Growth — the new magic word

It's not being called a crisis summit, this informal gathering of the government leaders of the European Union in Brussels on May 23rd. However, with Greece on the verge of a eurozone exit, a Spanish banking system on the brink of bankruptcy, record unemployment in the European Union and a European economy that just keeps on shrinking, we most definitely call it a summit meeting during a crisis.

According to European Council president Herman van Rompuy, the hot topic of the summit will be growth. This is the new magic word in Brussels: virtually all players who matter in Europe have already spoken of the need for economic growth. The French President Hollande made it the theme of his election campaign, helping him to beat his rival Sarkozy. The head of the European Commission Barroso sees a perfect job for Brussels: large infrastructure projects under the supervision of his commission that are supposed to breathe new life into the European economy.

Krugman versus austerity

Everyone pretty much agrees that greater economic growth can help solve the debt problem. The question is how can government leaders realise the needed higher growth. The British weekly The Economist compared economic growth to world peace: everyone is in favour of it, but everyone has a different opinion on how that peace is to be achieved.

Economic science does not offer any answers either. Since the financial crisis broke out at the end of 2008 with the fall of the American bank Lehman Brothers, a debate has been raging between economists about the way out of the crisis. There are roughly two options. On the one side there are the proponents of large-scale stimulus measures by the various national governments. On the other there are the people who favour rapid cuts in government spending.

The message from Chancellor Merkel that governments have to cut their deficits is perceived as dogmatic, while critics point out that the problems have only increased in many southern countries, with Greece and Spain leading the pack. Making cuts in times of recession only makes the economic malaise worse, is the counterargument.

The most important proponent of this theory is the American Nobel Prize winner Paul Krugman. Through his columns in The New York Times he repeatedly criticizes European government leaders. They seem to believe that no economic growth is possible without pain (in the form of cuts). According to Krugman, this moralistic view is now defunct, and the faster Europe leaves this path the better. The election results in France and Greece were not unexpected for him; it was proof that the European citizens had a better idea on how to get out of the crisis than the majority of the policymakers.

The Japanese recession

The example put forward by the opponents of stimulus policy is Japan. At the beginning of the nineties Japan was struggling with a crisis similar to that of the United States and Europe in 2008.

Since then the Japanese government has been trying to pull the economy out of its slump using stimulus measures. Despite all the money pumped into the economy, this did not prevent Japan from having only minimal economic growth for the last twenty years and regularly sliding back into recession.

Proponents of stimulus point out that the Japanese government did not take action until it was far too late; in the first years after the bubbles burst the government followed a policy of fiscal tightening, as Europe is doing now.

But even if we agreed that making cuts during a recession is harmful, this still leaves the question what the government should spend the extra money on. The opponents point out that the stimulus argument that the government has to support demand in the economy is the easy part. But demand for what? The government does not produce things, aside from infrastructure works such as roads, dikes and bridges. This is therefore often the way in which the economy is stimulated in practice. But does this really improve the economy?

Practical discussion

Take the famous Japanese story of a bridge costing 2 billion dollars to provide better access to an island with 800 inhabitants. This project allowed the government to give a couple of construction companies a juicy assignment and temporarily employ some people, but it does not increase the productivity of the economy.

The question is whether such projects can get the economy going again, or whether construction workers will not end up back in the unemployment line once the bridge has been finished and the government cannot continue spending.

This practical discussion is not really going on in Europe. European history is awash with examples: the motorways in Spain and Portugal via which tourists reach their holiday destination have been financed generally with European money. Poor regions are still being supported with money from the structural funds of the European Commission. That is what the cautious plans which have already been suggested for kickstarting growth in Europe look like: more budget for the European Investment Bank to finance big projects, more money for the Commission to expand the current work.

It must become clear whether government leaders believe that these measures will be enough to restore economic growth in Europe. And indeed whether they will be prepared to pull out their wallets.

Economy

OECD warns against “vicious circle” of recession

In a report published on the eve of the extraordinary European Council of 23 May the Organization for Economic Cooperation and Development (OECD) warns the Europeans that a “severe recession” threatens the eurozone, notes the Süddeutsche Zeitung. According to the Munich daily, the OECD feels that —

The weak economy and shaky financial system may lead to a vicious cycle that could even drag in Germany, Europe’s model student. [...] The economy could grow by 0.9 percent in 2013, but only if the crisis does not get worse.

The OECD also suggests that states in economic distress temper their austerity policies, as Die Welt highlights —

The OECD requires governments of states in crisis to find social solutions to complement their policy reforms and to take society’s weakest members into account. In states where growth is weak, governments could brake their efforts to enforce austerity to avoid the continued deterioration of the economy.