Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Euro Zone Austerity is Correct

Posted by butalidnl on 5 January 2012

US and UK economists are quite vehement in opposing the Eurozone’s stress on austerity. They say that this would jeopardize economic growth, which is important for increasing employment and maintaining welfare. But they are just expressing conclusions which stem from the dominant Keynesian view of economics. We will see that this view needs to be amended or replaced.

Addicted to Growth
American economists are addicted to growth. Keynesian economics teaches that governments should use fiscal and monetary policy to maintain growth at all times. Now, at its extreme, the US Fed is the one mainly holding up the US economy by using monetary policy alone. This obsession with growth has led to the Fed and the Bank of England (BoE) to print money (aka ‘quantitative easing’) in order to stimulate growth. People in these two countries have been led to believe that this is a good thing. That the economy will be alright, if only people continued shopping.

Non-economists may find such a policy of ‘printing money and encouraging shopping’ problematic; but then they would be faced by Keynesian economists assuring them that it is right. What the Keynesians fail to realize is that the world  is in the middle of an international tug-of-war for resources. Printing money and shopping are, in effect, asserting the US’ position as ‘consumer of last resort’ at a time when other countries would rather use resources elsewhere. And that is the weakness of the policy: third world booming economies are  increasingly reluctant to prop up the US economy if this means that they would be deprived of resources they need for their own development. The US economy, instead of benefiting the world with its consumption, is more becoming an impediment to growth of other countries.

In this light, the Euro countries’ call for governments to live within their means is a good policy. This means, concretely, that governments should no longer stimulate their economies through excessive government spending (fiscal policy). And combined with the EU’s thrust to lessen its carbon dioxide emissions; it means that Europe’s resource footprint will grow slowly, if at all. It will also mean that Europe will be producing goods and services in an increasingly efficient and competitive manner.

Building Efficient Economies
Government austerity forces economies to be more efficient, and to utilize all their resources properly. Austerity could mean cutting hidden subsidies on fossil fuel, taxes on waste, more efficient production or promoting recycling. While a natural problem with austerity programs is that they may also reduce vital services like the social safety net or public transportation, this will be corrected in the course of the political process as other parties would restore these.

Efficiency includes the concept of a good social safety net, because when workers who are displaced by rapid market changes are well taken cared of, they would more readily accept those changes. Societies should avoid, most of all, the destruction of human capital in the form of forced idleness and de-skilling.

There are also specific policies which skew a particular country’s utilization of resources. Among these are: differences in retirement age (e.g. Greece used to allow retirement at 52 years); low corporate tax (Ireland); or, tax-exemption for mortgage interest payments (Netherlands). Different rules for the Value Added Tax, for social security contributions and benefits; rules for buying and building houses; and, specific taxes on oil, ‘sin’ products etc distort economic and fiscal balances between countries.

Bank of Last Resort?
The idea that the ECB should step in and buy hoards of Italian bonds is wrong. The problem of Italy is that the ‘market’ thinks that its bonds are risky, and thus asks for a higher interest rates for them. While this perception is particularly problematic now, but if the problem does not get out of hand in the medium term, it will eventually solve itself. Investors would eventually settle on buying Italian bonds that have only slightly higher interest rates than German Bunds.

Higher interest rates are important for keeping governments more disciplined when it comes to making their budgets. Making interest rates uniform now (by instituting ‘Eurobonds’ for example) would effectively reward those countries who are misbehaving.

Time is on the side of the EU and the Euro. The Eurozone has a trade and payments surplus. This is quite different from the US, which has budget, trade and payments deficits.  Eventually bond buyers will need to park their money somewhere, and where better than the EFSF and the ESM (which are less than 1 trillion Euros in total, and are as solid as German Bunds)? It will eventually turn out not to be a good idea to park their billions of (petro)dollars in US Treasuries – whose supply increases by at least $1.6 trillion/year.

No Theory Yet
This is not to say that the Eurozone leaders are following a coherent plan, based on a well thought-out theory. Euro leaders are mostly improvising on the run, after being pushed by market conditions to take certain steps; while at the same time also hindered by those same forces from solving the problems quickly.

Economists heckle the policy of austerity because of the Keynesian prediction of an economic downturn if governments cut spending. But austerity is a move that is forced on countries by the market – the market is in effect demanding lower budget deficits, and will punish any government that now does deficit spending. But saying that governments are forced to undertake austerity does not mean that austerity is bad either. Governments are now implementing austerity , which it never would have done without market pressures.

The EU’s decreasing carbon footprint is an independent development, but one which fits neatly into the new EU economic ‘model’. So are the social welfare systems in EU countries, which are only marginally affected by the crisis. Now, the EU is confronted with the need for austerity, together with lessening its carbon footprint and maintaining its social welfare systems.

The present high pressure atmosphere within the Euro zone is clearing out many economic cobwebs. Technocratic governments in Italy and Greece will now work within the parameters, and try to both economize and grow. This means among others: that corruption be lessened, tax compliance improved, and protected professions opened to competition.

A new economic theory will eventually emerge that will affirm the correctness of austerity and reducing the resource footprint under conditions of resource scarcity.

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