Why do our world leaders cling to the dismal politics of economic austerity?

Austerity’s political cheer squad: but is the game over? G8 countries have committed to growth by setting sights on employment.

The lingering commitment to austerity of leading Western politicians in the face of impending economic tragedy is beyond belief. The dismal science is a sobriquet often wrongly applied to economics, but in this instance seems to have infected politics.

As the world teeters on the edge of depression, and all the human misery this entails, what do you do? Imposing aggressive austerity measures is the astonishing answer from German Chancellor Angela Merkel, British Prime Minister David Cameron and a host of other political leaders in Europe and the United States - who appear blissfully unaware of the chaos they are willingly constructing.

Rediscovering economic depression

We have of course been here before. The 1930s was a decade-long bout of desperate mass unemployment and poverty self-inflicted in the West, only finally relieved by the vast investment required to wage a World War. Indeed up till this defining moment, the history of industrialism was punctuated by periodic depressions, just as certainly as by recurrent booms. The post-war intervention of Keynesian economics facilitated and encouraged counter-cyclical government investment to modulate the severity of the business cycle.

Decades of relative economic growth and stability occurred in the second half of the twentieth century. In search of more rapid growth and structural flexibility from the 1990s, finance-led deregulation provided the latter, if not the former, but was accompanied by a series of more violent market oscillations with a denouement in the global financial crisis.

Conservative regimes led by Angela Merkel pushed austerity.

In responding to this crisis originating in the Western finance markets, the G20 revealed considerable resolve in employing public funds to rescue the private financial institutions facing bankruptcy. As the global financial crisis has morphed into the sovereign debt crisis, this resolve to apply a counter-cyclical stimulus has disintegrated, as self-interest has taken hold, and widespread austerity measures introduced to reduce public deficits.

The poverty of austerity policy

Ironically enough, following the global financial crisis, it was conservative regimes such as Angela Merkel’s Christian Democrat party in 2009, and David Cameron’s Conservative-Liberal Coalition government in 2010 that swept into power in elections, even though these were the parties with the closest relationship to the financial institutions that had failed. It was this market-friendly liberal axis - led by Merkel and France’s recently-ousted Nicolas Sarkozy, with the enthusiastic participation of UK Chancellor George Osborne - that launched the new austerity program across Europe.

The 2011 Euro Pact imposed a more stringent interpretation of the inflexible 1997 Stability and Growth which constrained member countries to an annual budget deficit no higher than 3% of GDP and a national debt lower than 60% of GDP.

This Pact severely limits member countries to provide an adequate economic response on an annual basis in the context of the current condition of their economies (though a constraint was formerly less rigidly applied to the more powerful economies of Germany and France than to the smaller Euro members).

President Obama succeeded in gaining a commitment to employment at the G8 meeting.

Strenuously attempting to meet deficit and debt targets, as the sovereign debt crisis loomed, European governments proposed wholesale cuts in public expenditure, employment and pensions.

At first the response of the public (apart from a vocal minority) was almost muted, as if the general public had caused the global financial crisis, and now realised they had to pay for it. However as the inequity and cruelty of these public expenditure cuts has dawned, a backlash against them is growing in force.

Reducing deficits and repaying debt are worthy goals for any government, but over time, not in an abrupt dislocation of already weakened economies. Economic recovery and stability are more critical goals and are achievable with the right policies (though in or out of the Euro, Greece will need help from the rest of Europe in fashioning long term solutions to its particularly acute structural problems).

The consequences of austerity

The first misconception to dispel is that the European countries had been living beyond their means for years, and now have to repay the debt. Behind the myth of fiscal profligacy as the US economist Paul Krugman refers to it, was the reality that pre-crisis deficits of all EU countries (with the exception of Greece) were largely in line with the target rates of 3-4%.

The majority of the debt in these countries is private not public debt, and public deficits started to rise dramatically only in 2007 after government spending rose to fund stimulus packages and bailouts.

The awful consequences of the austerity measures are now being felt across the Eurozone in blighted lives and missed opportunities as unemployment climbs to 10.7%. In the Eurozone as a whole, 17.4 million people are now looking for work and more than three million of those are under 25. Most gravely, the worst impact of the cuts have fallen upon the most innocent: youth unemployment has soared to 22% in the European Union and a frightful 51% in Spain and Greece (see Table 1).

The young people of Europe are being punished for a crisis that occurred before they even got into the labour market. Sacrificing the talents and aspirations of young people at their most creative and energetic is a political disaster of heroic dimensions.

Country/RegionDec 2007
%
March 2012
%
Germany11.77.9
Australia9.511.7
United States11.716.4
France18.321.8
United Kingdom12.621.9
Italy21.335.9
Portugal19.736.1
Spain19.751.1
Greece21.651.2
OECD12.817.1
G712.215.9
Euro Area 1715.222.2
European Union15.122.6
Youth Unemployment in selected OECD Countries (Dec 2007 and March 2012 Percentage of total youth labour force aged 15-24) **Source: OECD**

Regaining confidence in politics

Europeans en masse are now saying “Non” to the promise of endless austerity. Nicolas Sarkozy has been expelled from the Elysee to be replaced by President Francois Hollande who has a resolve to find a different route to restoring France’s economy.

In the UK the government was roundly defeated in the local elections, and in Germany the election in the most populous state of North Rhine-Westphalia saw Angela Merkels conservative vote collapse. The leaders of international financial institutions are shifting ground: European Central Bank president Mario Draghi now talks about a “growth compact; while IMF boss Christine Lagarde has just discovered that "fiscal austerity holds back growth and the effects are worse in downturns”.

At the Camp David hastily convened meeting of the G8 on the weekend, President Obama succeeded in knocking heads together to the extent that a joint communiqué could be issued adroitly bridging both sides of the austerity versus growth debate, with a focus on employment.

Even the apostle of austerity Anglela Merkel conceded new government investment was required: “This is not about stimulus programs in the usual sense, the way we applied them after the crisis,” she said. “What’s needed much more than that are investments in research and infrastructure, for instance in Europe in digital networks.”

In tackling the economic future of Europe with a more positive agenda as Sussex University’s Professor Mariana Mazzucato argues, governments must once again become more confident in their own powers to both tame recessions with fiscal and monetary policies, and to invest in the knowledge base that will produce new waves of growth: education, research in emerging technologies, useful infrastructure, and a financial system capable of nurturing innovative business for the long term.

Interestingly, this is closer to the mainstream economic policy of Germany, which invested more public funds in R & D than any other EU country, as the most viable assurance of prosperity.