Economic Austerity versus Growth: The European Survival Debate

by Nilio Gumbs Fri, May 25. 2012

The European Union is in the midst of a contentious debate of how to rid itself of the economic malaise that has beset the 27 nation grouping. Is austerity or growth the panacea for lifting the European Union out of its economic stupor? To cut or to spend – fiscal austerity measures or growth strategies to rejuvenate their economies?{{more}}

The high indebtedness and economic paralysis of some European countries, notably Greece, Spain and Portugal have led to Germany (the biggest most successful economically) being the most vociferous in calling for fiscal restraint and the cutting of government expenditure, while exhorting the other members to turn their backs on their past profligate ways.

The defeat of Nicholas Sarkozy in France and the strong showing of far left and right parties in the Greeks’ national elections have shown that voters in those countries do not approve of such austerity measures. The severe hardship that accompanies such policies in Greece (retrenchment and cuts in public servants salaries and pensioners wages, increased taxes and reduced expenditure on social services) were too much for the Greeks to bear.

The stage is set for the will of nerves between Germany, the biggest economy, and France – the second biggest, of how to get Europe’s economy moving again, reduce their mountainous national debts and the intractable unemployment situation that beset most countries in the European Union. The former advocates austerity measures, while the latter espouses expansionary policies.

Francois Hollande, the socialist president who recently won the backing of the French electorate, proposes to spend lavishly on big item projects to create employment and jolt start the economy. Contrast this with Germany’s Angella Merkel, who advocates budgetary cuts to reduce member countries’ budget deficits and national debts. These two opposing views can jeopardize the Eurozone austerity treaty that was hammered out between Merkel and Nicholas Sarkozy, Hollande’s predecessor. Member states that grudgingly swallowed the austerity pill have now gotten a voice in the presence of Mr Hollande.

A similar debate is heating up across the Atlantic in the United States. With Obama formally launching his re-election bid, his policies will undoubtedly be part of the election discourse, as it pits Obama’s Keynesian big spending approach against the Republican Party candidate Mitt Romney’s fiscal discipline approach: budgetary cuts and tax breaks for the rich to spur the economy.

What are the merit of the two approaches? One being a neo-classical self-correcting economic approach and the other being the Keynesian spending approach. These two approaches have raised many questions. Can governments adopt austerity measures in times of an economic recession? Or should a government spend and invest to stimulate the economy? Many argue that it is improbable to cut expenditure in a state of recession, as such policies would only compound the problem further. With consumption demand already falling, cutting government expenditure in such a climate would only accentuate and illuminate the recessionary problem further.

On the contrary, increasing government expenditure – creating new jobs and undertaking large capital projects (highways, bridges, schools, hospitals, military hardware etc) in times of recession, has the effect of stimulating consumption demand in the economy, putting in motion a ripple effect, which in the long run will improve government tax intake, paving the way to paying down government public debts.

History is the best guide to in assessing the virtues of these contending approaches. President Roosevelt’s Keynesian new deal program in the aftermath of the Great Depression in the United States, helped catapult that country’s economy into global economic dominance after the second world war.

The first experiment with austerity came in Germany in 1930, under Chancellor Heinrich Bruning. The brutal budget cuts, tax hikes and cuts in pensioners wages, when combined with his rule by decree to circumvent other politicians’ anger, led to public discontent and the collapse of the Weimar republic, setting an example and paving the way for none other than Adolf Hitler in 1933.

All across Europe in the 1930’s, public discontent and violence had accompanied austerity measures which were the order of the day. These austerity measures led to one of the biggest mutinies in Britain’s military history. In the Invergordon mutiny, at least one half of the Royal Navy rebelled and took over naval ships, spreading fears of a revolution throughout the country. As result of this action, the austerity measures were softened.

The neo-classicalists can claim success of their own, with such policies in Chile which opted for austerity under a military dictatorship between (1973-1990) and today boasts the most successful economy in the western hemisphere after the United States and Canada.

The success or failure of either policy in France and Germany will have reverberations around the world. It will be felt especially among third world states whose economies themselves are inextricably linked to the fortunes of Europe and United States.

From a more parochial analysis, it would shed light on the present policies of the ULP administration in this country. Undeniably, the present government in St Vincent and the Grenadines, has pursued an expansionist economic policy by default. The small and pathetic nature of the private sector has meant that the government had no choice but to fill that gap, by spending to create employment and stimulate growth in the economy. The question can be asked – would things have been worse off if such an approach was not adopted? Such a question is left to the imagination! However, spending your way out of a bad situation is analogous to that of a pyramid scheme where the last contributing member must lose; so too, the future generations who would be saddled with such debts and bear the brunt of the sacrifice.