What has happened to Europe?

In the absence of exchange rate adjustments, competitiveness for the countries falling behind can be recovered through sharp wage cuts and other such ways of cutting earnings, thereby further reducing living standards. This would yield much suffering and an understandable resistance. There would also be resistance to the other "solution" through increased migration of the population (for example from Greece to Germany). A unified currency in a politically united federal country (such as in the United States of America) survives through means (such as substantial population movements and significant transfers) that are not available to a politically disunited Europe. Sooner or later the difficult question of the long-run viability of the Euro would have to be addressed, even if the rescue plans are completely successful in preventing a break down of the Euro in the short run.

I turn now to the second issue, concerning the effectiveness of austerity in cutting public expenditures in steering the countries in difficulty out of their immediate problem of excessive deficits and huge debts. It is difficult to see austerity as a soundly reasoned economic solution to the European malaise today. And it may not even be a good way of reducing public deficits.

The policy package demanded by the financial leadership of Europe has been, despite its rhetoric, severely anti-growth. The economic growth of the Euro zone has been faltering so much and even the GDP has been falling so firmly (it declined even in the fourth quarter of last year, 2011) that the recent report that there was zero growth in the Euro zone in the first quarter of 2012 has been widely greeted as "good news." And if Germany is taken out of the total, the result would be continued bad news of falling output for the rest of Euro zone. Spain, Portugal and Italy continued to decline in these months, and while Greece tempered its free fall from a previous minus 6 per cent (in 2011); the Greek economy has lost nearly a quarter of its production since 2008. While the economies and the people involved have suffered, the deficits have been quite resistant.

There is, in fact, plenty of evidence in the history of the world that indicates that the most effective way of cutting deficits is to resist recession and to combine deficit reduction with rapid economic growth. The huge deficits after the Second World War largely disappeared with fast economic growth in the post-war years. Something similar happened during the eight years of Clinton's presidentship, when Clinton began with a huge deficit and ended with none. The much praised reduction of the Swedish budget deficit during 1994-98 occurred in a period of fairly rapid growth of GDP. The situation is very different today for many countries asked to cut the deficit that are having zero or negative growth rates under an imposed discipline of austerity heaped on a recession.

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