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Will austerity save Europe from crisis?

media France's President Sarkozy and Germany's Chancellor Merkel during a eurozone … Reuters

Austerity is the order of the day in Europe. But not everybody approves. As well as trade unions, who have led thousands onto the streets to oppose cuts in living standards, some economists point out that it will hamper economic recovery. And the US fears that it will be left to fund the world's escape from recession.

The International Monetary Fund (IMF) forecasts shrinking GDP growth for Greece until 2015 and maybe even beyond, In its World Economic Outlook.

But it may actually be worse, economist Mark Weisbrot believes, since the Greek finance ministry is predicting a sharper fall in 2010 than the IMF does . 

Tiny Latvia lost more than 25 per cent of its GDP in 2008-2009, a record in world history. Going by IMF forecasts, it is unlikely to reach its pre-crisis 2006 growth even in 2015. In the Latvian case, it’s not so much the IMF but the EU governments that forced harsh austerity on the country.

Euro-austerity unpopular ... in US

In the United States right-wing Republicans and centre-left Democrats have joined hands in thundering against the EU’s tough austerity measures.

Germany is their chief target, even though France and Britain are operating along similar lines. Britain is taking advantage of a cheap pound and France a cheap euro making exports more saleable.

The argument is that only the US is maintaining a Keynesian stimulus package that artificially boosts demand, while Europe's mainly right-wing governments enforce austerity.

The view from the US is that German Chancellor Angela Merkel plans to limit German consumer debt while US consumers carry on spending with their credit cards. By the end of the year the German debt will be only slightly larger, while the US debt bloats.

Senior centre-left economist Paul Krugman warns that the situation is getting out of hand and is demanding the US government go into action.

"Merkel says that budget cuts will make Germany more competitive but competitive against whom, exactly?" he asks. "You know the answer, don't you? Yep: everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi [the Chinese currency]. Oh, and while they rely on US demand to make up for their own contractionary policies, they'll lecture us on how irresponsible we're being, running those budget and current account deficits.”

Germany's current account surplus is expected to reach 154bn euros this year, or six per cent of GDP, driven by car exports, which increased by nearly half in May compared with a year ago.

German carmakers Porsche, Volkswagen, BMW and Mercedes owner Daimler exported 367,700 cars in May this year, an increase of 46 per cent on May 2009. In April car sales, many of them to the US, increased 58 per cent year-on-year.

The US deficit will hit more than 10 per cent of GDP this year.

Krugman’s last word is that China and Germany, or "Chermany", are a problem.

China’s "massive currency manipulation" should be punished with extra taxes on imports, he recommends. As for Germany, he says, “Send a message to the Germans: we are not going to let them export the consequences of their obsession with austerity."

In the case of Greece, too, its fellow EU governments are insisting on tough austerity measures in exchange for lending cash to Greece so that the country can pay back its creditors.

In his book Globalisation and its disconents, senior US economist Joseph Stiglitz writes that one reason the IMF has been advocating austerity and slashing government expenditure, even in key sectors such as health and education, is that it expects the spending cuts to yield more revenue for the government, thus enhance its capacity to repay its debts.

But putting the priority on repaying debts means ensuring that creditors, usually powerful banks, would recover loans or, at least, get away without losing too much.

Of the 1997 east Asian crisis, Stiglitz writes, “I believe that capital account liberalisation was the most important factor leading to the crisis. I have come to the conclusion not just by carefully looking at what happened in the region, but by looking at what happened in almost 100 other economic crises on the last quarter century.”

The free inflow and outflow of capital, whatever the country or its specificity, was the central line adopted by the IMF along with the US treasury department. The Washington consensus, as it was called, remains alive and kicking. Even the European Union takes inspiration from it.

With crisis staring them in the face, the autorities' policy seems to be to throw money at it. And they are borrowing from the same big finance which helped create the crisis to start with.

In the case of the EU, especially in the 16 eurozone countries, belt-tightening and general austerity is the recommendation. Greece and perhaps some others may have to suffer negative growth for some years. These will be years lost for investment that could modernise the economies, create more wealth and repay debts more easily.

To come back to test-case Latvia, IMF projections for Latvia show the economy in 2014 still smaller than it was in 2006. To make things even worse, these projections show a public debt of 90 per cent of GDP in 2014 – far beyond the 60 per cent limit required by the EU for the country to join the euro. This has been one of the Latvian government's main goals, and justifications, for maintaining its currency pegged to the euro and putting the country “through hell” .

The IMF has long had a double standard when it comes to macroeconomic policy: for the rich countries it is generally Keynesian, advocating the kinds of counter-cyclical fiscal and monetary policies that the US has adopted during the current recession, writes economist Mark Weisbrot.

Yet for the low-and-middle income countries, he points out, it has often pushed the opposite policies. That’s what the EU is now imposing on the ailing eurozone states currently.

Despite the bitter medecine, the danger remains that Greece and/or one of the others may default on what they owe.

“The Greek government is being asked to implement austerity measures that will cause a major decline in incomes and employment not just now but in the foreseeable future, and which will not correct the existing imbalances but actually worsen them,” comments economist Jayati Ghosh.

Dossier: Eurozone in crisis

“The heavily indebted poor countries of Africa could tell the Greeks a thing or two about this process.”

IMF-inspired deflationary measures mean falling GDPs and that makes it harder to service debts. These not only pile up, but expand, because of the unpaid interest that keeps getting added to the principal and then compounded, so that the country's debt just keeps rising.

Greece and some of the other Pigs (Portugal, Ireland and Spain) may well have to restructure their debts. This means renegotiating them, stretching out repayment over longer periods, ultimately paying back less than the lenders would have liked.

It mainly means some losses for the lenders who made the lavish sums of money available in the first place. But restructuring public debts is not on the agenda.

And, while ordinary people in the Pigs group and elsewhere in the eurozone are being asked to pay, there is rarely serious talk of taxes on capital. Some eurozone leaders are broaching the topic of taxing transactions.

Don’t bet too much on it. Big finance doesn’t like it. And these days, what it says goes!

Greece and its fellow Pigs have already begun ushering in austerity plans bound to weaken their economies. Spain is tightening monetary policies, cutting public sector pay and pensions and much else.

This is particularly remarkable, because until two years ago Spain ran a fiscal surplus.

Its big problem is not government debt but the mountains of money the private sector - companies and households - owe to lender banks, many of them foreign.

Similar trends are being applied in Ireland, the Baltic countries, even in Romania. In Britain, the new government is already talking about measures to cut the deficit by slashing spending and raising indirect taxes.

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