According to the European Commission the eurozone is on the mend and austerity policies are responsible. The first part of this statement is, we hope, supportable. The second is not and needs to be called-out. If the eurozone recovers and the lesson learned is that austerity worked, then we are, like Marx’s historical stooges, doomed to compound the current tragedy by repeating it as farce the next time we are faced with an economic crisis. With 26 million unemployed in the eurozone and a periphery burdened with more debts than it can ever hope to pay back as a result of this policy, the notion that austerity worked, or even targeted the right problem, is exactly the wrong lesson to learn.
First, averages hide a lot. Remove Germany and France from the data and the eurozone is not recovering. Portugal’s unexpected return to growth, like France’s, comes partly from missing, not meeting, troika targets, allowing automatic stabilizers to work. That is, not doing austerity. Germany’s rebound is, as usual, export led, which is dependent upon growth outside the eurozone. Second, one swallow makes neither a summer nor a recovery. Go back 18 months to the last time the eurozone supposedly recovered and we find those same predictions turned out to be quite wide of the mark. Let us hope that the forecasters’ lens has improved. Third, if this is a genuine recovery, it is sclerotic at best and will do little to restore employment and growth give the depth of the pit that austerity policy has dug. It’s going to take a very long time for growth of between 1 to 2 percent, to even get back to where these economies started.
To see why austerity hasn’t promoted recovery consider that the entire Western world has been running an austerity experiment for the past few years. The economy that has grown the most and reduced deficits the fastest has been the US, which has not cut, at least until very recently. The UK has crawled along for the past four years because of voluntary tightening, and its recent rebound has a lot to do with giving everyone in the country their own personal Fannie and Freddie, with £1.3 billion hitting the housing market in the past six months. Peripheral Europe has cut the most and now has more debt not less, massive unemployment, and a much lower GDP. Given this, claims that austerity came good in the end has no evidence going for it. Indeed, austerity was the wrong policy applied to the wrong target right from the start. The underlying problem in Europe is not, and never has been, the debt loads of sovereigns. That there was a crisis in the sovereign debt markets is indisputable, but the debt loads of European sovereigns of all stripes have gone up, not down, over the past four years, in some cases spectacularly so, while the yields on eurozone government debt have gone down.
The problem that Europe actually faces is a banking sector that is three times the size and twice as levered as its US counterpart choc-full of toxic assets that the European Central Bank, unlike the US Federal Reserve, can neither swap for cash, sterilize by burial on its balance sheet, nor mutualize with other assets. Recognizing this lack of a credible central bank insurance policy for their euro-denominated assets, markets began to price in break-up risk in early 2010 and yields spiked accordingly. Having such a policy in place, dollar and sterling assets barely moved. The markets did not demand austerity, they wanted insurance, which was only provided when the LTRO and ELA programs, plus Drahgi’s “whatever it takes’ promise was put in place. Given this, if the whole point of austerity was to lower yields by reducing debts it was at best useless and, given its impact on the targeted sovereigns economic wellbeing, downright toxic.
Rather than learn the wrong lesson from Europe’s austerity binge, it’s perhaps better to recognize that it is impossible to cure a crippled banking system with fiscal reform. The stalled Banking Union is where to push in this regard, not more cuts. And while there is no doubt that peripheral economies need deep structural reforms, doing so in the midst of a policy-induced depression is never going to restore the growth that is needed to actually reduce debt. Austerity has not brought about this nascent recovery. Growth is occurring despite the cuts, not because of them.