Brave New World: Debunking Myths on the European Economy

by Antoine Cerisier

“An unexciting truth may be eclipsed by a thrilling falsehood”, Aldous Huxley, Brave New World

A Brave New World?

A Brave New World?

European economies have been facing severe difficulties since the outset of the global financial meltdown. The Eurozone crisis makes the headlines in financial publications and the mainstream media virtually every week. The accepted wisdom on economic recovery and debt reduction has rarely been questioned by journalists and policymakers. If a Martian were to land on earth – say in The Economist’s London press room – with no preconceived ideas or previous knowledge of our old continent, he would probably come to the following conclusions. In this world, Scandinavian countries like Sweden, with high taxes and bloated welfare states, cannot reverse their inevitable decline and will soon be faced with mountains of debt. Britain, he would think, is on the verge of becoming Europe’s new economic superpower thanks to a vibrant financial sector and courageous reforms undertaken by David Cameron’s coalition government since 2010. Southern European economies like Greece, Spain and Portugal are quickly recovering from recent debt crises and can expect a future of prosperity and competitiveness. And they lived happily ever after.

If the neoliberal logic were consistent, our Martian would be exactly right: austerity is the only answer to the crisis and anyone denying it will face the consequences. However, this ideological fairytale falls quite far from the truth. Sweden has been running budget surpluses since 2010 and its public debt to GDP ratio is a low 38% – the average is 85% for EU member states. It remains one of the world’s most prosperous and equal countries ‘despite’ very high taxes and government expenditure. As for Britain, the picture is not as bright as many would like us to believe. Despite some of the most brutal austerity policies in the continent, the UK contracted in 2012 and is expected to run a budget deficit surpassing 8% this year. This is significantly higher than any other European country, including debt-ridden Greece and Ireland. It seems cutting welfare benefits and trebling tuition fees do not have the desired effect. When it comes to Southern European states, fantasy turns into shocking science fiction. Prosperity is still a long way off for Spain, Portugal and Greece. Unemployment has reached 16% in Portugal and stands at a record 26% in Greece and Spain, with almost half of young people without a job. The Greek economy contracted by 6.5% in 2012 and should shrink for the sixth consecutive year in 2013; more than two million Greeks now live under the poverty line – 22% of the total population. Social unrest is rife and far-right extremists take advantage of the crisis to gain political influence.


German economist, Hans-Werner Sinn

In that context, it takes some skill and imagination to defend austerity and argue European leaders are on the right track. Hans-Werner Sinn, one of the most influential German economists, shows such skills in a recent article for Munich-based think tank IFO. EU officials and governments in Italy, Greece and Spain, he insists, “understand what must be done”. The professor is well-versed in storytelling but blatantly ignores some basic facts, including all the figures I highlighted above. He also disregards the much discussed report published by the International Monetary Fund questioning the efficiency of austerity policies currently implemented in European economies. The IMF – which cannot be suspected of leftwing propaganda – admitted they were wrong about the fiscal multiplier, namely the impact of austerity on GDP and debt reduction. The multiplier was assumed to be 0.6; in fact, it could be as high as 1.7. In concrete terms, this means a 10€ spending cut actually reduces output by as much as 17€ – thus crippling growth and resulting in an even bigger deficit. It is not the first time IMF economists get it wrong and admit their mistakes. Their policy recommendations in the 1990s triggered the infamous Argentine economic crisis which forced the country to default on its foreign debt in 2002. The Fund apologised to the Argentine government, but only several years later. Then like now, their reaction was long overdue; nonetheless, they should be praised for this unforeseen epiphany. Meanwhile, EU finance commissioner Olli Rehn refused to accept any criticism on the part of the IMF and insisted European citizens “will see improvements in their day-to-day lives, only with some delay”. The brave new world is not yet upon us.

Income changes graph

Hans-Werner Sinn picks his facts on austerity and the Eurozone crisis and applies the same method to his home country. He argues neighbouring states should follow Germany’s example and “pave the way for the creation of a low-wage sector”. Indeed, the economist played a major role in setting up the so-called Agenda 2010 launched by then Chancellor Gerhard Schröder ten years ago. This liberal agenda comprised tax cuts on the rich and radical labour market reforms, including the controversial Hartz concept. The infamous Hartz IV programme took effect in 2005 and lowered monthly benefits for the long-term unemployed to less than 400 euros. The reform also created so-called ‘minijobs’ which encouraged employers to take on cheap labour. As a result, more than 4 million German workers earn less than 7€ an hour, half of which are paid around 5€ with no security or pension entitlements. This race to the bottom in wages and work conditions has a direct impact on social justice and income distribution in the country: the poverty rate has increased by 30% since 2005 according to official Eurostat figures. Besides, most Germans earn less than they used to ten years ago, as illustrated by a 2011 report published by the OECD. Real average income declined in the past decade, especially among poor workers and pensioners. Household income for the bottom decile increased by a meagre 2.6% – or 0.1% annually – between 1985 and 2011, as shown in the table above; by comparison, this figure was 42% in France and 23% in Britain. This is worrying, not only for social justice but also for internal demand levels, as the average German’s disposable income has been stagnating since the Schröder reforms. Combined with stark demographic decline, this trend could become a major threat to the German economy – but of course, it is not mentioned in Hans-Werner Sinn’s article.

poverty greece

Poverty in Greece: the cost of poor economics

The prominent German economist defended austerity policies in crisis-stricken countries and vigorously praised his country’s low-wage sector which he contributed to create. Only one element was missing to complete the conventional picture: good old ‘French bashing’, which has become the latest fad after a series of articles published by The Economist. As I explained in a previous contribution to this blog, I have grown increasingly critical of François Hollande’s Socialist government in the past few months. Their lack of determination and inventiveness has been criticised even among leftwing circles. Nevertheless, my interpretation differs greatly from the one offered by Hans-Werner Sinn, who insists France “does not appear to have noticed the writing on the wall”. I belong to those calling for real fiscal reform rather than symbolic taxes on millionaires and industrial policies targeted at small and medium-sized enterprises – among other things. Sinn and his co-thinkers, however, hold a very different view and their condescending comments exacerbate the logical flaw at the heart of the neoliberal discourse. Indeed, an honest approach to the challenges facing European economies would be to outline different alternatives and argue in favour of one or the other, taking tradeoffs and second-best options into account. Instead, too many scholars and EU leaders continue to bury their heads in the sand, following Margaret Thatcher’s sinister principle: “there is no alternative”.

head sand

The wrong approach to policy-making

1 comment
  1. senex72 said:

    Sadly Antoine Cerisier has hit the nail on the head and Europe is paying the price for Monetarist stupidity in poverty and wasted lives and destruction if existing capital goods. It is not as if we don’t know what to do. We have bee here before in the 1930’s and policies preventing banks from trading on their own account with retail depositor’s money, and macro-economic targeting on demand and employment and physical investment, showed the way forward.. Now with the collapse of “left wing” regimes there is no countervailing force to check the Financial industry’s lobbying and access to real assets (indeed social and national asset-stripping) via taxation and interest-rate fixing.

    Interestingly the country which is said to surprise everyone in the EU by its progress is Poland – compared to Greece, Ireland, Spain, Portugal and Italy: it has of course retained its own currency. Britain runs a cheap-labour policy by long-standing choice and so relies on imports of technology, selling off what advantage it might have to overseas developers..

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