the GDP will start to fall, convincing traders in financial markets that responsible fiscal management has returned. Reduced interest rates will follow, producing in turn the business confidence needed to regenerate investment, jobs, and the growth of incomes. Higher tax revenues will be earned to pay off debt.
Those in what we can loosely call the Keynesian camp instead advocate fiscal stimulus—more government spending and temporary tax cuts—to get the economic growth motor running again. They cite the work of John Maynard Keynes and the empirical observations of his followers, which show that government spending has consistently created more growth than the cost of the additional stimulus; the Great Depression itself was lifted from the depths by World War II spending. Indeed, the evidence shows that austerity—the prescription of choice in the early 1930s and then again in 1937—was partly to blame for the durability of the Great Depression, which included a second deep recession in the late 1930s.
But the Keynesians can also draw on recent economic history to support their views. Austerity has failed to reduce debt as a proportion of GDP in every European nation in which it has been tried since 2008. More to the point, it has also—as Keynesian economists predicted—directly resulted in another recession in much of Europe, thus reducing tax revenue. I argued in the NYRblog at the beginning of January that this would be the likely outcome.
There are many schools of anti-Keynesian thought, most of which claim more government spending does not produce more income than the amount of additional spending. Austerity is the only answer. Under some conditions, if we wait long enough, the pro-austerity argument will be right. After all, economies reached bottom in the US and other nations in the nineteenth century time and again, yet eventually recovered without government stimulus. Globalization should not change this pattern in itself.
But the questions for austerity advocates is at what cost and for how long? Had there been no World War II, the US economy of the Great Depression might have slid down still further, with unemployment remaining high for a much longer time. What would that have done to social cohesion and stability in America? In Germany, which suffered its own crises beginning in the 1920s, the drastic economic situation contributed to the rise of Nazism, a possible outcome Keynes himself warned about in his 1918 book, The Economic Consequences of the Peace.
The powers that held control in the eurozone since the great recession of 2008–2009 were apparently willing to take their chances with poor levels of employment. Youth unemployment in Spain is now about 50 percent, to take one alarming example. They knew there would be pain and were willing to tolerate it. But they were also generally convinced that stable deficits and business confidence would soon return. This has not happened, as historical data have long predicted it wouldn’t. An International Monetary Fund study, for example, showed that in almost no cases where it was explicitly adopted, did austerity economics result in new growth. Even as austerity economics failed to perform as promised, however, the tough-minded leaders of Germany and other eurozone nations stuck to their guns. (Britain is the classic example of a non-eurozone country that has doubled down on austerity only to find its economy sinking again.)
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The result of these policy errors has been to turn voters against their leaders in Britain, France, Italy, and now most resoundingly Greece. The Dutch austerity government fell and even Germany has found its government under threat. Did these leaders have no sense that the harsh penalties would ultimately be met by electoral rejection rather than acquiescence?
It is getting late, but there is a way out, and the outcome of recent elections across Europe may force those in power to take it. High in the minds of those controlling the levers should be the core principle: that without growth there is no solution. Second, they will have to recognize that the nations in most financial trouble—Greece, but also Portugal, Spain, Italy, and Ireland, need growth very soon. Already, financial markets are pushing up interest rates again, as Greece, and then others may refuse to abide by austerity terms to satisfy an angry electorate.
Ironically, Greece could help open a path to resolution by demanding new terms for its bailout rather than simply abandoning the euro. The nation probably always had a stronger negotiating hand than it realized, and it still does. A Greek departure from the eurozone could create a possible panic in the financial markets, as investors even in the financially strongest nations, including the US, fear other countries may follow Greece’s lead. Financial crises could follow across Europe as markets anticipate that debt will be repaid in far less valuable, newly created lira, pesetas, and drachma.
Until now, those who advocate growth, like Mario Monti, Italy’s prime minister, have not offered a clear path to it, cautiously emphasizing cutting worker protections to reduce labor costs rather than directly stimulating the economy through government spending. It remains to be seen what the new president of France, François Hollande, will propose, but with his election there is at least the prospect of a new, constructive debate on policy.
Once one can admit that serious compromise is needed by the eurozone north, however, a workable solution begins to emerge. Such a solution will require an immediate easing of austerity in the peripheral nations: Greece, Spain, Portugal, and Italy. The richer nations must also augment the safety nets of the periphery to enable them to still cut government spending some without extreme and socially unstable sacrifice for their populations. In turn, the stronger nations should help finance the repayment of the weak nations’ debt by issuing a new jointly guaranteed Eurobond and with more aggressive sovereign debt purchases by the European Central Bank. They should also develop industrial policies to invest constructively themselves in these nations. Finally, the ECB could loosen its outright resistance to inflation, a step that would allow it to pursue more expansive monetary policy.
The main cause of the crisis—high trade surpluses by Germany combined with high trade deficits in peripheral nations—can be addressed if Germany allows itself to grow faster through stimulus, lets wages rise, and tolerates higher levels of inflation. This will introduce a Keynesian stimulus to the eurozone. The peripheral nations need not reduce wages as much as has been demanded through austerity policies, but they will have to be somewhat restrained about them. Over time, such policies would allow weak nations’ exports to become more competitive.
This is an economically just and entirely feasible solution. But it will require consent and cooperation from Germany and the handful of other rich nations. With German Chancellor Angela Merkel’s belated acknowledgement this week that economic stimulus by Germany and other rich nations may be forthcoming, there is also a ray of hope that the austerity camp might yet modify its position. (Although there were earlier reports that the German establishment has become increasingly sanguine about a possible Greek exit from the eurozone.)
The longer the current crisis persists, the greater the danger of resurgent nationalism, ethnic resentment, and outright bigotry among stronger and weaker eurozone nations. The pain asked of Greece is currently too great and unless some of the steps I outline above are taken, it may ultimately leave the eurozone as a result. Crisis itself could force Greece’s hand to a hasty withdrawal from the euro, amid financial confusion, bank collapses, and even more widespread unemployment. A sharply lower level for a new drachma could usher in new growth, but not without initial pain. If Greece leaves, so may Portugal and Spain. Germany’s great trade advantages would end as newly created currencies plummeted in value, making its exports expensive. Its banks would lose a lot of money, their loans paid back in cheap currencies. No one should think there is no better alternative or that the euro cannot be saved.
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Though the negotiations will be difficult, the recent elections in Greece may actually create a blueprint for such a solution and force Germany to come to its senses. It has long benefitted from purchases of its goods in Greece and the other periphery nations, exploiting a low-valued euro. It is time to give some of that back. And in the process, once a plan for true growth is in place, Greece will have to manage itself well, end patronage, spend cautiously, pay its taxes, and stand tall as part of the EU. It will meet this challenge because it will be then be able to, and it is, I suspect, eager to do so.
