In this, the deepest economic recession (at least in the West) in a century, the policy prescriptions of orthodox economics are being challenged by the people of Europe. European leaders, advised by neoclassical economists, had agreed to an “austerity compact”. In the elections on May 6 in France and Greece, respectively, the leaders who had propounded sharp reductions in public expenditure as a means of pulling out of the crisis have suffered a resounding defeat. Soon after his election victory in France, newly-elected President Francois Hollande announced his intention of renegotiating the economic strategy for addressing Europe’s crisis. However Angela Merkel, Chancellor of Germany, stuck to her guns by saying that the fiscal pact agreed by 25 countries was not negotiable.
Underlying the political deadlock is a contention between two schools of thought: the Neoclassical economists and the Keynesians — just like the historic debate between the Classical economists and Keynes during the Great Depression of the 1930s.
The Neoclassical view of conservative European leaders, along with the IMF, is that the central issues to be addressed are unsustainable budget deficits and rising debt. So slash public expenditure, they say, even if it means cutting expenditures on pensions, education and health, let alone physical infrastructure. But how will this help pull Europe out of double-digit unemployment and end the growing misery of the underprivileged, made worse as government welfare payments are axed as part of austerity measures?
The Neoclassical answer to this question is the argument that when budget deficits are reduced, and “financial stability” restored, this will (through a yet unspecified mechanism), create the confidence amongst entrepreneurs to invest, and so economic growth will once again pick up. This proposition which is being propounded with such stridency by the neo-classicists led by the IMF, actually rests on rather weak theoretical and even weaker empirical foundations. How does a mere reduction in the budget deficit induce capitalists to invest, especially in the face of falling aggregate demand due to declining consumption expenditure and public sector outlays? To argue that by deepening the recession now, economic growth can be accelerated at some unknown future date, through the mysterious hidden hand of the market, is a kind of oxymoron: unless the causal mechanism between expenditure cuts today and increased investment in the future is clearly articulated and backed by data. Neither exists. As Paul Krugman in a recent article in the International Herald Tribune has pointed out, persisting with the economic strategy associated with the “austerity compact” would be reasonable “... if it were working, or even had a reasonable chance of working. But it isn’t and doesn’t”. Hence, the hope in Monsieur Hollande’s promise of rethinking policy.
The European policy dilemma essentially emerges from the very concept of a common currency, in a situation where such wide disparities exist in the relative economic strength and economic management capacity of countries within the European Union. In the old days, a particular European country faced with a lack of export competitiveness and slow growth could devalue the national currency as a quick fix to achieve export-led growth. Now this device is not available, given a common currency. So what happens is that the stronger countries, as a condition for a financial bailout, insist on cost reductions through austerity, reduced real wages, and higher unemployment. The events in Greece and France show that the people have rejected this view. That the official economic argument is questionable in terms of its conceptual and factual basis, makes the manifest pain of the people even more poignant. The protracted recession and associated human suffering requires a fundamental rethinking of economics and economic policy. As Professor Joseph Stiglitz has observed recently, it is time to “rewrite the textbooks”.
Published in The Express Tribune, May 13th, 2012.
COMMENTS (4)
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Very good analysis, based on research. Countries like Greece, Portugal and Ireland have fallen into an appalling debt trap partly by accident and partly as a result of its politicians who either colluded or were grossly inept, for me it was always about the peoples of Europe, those people who now carry the can for the sins of others, the people have shown great courage and carried the burden for 4 years in the hope the situation would turn itself around, austerity has clearly failed and now they welcome the lead of Francois Hollande and others who rightly call for a 'growth pact', Merkel has no credibility as a politician when she maintains almost like Thatcher that we must continue on the failed path we currently travel, yes we need greater regulation, more fiscal responsibility and reduced deficits but equally we have to get growth going through some form of stimulus otherwise we are headed for the wall. But in the end it will not harm the european project. Exclusion of € from one or two countries might be the price Europe has to pay-
I would say that the problem is that we had Keynesian policy advisors before the crash, and classical economists advising after the crash. Perhaps if we'd had a consistently classical approach, we'd not have seen this crash in the first place?
Dr Sahib,
You do Krugman justice and he is one of my favorite western economists and I have been buying his books at a rate that must be alarming my credit rating agencies! I just received his "End this Depression Now".
But I think you do the IMFsome injustice. Please read what the MD has been saying recently. She is a bright women and is backed up by some first-rate economists. The IMF recognizes the "fundamental tension" between austerity and growth. Their recently-released flagship publication, 'World Economic Outlook', is also instructive in this regard. Do take a look at it and, most importantly, do read between the lines!
As always, best wishes.
Some are suggesting that the only way of current European crises is to walk out of Euro-currency zone and return to the traditional currency systems. I am not sure if this will work for weaker countries like Greece, Portugal, and Spain. If they return to their traditional currencies, the value of their currencies will deplete in a moment thus pushing them to adopt the IMF or neoclassical austerity measures. The debate between Keynesian and neoclassical is an interesting academic exercise but will it solve the problems faced by European nations? I doubt it very much.