Europe's medecine could cure America

European austerity measures have come in for much criticism from US economists. According to Melvyn Krauss, this betrays a misunderstanding of Europe's economy and consumption patterns. Instead of criticizing Europe, America would do well to adopt similar tactics.

Published on 13 July 2010 at 09:44

Even before the G-20 Meeting convened in Toronto, US President Barack Obama was sounding the alarm that new moves towards fiscal austerity in Europe was threatening the fragile global economic recovery.

President Obama should relax--and stop listening to his US neo-Keynesian advisors who know little about what really makes Europe tick. Not only will Germany’s fiscal consolidation package of 80 billion euro of spending cuts and tax hikes not hurt the recovery, it actually will give it a boost by sparking increased German domestic consumption.

Typically, US economists, even distinguished ones, get Europe wrong, because they think America is the world and the world is America.

Here is the story on the new German austerity program the US president is missing—and why Mr. Obama should be hugging German Chancellor Angela Merkel instead of scolding her.

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US economists think all consumers behave like American ones

Germans, and not only the older ones, currently save a relatively large proportion of their incomes, because they look at the size of the public budget deficits and see inflation down the road. So, high private savings in Germany are a consequence of low—indeed negative-- public saving. Cut the public deficit and domestic consumption should receive a boost, which is exactly what the critics are demanding from German macro-economic policy. What’s the problem?

But US economists like Paul Krugman—who is reputed to be Mr. Obama’s favorite economist and who recently materialized in Berlin to denounce Mrs. Merkel’s austerity package in her own back yard-- do not buy this analysis, because they think all consumers behave like American ones.

Yes, put more money in the hands of US consumers and they’ll spend it, not caring a whit of the long-run consequences of the increased public debt that put the money there. But German consumers (and Dutch ones as well) do worry and will adjust their savings behavior accordingly. They also appreciate a “stability oriented” culture more than the Americans do. So, the consequences of fiscal austerity (or expansion) measures can be very much different in Northern Europe and America.

“One size fits all” analyses will not do for European issues

The “one size fits all” analyses of many US economists simply will not do when it comes to dealing with European issues. Behind the new German austerity also lies the important question of economic leadership. Mrs. Merkel is down in the German polls because she has lost the leadership initiative in Europe to the French on bailouts and emergency aid.

To regain it, Germany must encourage the southern tier countries of Greece, Spain, Portugal and Italy to cut their budgets and cut them convincingly. But to be credible on this issue, you must lead by example. How can Germany and the Netherlands demand drastic budget cuts of other poorer member states if they don’t do the cuts themselves?

Washington should be sympathetic to this. Mr. Obama does not want the European sovereign debt problem spreading to America. The United States and its banks are as vulnerable to contagion as anyone else, perhaps even more so. Instead of telling the European leaders to go slow with their austerity moves, at the very least the US president should hold his tongue.

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