Davos 2012: Europe Sticks to Austerity, but Finds It’s Not Enough

On a concrete wall in Oporto, Portugal, where a tough austerity effort has hit hard, a somber graffiti mural depicts a submarine in a nose dive.

“Austerity doesn’t save,” the caption warns. “It sinks.”

As Western countries grapple with lingering economic malaise, even some traditionalists within the policy-making fraternity are starting to worry that such slogans might be right. But as a phalanx of politicians, academics and other experts gathers this week at the World Economic Forum
in Davos, Switzerland, perhaps the biggest question they will face is whether it is possible to develop policies to revive growth even as Western countries seek to reduce debt.

Europe and the United States are both locked into fiscal strategies based on curbing government debt and paring borrowing. Europe has been following a German prescription intended to save the euro zone. Meanwhile, Washington, which is in the throes of a heated presidential campaign, is divided over whether to extenda payroll tax cut
for the rest of the year and has committed, at least on paper, to cutting spending by $1.2 trillion starting this year.

Whether austerity will help revive economies over the long term is the subject of an intensifying debate, especially as much of Europe heads into what looks like its second recession in three years. The United States — where belt-tightening, though painful, has not been nearly so severe — shows glimmers of a recovery.

“It is clear that austerity alone is a recipe for stagnation and decline,” said Joseph E. Stiglitz, a Nobel laureate and professor at Columbia University in New York. “The likelihood that things would work out well is extraordinarily small.”

Recently, there have been signs the tide is shifting. In the past several weeks, European politicians have begun to insist quite publicly that austerity can no longer be the sole answer to putting even the most heavily indebted economies on the path to a brighter future.

After months of talk of almost nothing but cuts, Prime Minister Mario Monti of Italy and President Nicolas Sarkozy of France delivered such a message to the German chancellor, Angela Merkel, during recent visits to Berlin, with a surprising result: “Growth” has become the new watchword on everybody’s lips — even Mrs. Merkel’s.

“Budget consolidation is one of the legs Europe’s future must be built on,” Mrs. Merkel said this month after meeting with the Italian and French leaders. “But of course we need a second leg,” she added, which is “economic growth, jobs and employment.”

Germany is still insistent that the most foolproof path to sustainable recovery is through structural change, including the overhaul of rigid labor markets and changes to pension laws, much like those Germany painfully pushed through in the 1990s.

But the fruits of such labors often take years to emerge. In the meantime, the concern is that economies that are already in a slowdown will be weakened further by large cuts in national spending and by tax increases that governments are embracing to satisfy lenders and to placate the financial markets.

“You could say that if there’s no austerity, growth might be higher,” said Stefan Schneider, the chief international economist at Deutsche Bank in Frankfurt. “But then again, no austerity would probably escalate the bond crisis in Europe, and then you would wind up with total chaos.”

In the United States, where the budget deficit remains high and President Barack Obama has pressed for more stimulus, there are tentative signs of an economic comeback. The unemployment rate fell to 8.5 percent in December, its lowest level in nearly three years, after about 200,000 jobs were added.

The outlook remains fragile. The phaseout of an earlier stimulus program cost the United States an estimated half a percentage point in growth last year, and could further reduce potential gains in 2012. Washington is also likely to provide less government support this year amid continued wrangling between Republicans and Democrats over economic policy.

But the U.S. Federal Reserve has been more accepting than the European Central Bank of keeping interest rates low and of pumping extra money into the banking system in a bid to restart the engines of the economy.

“The U.S. government has been willing to provide more stimulus than the Europeans, and the Federal Reserve has been more accommodative on monetary policy,” said Paul De Grawe, a professor of economics at the Catholic University of Leuven in Belgium. “So America’s environment is easier right now because its macroeconomic policies are less contractionary than in Europe.”

In Europe, Mr. De Grawe added, “excessive austerity, no fiscal stimulus and a European Central Bank not willing to do the same as the Fed is the wrong policy mix.”

Article source: http://www.nytimes.com/2012/01/24/business/global/europe-sticks-to-austerity-but-finds-its-not-enough.html?partner=rss&emc=rss