Can the EU still be rescued following its disastrous failure to tackle the economic crisis?
The wheels are falling off the EU's austerity wagon. Unfortunately, no new wagon is in a state of readiness. There are some signs that European, and in particular German, social democracy is beginning to change direction - but because the EU is such a large and complex institution it can't be expected to change direction too quickly.
One of the loosening wheels on the austerity wagon is scientific respectability. From the start a large number of economists and economic commentators have been opposed to the austerity agenda, but that opposition has now widened and deepened. Thus, for example, Carmen Reinhart and Kenneth Rogoff's influential 2010 study, Growth in a Time of Debt, frequently invoked by the proponents of austerity, has now been widely discredited.
This study was taken seriously on publication because its authors are not free market ideologues but economists who are respected for their careful empirical approach. They had recently published a detailed history of economic crises, This Time is Different: Eight Centuries of Financial Folly, which, although it certainly attributed many crises to misguided public policy, had not spared private investors, banks and other financial corporations; these were held responsible for many others, especially in OECD economies and in more recent times. The book certainly added to the prestige of Growth in a Time of Debt, which claimed that a high level of government debt (more than 90 per cent of a country's GDP) was a decisive barrier to economic growth. The paper has been frequently cited - including by George Osborne and Olli Rehn, who is responsible for economic policy at the European Commission - to justify the sacrifice of all other objectives to deficit and debt reduction. [End Page 133]
It has subsequently turned out that the study was full of errors and miscalculations, as was discovered when professors at the University of Massachusetts at Amherst set, as an exercise for their graduate students, the reproduction of results in a number of well-known economic articles. The student assigned the Reinhart-Rogoff paper was quite unable to replicate its calculations. Further inquiry confirmed that the student was right and the authors wrong. Reinhart and Rogoff have since tried to minimise the damage both to their own reputations and to the argument they were making, but the argument, at least, seems to be holed below the water line.1
A second detaching wheel is support for austerity policies from the IMF, which, as the third member of the 'Troika' along with the European Central Bank and the European Commission, has helped to impose drastic budgetary restrictions on those member states which have accepted emergency loans. Some time ago the IMF's chief economist Olivier Blanchard raised questions about the speed and intensity of budgetary retrenchment in an IMF working paper jointly written with Daniel Leigh, which presented convincing evidence that governments were underestimating the 'fiscal multiplier': that is, they were underestimating the costs of spending cuts and tax increases to the wider economy in terms of their effects on lost output and higher unemployment. The paper itself did not commit the IMF to this view, but when the core of its argument was prominently displayed as a box in the IMF's World Economic Outlook in October 2012, it seemed to be gaining official support. The most recent Outlook, published in April 2013, goes still further in its questioning of current policies in the EU. It stops short of direct criticism of policy-makers, but suggests that the balance between budgetary consolidation and maintenance of economic activity and employment needs to be changed: 'There is no silver bullet to address all the concerns about demand and debt. Rather, fiscal adjustment needs to progress gradually, building on measures that limit damage to demand in the short term ...' (p xvi).
A further sign of disarray among the Austerians is a widening gap between the European Commission and the German government. Until recently the Commission always echoed the position of the German government: no concessions to the supposedly profligate periphery; fiscal rectitude at all costs; and an...