Why Austerity Programmes across Europe will Bring Disaster...

The fashion for budget cutting has now run all over Europe - including the French. And the English have gotten into the act too. So far, the biggest cutters are still the Germans, with a proposed €80 billion austerity programme over the next four years. The European Central Banker, Jean-Claude Trichet, raves about it and so does Ms. Merkel, the German Chancellor.

I wonder why. These are presumably savvy, educated people with a head on their shoulders, or are they? Haven't they read Keynes? Haven't they heard about the Great Depression and how Roosevelt didn't manage to get out of it? In 1937, he reversed his Keynesian-inspired expansion policies because they cost too much to the budget. To get out of the Great Depression, America had to wait for World War II and the extraordinary level of government war expenses.

Before the Great Recession came along - I mean before 2008 - I can understand that Keynes might have been considered passé. Those were the days of the real estate bubble and financial hubris. Those were the days of the so-called "Washington Consensus" which had put centre stage the free market ideology and pushed under the carpet - seemingly forever - any role the State might have in the economy. The Soviet Union had collapsed and with it the Communist, centrally planned vision of the world. All that was left were wildly liberal monetarists à la Milton Friedman - no other kind of economist allowed. The Market had become a New Idol, one that was never wrong. Just let it act in total freedom, and any recession would automatically correct itself. And, of course, a depression was impossible.

But now? We've seen to what excesses the Market Idol can take us. Governments have had to move in, they've devised stimulus packages and saved the banking system from collapse. That has cost money, of course. And when the stimulus stops, it is often too soon, as we've recently seen with the American real estate market that has taken another plunge. And much work still remains to be done to force banks back into banking, i.e. as keepers of our savings and lenders to business. That is their role in the economy. But of course they much prefer to play around with derivatives and other new-fangled financial products rather than focus on their traditional role. No doubt gambling is far more fun than serious work. Still, with luck, Congress might soon pass some responsible legislation (including the Volcker rule) that will help curb the financial hubris that has hurt everybody (except the bankers, of course).

Yet European politicians are strangely impervious to this. All they see are the rising public debt - a natural outcome of their earlier interventions to sustain the economy - and they feel they must do something about it. Immediately. And they've brought their Weltauschauung to the G-20 in Toronto - with the odd result that every country agrees that cuts are in order but everyone is left to do as it pleases...

Cut, cut, cut! That is what the financial markets demand, says Trichet. That is what will restore confidence to the German consumer, says Merkel. She knows Germany is accused of not consuming enough and focussing only on its export industry (which in fact is now roaring along, thanks to the weakened Euro).

Do German consumers really need to see a government austerity programme in place to spend their money? Have you ever met anybody who worried about Government debt when contemplating the purchase of, say, a car? And an austerity programme, by cutting down on government posts and pensions etc and sending people home with less money, is bound to cut back on personal income and cause a further drop in German consumption...

But why should a Central Banker ever bow down to a speculative attack on his currency? What is the problem with the European Central Bank? Normally any Central Banker worth his salt would defend his national currency with all means available, including purchasing treasury bonds to control undue rises in interest rates. So why should the European Central Bank not act as any other Central Bank would ? Why should it feel apologetic when it does? Trichet a couple of days after buying Greek bonds immediately announced to the press in Frankfurt that he would "sterilize" the purchases - meaning reverse them.

The answer? He means to please the Germans - everybody in Europe is following in German footsteps. When the Greeks confessed their sins and proceeded to reign in their budget deficit, there was an uproar in Germany and much indignation. That, as we have seen,after much huffing and puffing, set the stage for the next round of budget cuts, including the Germans.

But these are indiscriminate cuts and they come at a very, very bad time, when the Euro-zone economy still hasn't recovered from the recession. Unemployment is still high and, in many places, still rising. Consumption is flagging. Only exports have recovered - mainly German exports, and among them, most remarkably, big luxury cars produced by Audi, Mercedes and BMW. They're reportedly doing particularly well in China and the USA. Why? Because there's a market for them again: the rich are back to being as rich as before the Big Recession (there are some 10 million billionaires across the world, and their combined wealth has increased). And the Euro has lost some 15 percent since the start of the Greek budget crisis.

So far, this weakening of the Euro does not seem to have helped Greek tourism (presumably would-be tourists fear to get enmeshed in strikes). Because that's the real problem with austerity programmes: the social unrest they are bound to cause. The cuts hit the low and middle classes first and foremost. So it is natural to expect everybody to descend in the streets and scream to high hell. The French Finance Minister, Ms. Lagarde, had called for austerity programmes that would cut the budget yes, but at the same time "preserve growth". The Italian Finance Minister, Mr. Tremonti, has also tried to limit the damage, although he now reckons that his package of cuts will cost a half percentage point in future GNP growth (and he's probably being optimistic - it is likely to be much more of a brake than that).

The result of this social unrest? My bet is that the eventual austerity programmes that will be passed by parliaments across Europe will be less severe than those first announced. Ms. Merkel could still lose political support because of her programme - and she already has lost a lot.

So is all this a great deal of noise about nothing? Not quite. Budget cuts, even modest ones, will inevitably cause a loss in revenues and consumption - precisely at the wrong time in what is still a very fragile recovery. So one can expect, without being unduly pessimistic, that the Great Recession is bound to last a little longer - even much longer than necessary.

If only European politicians had remembered Keynes' lesson about using the weight of the State in the economy as a counterbalancing power: when there is an economic slowdown in the private sector, you accelerate the public sector. You spend money, you run deficits and you worry about balancing the budget only once the economy has fully recovered. That's when improved tax revenues fill government coffers, and that's when you start acting virtuous about budget deficits. Indeed, with the increased tax revenues, it will be that much easier to balance the budget!

What really makes me angry is the way this budget deficit saga has unfolded.

It would have been a wonderful political opportunity for REFORM, in particular to CUT back on UNNECESSARY government expenses. True, much was done on that score - but not enough: for example, there are still invalidity pensions and early so-called "baby pensions" that are a scandal in most Southern European countries.

It would have been a wonderful opportunity to tighten fiscal systems and MAKE people PAY their TAXES. Again, and especially in Southern Europe, too many people get away with paying no taxes at all - and I don't just mean income tax but also the sales (VAT) taxes. In Italy alone , the "economia sommersa", the "submerged economy" as the Italians call it, is some 20 percent of GNP. That's the segment of the economy that's not counted in national statistics, it simply "disappears" - meaning no one is paying any taxes at all.

Why is everybody in Europe - and especially in Southern Europe - so keen on avoiding their taxes?

Two reasons: one, the State especially in Southern Europe, is "weak". It hasn't the structures needed to collect taxes efficiently. Two, the tax rates are too HIGH. Again, in Italy (this is where I live so I know), the rates are way too high - much higher than in most of Europe and definitely higher than in the States - . People are inevitably tempted to avoid paying taxes. If the rates were brought down to a more reasonable level, people would be more willing to pay. Lighten the tax burden for everyone - and thus gain political consensus for your reforms - but make sure that everyone pays exactly what they should pay and right on the dot! No tax evasion allowed in return for lower tax rates...How does that sound to you?

Then, of course, it wouldn't hurt, would it, if the State really did deliver the public services it is supposed to...Why pay taxes if you get nothing - or very little - in return?