Three decades ago, British prime minister Margaret Thatcher was confronted with a nation bordering on irrelevance, a stagnant economy and a set of entrenched beliefs about the relationship between the government and the people.
Thatcher faced down striking coal miners and forced through a series of free-market reforms that unshackled Britain’s economy and made it vibrant once again. To the chorus of accusations that she was killing the economy, she replied: “There is no alternative.”
She was right. Short-term pain for long-term gain is generally a winning strategy.
We could use a dose of Thatcher today. Instead, German chancellor Angela Merkel has been cast in the Iron Lady role, charged with fending off policy prescriptions that run counter to her preferred fiscal discipline for the eurozone.
In the last week alone, Harvard’s Lawrence Summers, Princeton’s Paul Krugman, Joseph Stiglitz of Columbia and Berkeley’s Christina Romer wrote op-eds claiming austerity isn’t working. Instead, the focus should be on growth.
That’s a false dichotomy. Who wouldn’t choose growth over austerity?
Europe’s real choice isn’t unlike the one faced by the US, according to Jim Glassman, senior US economist at JPMorgan Chase & Co. The choice is cyclical versus structural.
“It’s all about recession,” he says. “The thinking is, when the economy comes back, everything will be fine. There’s a resistance to looking at fundamental structural problems,” which in Europe include an aging population, overly generous pensions, a rigid labour market and a large, unsustainable social safety net.
“The more you push back on austerity, the less focus there is on structural problems,” he says.
And that’s only part of the problem. Economists can’t agree whether government spending creates growth, creates the illusion of growth or hampers growth because the private sector, anticipating a higher tax bill, reacts adversely.
Krugman pooh-poohs the idea that the private sector will step up to the plate if government puts its house in order. He derisively compares this notion to a belief in the “confidence fairy.”
What should we call his premise that government spending is the route to salvation? A confidence game? Why would taking money from one individual via borrowing or taxation and giving it to another have anything more than a transitory effect on the economy? Answer: Because economists believe a dollar of government spending creates more than a dollar of GDP growth. It does because they say it does.
There are other models, such as Barro’s, that find a multiplier of less than one. French political economist Frederic Bastiat explained how that could be 162 years ago in his parable about the broken window. We can see the dollar spent by the government; what’s unseen is how the money would have been spent had the government not commandeered those resources.
And if this isn’t enough to make you question the anti- austerity advice, consider that countries such as Spain& might not be able to borrow the amounts necessary to crank up growth.
Europeans, excluding Germans, have started to bridle at austerity, which is a surprise since most austerity measures are only on paper.
Last month, Socialist François Hollande edged out President Nicolas Sarkozy in the first round of France’s general election. One day later, the Dutch government, aligned with Germany on the issue of austerity, collapsed over budgetary cuts.
Will Merkel capitulate? My bet is she stays in character and responds with something that would make Lady Thatcher proud: “This Frau’s not for turning.”
Caroline Baum, author of Just What I Said, is a Bloomberg View columnist
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