Economic analysis

Why won't Germany understand austerity is killing Europe?

A growing number of economists are warning that too much fiscal tightening is making things worse


German leaders are looking increasingly like loners in their insistence that austerity is the sole cure for the eurozone’s ailing economies. Chancellor Angela Merkel and Bundesbank Governor Jens Weidmann continue to maintain that the only way for Greece, Italy, Spain and Portugal to fix their finances and calm investors’ nerves is higher taxes and spending cuts. But scores of prominent economists have been arguing that too much of that medicine risks killing the patient. Their warnings are becoming more and more dire.

Nouriel Roubini, aka Dr. Doom, was frantically waving red flags from the (web) pages of Slate last week:

“(…) the recession [in Europe] will worsen throughout this year, for many reasons.
First, front-loaded fiscal austerity—however necessary—is accelerating the contraction, as higher taxes and lower government spending and transfer payments reduce disposable income and aggregate demand. Moreover, as the recession deepens, resulting in even wider fiscal deficits, another round of austerity will be needed. And now, thanks to the fiscal compact, even the eurozone’s core will be forced into front-loaded recessionary austerity.

Moreover, while über-competitive Germany can withstand a euro at—or even stronger than—$1.30, for the eurozone’s periphery, where unit labor costs rose 30 percent to 40 percent during the last decade, the value of the exchange rate would have to fall to parity with the U.S. dollar to restore competitiveness and external balance. After all, with painful deleveraging—spending less and saving more to reduce debts—depressing domestic private and public demand, the only hope of restoring growth is an improvement in the trade balance, which requires a much weaker euro.

A bit further down, he delivers the punchline:

“The trouble is that the eurozone has an austerity strategy but no growth strategy. And, without that, all it has is a recession strategy that makes austerity and reform self-defeating, because, if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels. Moreover, the social and political backlash eventually will become overwhelming.” 

Paul Krugman fired his own warning shot the very same day, with a column titled “Europe’s economic suicide.” Speaking about European leaders’ handling of Spain’s ballooning debt, he writes:

“(…) the prescription coming from Berlin and Frankfurt is, you guessed it, even more fiscal austerity.

This is, not to mince words, just insane. Europe has had several years of experience with harsh austerity programs, and the results are exactly what students of history told you would happen: such programs push depressed economies even deeper into depression. And because investors look at the state of a nation’s economy when assessing its ability to repay debt, austerity programs haven’t even worked as a way to reduce borrowing costs.”

Compare that with this interview in Der Spiegel with Weidmann, where he carefully dodges the question of how exactly Greece is supposed to find a way to grow its economy if all it has to work with is austerity:

SPIEGEL: “Greece is in the fifth year of a recession, with no sign of a recovery in sight. Where is the much-needed economic growth supposed to come from?”

Weidmann: “We now know that Greece will have to completely reposition its economy. This is only possible if there are comprehensive reforms of the private and public sectors. All of this requires time. An honest assessment of the situation also entails facing up to the fact that Greece won’t be able to stand on its own two feet again overnight.”