The Latest Fashion in Economics? Cut the Budget!

The Greeks started the ball rolling. They weren't actually the first to adopt an austerity programme in Europe, the Irish were. But the Irish austerity policy created no waves. Somehow the Irish people accepted the fact they had to tighten their belt - maybe it's the Catholic in them. They know there's a time for everything, after abundance comes famine. The Greeks, being loud Mediterraneans, were far more vocal about it. They went on a wild rampage and managed to attract world attention. They gleefully burned down shops and banks in Athens, killing in the process a few hapless employees. That unfortunate event seems to have calmed them somewhat, but the damage was done. It added (greek) pathos to the proceedings, and helped ensure that austerity programmes came to the fore everywhere in the world media. Balancing the budget became the mantra across Europe. The only way to save the Euro, the only way to defend sovereign debt.

In truth, a fashion had been started. A trend that spread like wildfire to the other countries that felt threatened by waves of speculators under the banner of grading agencies like Moody's or Fitch. As soon as Portugal and Spain faced a downgrade of their debt, they rushed to announce cuts to their budget. Italy has not been downgraded (yet) but it followed soon with its own 24 billion Euro austerity policy. Then the Brits. Within a week of taking over government, Cameron had announced cuts, and you can bet bigger cuts are coming soon. The Germans have just announced wallopping cuts: nothing less than an eye-boggling 80 billion austerity programme. They've outdone everybody: three-to-one to the Italians, ten-to-one to the Brits. But, as I said, the game isn't over. It's just starting. The Hungarians have also joined the melée, and I wonder who's coming next, the French? Perhaps not, they've got a very sober lady as finance minister, the kind of woman who's too intelligent to follow a fashion, but you never know. And Obama beware! The fashion could come to America, riding the wave of the Republican Tea Party.

Fashion? Yes,because budget cutting is the latest fashion.

I know what you're going to say. This is ridiculous, it's not just a matter of fashion. It's hard, cold numbers: the size of the deficit in relation to GNP is the key indicator. Fiscal discipline makes sense. One has to follow the rules or else the whole system will collapse. It hasn't collapsed yet but it might. So you prop it up.It's nothing but preventive medicine, stupid!

I beg to disagree. Austerity programmes in times of recession (such as now, for God's sakes!)are nonsense. Economic nonsense, and highly dangerous. You put on the brakes just as the economy has stalled and finds it hard to start up again.

Yes, I know, I'll confess my sin right away: I'm a hard core Keynesian. I'm not the only one, I'm in good company: so is Stiglitz, the Nobel Prize winner. You ought to read his analysis of our current Great Recession: Freefall (published by Norton, 2010). It's a must. Unfortunately he wrote it midstream through the crisis and focused on the (dramatic) effects of failure in the financial system, with Wall Street unwilling to lend to Main Street. He didn't mention sovereign debt. At the time he wrote, it hadn't become a problem yet. But now it is. At least in Europe: we are in the midst of a different kind of crisis, and it is certain to reach America soon.

Why? Because to control the financial crisis and put their economic house in order, all G20 governments have engaged in stimulus packages. Now, all of a sudden, the implications of a stimulus package are hitting home: it means deficit spending. Or worse, resorting to the money printing press. So the next thing that needs fixing is the deficit. Off with its head!

Not so. You cut the deficit, you close down 10,000 government jobs as the Germans plan to do, plus all the parenthood subsidies etc etc and you find that you've effectively cut down on national consumption. Less consumption means fewer products sold. Trade winds down, investments slow, people are laid off, incomes fall and so do taxes. Governments in adopint policies to balance their budget will only succeed in obtaining less funds in their coffers as people have less money and pay less taxes in the coming years.

It's a downward spiral. And the Great Recession is already a downward spiral caused by the private sector. Now if you add the public sector to the equation - going in the same downward direction - there's no end in sight. Some central bankers are aware of the danger. The Italian Mario Draghi, a man of great common sense and (in my view) a perfect candidate to run the European Central Bank after Claude Trichet retires, has warned the Italian government that its proposed austerity programme would cause a slowdown in growth - a small one, but then the Italian programme is relatively modest, with a good third focussed on better controlling tax evasion (a perennial problem in Italy) which has no direct incidence on consumption.

Perhaps the adoption of austerity programmes won't cause a double dip recession as so many have feared, but it sure is going to ensure that the recession will be a very long, slow downward slide. It could last years, if not decades.

Surely there's a better way to defend the sovereign debt? It seems that governments have been bending backward so hard to please their electorate that they have forgotten something very simple and essential: they're sovereign. To defend the Euro - or any currency for that matter - what is needed is not silly consumption-cutting policies that make a politician feel morally good. What is needed is an intelligent economic policy that correctly handles the main elements that make an economy function: consumption, savings and investment.

Yes I know, I'm back to Keynes, but nothing else works. You're going to say we didn't get out of the Great Depression thanks to Keynesian policies but because of World War II expenditures. And I'll tell you that (1) Roosevelt never had the political courage to consistently apply Keynesian policies, and (2) World War II expenditures were the precise equivalent of what Keynes was talking about: he suggested digging holes and covering them up - any work was better than none - and that's exactly what the war did. Unfortunately putting corpses in the holes.

Let's hope we don't need another war to get us out of this Great Recession!