Austerity has measurably damaged Europe: here is the statistical evidence
- The Institute of International Finance says austerity probably damages economies trying to recover from the great financial crisis.
- Since 2008, GDP growth in the US has been 10% greater than in Europe, the IIF says. In terms of GDP growth per capita, the reduction was 5%. Fiscal tightening in Europe was the main difference.
- Trend growth in the US was double what it was in Europe following the financial crisis, the IIF says. Prior to 2008, they had been the same.
- “Fiscal austerity is a mistake,” IIF Managing Director & Chief Economist Robin Brooks tells Business Insider.
Since the great financial crisis of 2008 there has been a debate about what the right plan for economic recovery should have been across the US and Europe.
For conservatives, fiscal “austerity” was the answer — limiting debt, deficits, and consequently government spending, in order to put the economy on a sound basis for future growth.
The left, by contrast, argued that fiscal spending was the solution — using the government to supply the investment money that disappeared in the private markets during the crash, thus priming the pump (but at the risk of funding it with more debt).
Now, the Institute of International Finance has published a series of research papers showing that austerity was probably the wrong choice. Fiscal tightening in Europe reduced GDP growth by 10% compared to the US, the IIF says. In terms of GDP growth per capita, the difference was 5%.
Trend growth in the US was double that of Europe following the financial crisis, the IIF says, whereas prior to 2008 they had been the same.
Austerity hurts growth, in other words.
The main difference between Europe and the US in the post-crisis period was that the US embarked on an era of robust government spending in addition to a massive monetary stimulus package from the US Federal Reserve.
The European Central Bank also adopted a monetary program of low interest rates and quantitative easing (QE). But the European Union continued to enforce its fiscal austerity program, banning member governments from running deficits greater than 3% of GDP. The EU also forced countries to pay down their debts during the recovery. The most dramatic example of that was Greece, which stayed inside the EU’s debt repayment program even though its economy shrunk by 45%, peak to trough. Today, the EU is trying to force Italy to keep its deficit below 1.8% of GDP, even though the Italian economy has stalled at 0% growth.
Two continents conducted an historic experiment in macroeconomics, and the data is stark
The two continents thus conducted an historic experiment in macroeconomic policy: The US went on a government spending splurge while Europe tightened its purse strings.
The IIF’s data is stark. Europe is now poorer than the US, in growth terms, because of austerity, according to Managing Director & Chief Economist Robin Brooks and Senior Research Analyst Greg Basile.
“What I find fascinating is that trend growth in the US and the eurozone was basically the same,” Brooks told Business Insider. “Leading up to the global financial crisis, they were both growing around 2%. And afterwards you have this big divergence.”
“It’s not like Europeans are fundamentally lazier than Americans in the last 10 years”
“So to me, that says it’s not like Europeans are fundamentally lazier than Americans in the last 10 years. It’s just that [economic] policy hasn’t been as supportive.”
Brooks and Basile discovered the gap while researching the IMF’s data on potential GDP output gaps. Put simply, economists like to compare current economic growth with a measure of “potential” economic growth in order to test whether an economy is functioning at its peak capacity or not.
They noticed an anomaly in the data that was particularly dramatic in a comparison of Italy and Australia. Australia, famously, has not had a recession since 1991 and escaped the great financial crisis relatively unscathed. Cumulatively it has added 30 percentage points of GDP growth since 2008. Italy, however, took a big hit in 2008 and has been mired in a debt crisis ever since. Its economy contracted by 4% since 2008. Yet according to the IMF data, both countries only had output gaps of just under zero, suggesting that both countries are functioning at near-full capacity. Brooks and Basile’s research says.
Read more: Europe is faltering
On its face, that’s weird: Australia’s economy ought to be busting at the seams. And stagnant Italy ought to have plenty of unused economic “slack” sitting on the sidelines. But statistically, they are the same (in terms of how far they are from fulfilling their potential).
“It’s just a completely counterintutive result, where the definition of the output gap runs counter to any economic common sense, basically,” Brooks says. It’s a similar picture for Spain and Greece. It’s “devoid of economic intuition.”
If the IIF is right, then the ECB might be about to make an historic mistake
The poor performance of Europe vs America is further disguised by Europe’s current account surplus. The surplus is the excess of exports Europe produces compared to imports. A surplus suggests Europe is selling more things to foreigners than it is buying from them. Economists usually regard this as a sign of health. Germany’s historic manufacturing strength is the usual explanation for Europe’s rosy export surplus.
But Brooks and Basile say Europe’s glass is actually only half full. There’s a trade surplus because domestic demand outside Germany is so weak, lowering imports. If you factor in a more realistic output gap, then Europe’s current account would be in deficit, they say.
The trade stuff is highly technical, to be sure. But if the IIF is right, then the ECB might be about to make an historic mistake. It is currently in the process of “normalizing” its monetary policy, by bringing QE to an end and raising interest rates. Brooks and Basile argue that the trade data and the mismeasured output gap show that eurozone economic activity is much weaker than the bank presumes, and deflationary pressure is much stronger. Conditions suggest the ECB needs to continue to help the economy with loose monetary policy, not end it; and the euro is overvalued vs the dollar, and thus ought not to be strengthened via tighter monetary policy.
Solid data show that austerity in response to a recession makes both countries and people poorer
For ordinary people, the bottom line is that there is now solid data to show that austerity in response to a recession makes both countries and people poorer than they need to be.
This also helps explain why many European countries continue to have persistently high unemployment rates — Italy’s is more than double the US or the UK — even though the stats say the output gap is small, the IIF’s data suggests.
Persistent unemployment also generates a phenomenon called “hysteresis.” It means that when people are out of work for a long time, they lose the skills they need to rejoin the workforce. The economy is then prevented from growing faster when conditions improve because employers cannot find the workers they need, even though there are plenty of people out of work. Austerity inflicts damage on the total economy, in other words.
“I think the main message as I see it is, ECB normalisation is a mistake,” Brooks says. “Fiscal austerity is a mistake.”
Read the full article from it’s original source: http://uk.businessinsider.com/austerity-has-damaged-europe-vs-us-gdp-growth-2018-11