Europe's Austerity Backlash: History Repeats Itself

Jun 11, 2013Mariam Tabatadze

Austerity's failure in Europe was easy to predict, even if politicians and economists didn't see it coming.

A few weeks ago we saw an interesting debate unfold in Europe: European Commission President José Manuel Barroso said that austerity in Europe had reached its limit, and a few days later, the German Finance Minister Wolfgang Schaeuble responded, “somebody should tell Barroso” that strict budget rules are not the main issue in the eurozone. Though some politicians are stubbornly refusing to admit that the default policy in Europe for the past three years has been a devastating force, most policymakers and influential leaders are already changing their tunes. The most salient example of this is the IMF, whose Managing Director, Christine Lagarde, has been toning down her austerity recommendations and calling for more gradual reforms. Most recently, she supported the Spanish government’s decision to ease austerity policies and focus on decreasing the alarmingly high unemployment rate (especially among young people, for whom it reaches over 50 percent).

The fact that European leaders are seeing the light of day and turning their backs on austerity is a welcomed development. Perhaps the eurozone has a chance to grow now that governments have stopped purposely crippling themselves. But why was austerity the default policy, and why weren’t its devastating effects foreseen? Since 2010, various European nations have been following the policy prescriptions of right-wing economic thought, and the reality illustrates a strikingly different result than what was expected. Greece’s debt-to-GDP ratio rose from 144.6 percent in 2010 to 170.7 percent in 2012. Austerity, which set out to restore confidence, help economies flourish, and most importantly, reduce debt, has failed to accomplish all of the above so far. In fact, the eurozone as a whole contracted for the first time ever in 2012, two years after austerity policies were implemented.

Ideologically, austerity policies come from a familiar place – most individuals are intuitively aware that one should spend less than one earns. Furthermore, one does not cure sickness with more sickness, and it is simple to make the argument that debt cannot be cured by more debt. While it is true that fiscal responsibility is important, there are other aspects of austerity worth considering.

First, spending cuts often affect the layers of society that are most vulnerable, because they were already more dependent on government support. Impoverishing the poor and lower middle class is not synonymous with promoting entrepreneurship and dynamism of the private sector. The lower layers of society end up suffering and bearing the burden of an economic crisis caused by members of the upper levels of society, whether they are bankers or politicians.

Second, it makes no sense to cut spending across the board on an entire interconnected continent. Austerity is supposed to restore competitiveness and promote exports through efforts like reducing domestic wages, but who will spend the necessary funds to consume those exports if every country is cutting budgets and focusing on saving? It seems common sense that not all nations within the eurozone can run surpluses; it is equally obvious that not all countries can be export-led, the way Germany is.

Third, and most important, is the glaring problem in the set of assumptions behind austerity. The first is human rationality. According to this line of thought, economic stimulus will provide a net effect of zero because consumers are smart enough to factor rising government debt into their calculations and therefore will save today in order to prepare for rising taxes in the future. On the other hand, spending cuts signal to these (largely imagined) rational, calculating economic actors that their income will be higher in the future due to lowered taxes and lowered debt. Thus, they will be more comfortable spending in the present, and voila, demand has been boosted. Except, there is one problem: Homo economicus has very little in common with Homo sapiens, in that actual living humans are not rational and not nearly as farsighted as most economists would like you to believe. If, in the midst of an economic crisis and austerity policies, your neighbor gets fired and your newly graduated son is having a hard time finding a job, you are not likely to spend more money now because you anticipate your taxes being lower one day.

Despite overwhelming evidence, politicians and economists alike are still convinced that austerity works. Historical examples like the austerity policies put in place before Roosevelt’s famous New Deal leave little doubt that “expansionary contraction” is not beneficial during economic downturns. Even so-called austerity success stories with supposed applicability to the eurozone have been called into question: Australia and Denmark, regarded as model austerity countries, fell into crises after two years of implementing austerity policies. The only real success stories of reductions in debt have not been during downturns, but during periods of economic growth. The United States, for example, succeeded in reducing the deficit significantly under Bill Clinton, and Sweden reduced its fiscal deficit from 1994-1998 during a period of rapid GDP growth.

The bottom line is simple: none of what is going on in Europe after adopting austerity policies should be a surprise. It is just inexplicable that we have to keep reinventing the wheel and rediscovering the adverse effects of austerity in a struggle to recover from a crisis. Why can’t we tell austerity (in the words of Kelis), “might trick me once, I won’t let you trick me twice”?

Mariam Tabatadze is a a member of the Roosevelt Institute | Campus Network and a recent graduate of Connecticut College with a double major in Economics and International Relations. She is interning at the Institute for New Economic Thinking this summer. Click here to read her full paper on the eurozone crisis.

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