Why can’t Europe save austerity for later?
Right now, the European countries facing debt crises are all being told the same thing: Austerity is the answer! Cut spending, raise taxes, pay off your debts. Now. The pitfall, of course, is that austerity measures could trample the already-fragile growth in places like Italy and Spain, which will, in turn, just exacerbate their short-term debt problems. As an example, the OECD is predicting that Britain’s austerity experiment could push the country into recession, which might, in turn, lead to a higher debt-to-GDP ratio than before the Cameron government began slashing.
So here’s a question: Why don’t countries like Spain or Italy or France try to do what the Obama administration has proposed in the United States? Enact some stimulus this year, while the economy’s weak, and then cut future spending. Avert a recession now, austerity later. This is what the IMF has recommended, after all. Why wouldn’t that placate the bond markets? One problem, says Joe Gagnon of the Peterson Institute for International Economics, is that the structure of European political institutions make these sort of timed cuts a lot more difficult.
American commentators have often expressed frustration over the fact that it’s nearly impossible to get anything passed through Congress. Why can’t we have a parliamentary system like those in Europe, where a majority can simply enact its preferred policies? But one downside to parliamentary systems, Gagnon notes, is that they make it much harder to promise spending cuts down the line, since laws are so easy to enact and repeal. “Ideally, you’d like fiscal consolidation to be geared toward the long run,” Gagnon says. “In our system, a long-run budget cut is more credible. But in a parliamentary system, it’s much easier to undo.” No one would believe Italy if it promised stimulus today and cuts tomorrow.
It’s worth noting, meanwhile, that the European Central Bank isn’t solely demanding spending cuts and tax increases. Back in September, when it fired off an ultimatum to former Italian Premier Silvio Berlusconi, the ECB emphasized labor-market reforms that would (supposedly) boost Italy’s economic growth: things like privatizing public services, reforming collective bargaining agreements, and making it easier to hire and fire workers. In theory, says Gagnon, some of those rules could boost provide an immediate boost — if, say, they reforms made it easier to hire workers.
Yet other economists have argued that these labor-market reforms could increase unemployment in the near term. And such policies tend to trigger popular resistance — witness the mass protests going on in Greece right now. Presumably these painful structural reforms would be easier after Europe emerges from its imminent recession. But investors are putting pressure on these governments now, and, as Gagnon notes, it’s a lot harder for a parliamentary government to swear that it will put new reforms into place once the coast is clear.
Now if only there were some sort of European central bank that could step in here...