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The recent eurozone crisis has shown that austerity measures are self-defeating. They produce severe recessionary consequences which – at least in the short term – tend to increase public debt, as a ratio to GDP. This assessment is confirmed by econometric analysis showing that budgetary adjustments have been more recessionary than expected, with fiscal multipliers being higher than unity
Why do policy-makers in the eurozone persist in making the same mistake? The answer implicitly given by Krugman* is that policy-makers are not particularly smart – or they have been badly advised. Or they have underestimated the effects of their policies. Another way to put it is that by pursuing austerity European politicians are economically ignorant – or stupid.
Assuming that politicians are irrational or stupid may be an easy way out, especially for academics. An alternative way to look at the issue is to question the causality in the correlation between austerity and growth. Krugman considers that by pursuing austerity measures European policy makers show their irrationality, or stupidity. They are stupid because they pursue austerity rather than a more preferable policy option.
The question that I would like to raise is the following: Could it be the other way around? European policy-makers are not stupid because they pursue austerity, but they pursue austerity because they are stupid, or – to put it more diplomatically - they are short-sighted and have ignored other alternatives and were ultimately left with only one option, austerity. In other words, they implemented austerity because they arrived at a point where they had no alternative.
It’s not austerity which caused low growth, but low growth which ultimately caused austerity. Put it in other terms, the countries which experienced low potential growth, because of fundamental structural problems such as literacy or low productivity growth, accumulated an excess of public and private debt before the crisis to try to sustain their standards of living and their welfare systems, which turned out to be unsustainable and required a sharp adjustment when the crisis broke out.
Concluding remarks
Austerity has certainly caused low growth but may itself be the result of the poor and unbalanced growth performance before the crisis, which was due to the lack of reform. The postponement of reforms to improve growth potential has left countries with only one solution, austerity. Austerity is thus the result of policy-makers’ past inability to take timely decisions, in other words it’s the result of their short-sightedness – and stupidity. The way out of austerity is more fundamental structural reforms which increase growth potential and create the room for manoeuvre for a more gradual fiscal adjustment.
Krugman, P. (2013), “How the Case for Austerity has Crumbled”, The New York Review of Books, 6 June