Europe's austerity recession

Budget cuts have plunged the EU economy back into crisis, and America should pay attention

Published April 25, 2012 8:30PM (EDT)

This originally appeared on Robert Reich's blog.

Europe is in recession.

Britain’s Office for National Statistics confirmed on Wednesday that in the first quarter of this year Britain’s economy shrank .2 percent, after having contracted .3 percent in the fourth quarter of 2011. (Officially, two quarters of shrinkage equal a recession.) On Monday, Spain officially fell into recession for the second time in three years. Portugal, Italy and Greece are already basket cases, and it seems highly likely France and Germany are also contracting.

Why should we care? Because a recession in the world’s third-largest economy (Britain), combined with the current slowdown in the world’s second-largest (China), spells trouble for the world’s largest.

Remember – it’s a global economy. Money moves across borders at the speed of an electronic impulse. Wall Street banks are enmeshed in a global capital network extending from Frankfurt to Beijing. That means that, notwithstanding their efforts to dress up balance sheets, the biggest U.S. banks are more fragile than they’ve been at any time since 2007.

Meanwhile, goods and services slosh across the globe. If there’s not enough demand for them coming from the second- and third-largest economies in the world, demand in the U.S. can’t possibly make up the difference. That could mean higher unemployment here as well as elsewhere.

What’s the problem with Europe? Don’t blame it on the so-called “debt crisis.” There was no debt crisis in Britain, for example, which is now experiencing its first double-dip recession since the 1970s.

Blame it on austerity economics – the bizarre view that economic slowdowns are the products of excessive debt, and so government should cut spending in a slowdown. Germany’s insistence on cutting public budgets has led Europe into a recession swamp.

German Chancellor Angela Merkel, who has led the austerity charge, and the other European policymakers who have followed her have forgotten two critical lessons.

First, that the real issue isn’t debt per se, but rather the ratio of the debt to the size of the economy.

In their haste to cut the public debt, Europeans have overlooked the denominator of the equation. By reducing public budgets, they’ve removed a critical source of demand — at a time when consumers and the private sector are still in the gravitational pull of the Great Recession and can’t make up the difference. The obvious result is a massive slowdown that has worsened the ratio of Europe’s debt to its total GDP and is plunging the continent into recession.

A large debt with faster growth is preferable to a smaller debt sitting atop no growth at all. And it’s infinitely better than a smaller debt on top of a contracting economy.

The second lesson Merkel and others have overlooked is that the social costs of austerity economics can be huge. It’s one thing to cut a government budget when unemployment is low and wages are rising. But if you cut spending during a time of high unemployment and stagnant or declining wages, you’re not only causing unemployment to rise even further. You’re also removing the public services and safety nets people depend on, especially when times are tough.

And with high social costs comes political upheaval. On Monday, Netherlands Prime Minister Mark Rutte was forced to resign. U.K. Prime Minister David Cameron is on the ropes. The upcoming election in France is now a toss-up; incumbent Nicolas Sarkozy might well be unseated by François Hollande, a Socialist. European fringe parties on the left and the right are gaining ground. Across Europe, record numbers of young people are unemployed – including many recent college graduates – and their anger and frustration is adding to the upheaval.

Social and political instability is itself a drag on growth, generating even more uncertainty about the future.

What European policymakers should do is set a target for growth and unemployment — and continue to increase government spending until those targets are met. Only then should they adopt austerity.

What are the chances that Merkel et al. will see the light before Europe plunges into an even deeper recession? Approximately zero.

The danger here for the United States is clear, but there’s also a clear lesson. Republicans have become the U.S. party of Angela Merkel, demanding and getting spending cuts at the worst possible time – and ignoring the economic and social consequences.

Even if the U.S. economy (as well as President Obama’s reelection campaign) survives the global slowdown, we’re heading for a big dose of austerity economics next January – when drastic spending cuts are scheduled to kick in along with tax increases on the middle class. But the U.S. economy isn’t nearly healthy enough to bear this burden.

If nothing is done to reverse course in the interim, we’ll be following Europe into a double dip.


By Robert Reich

Robert B. Reich is Chancellor's Professor of Public Policy at the University of California at Berkeley and Senior Fellow at the Blum Center for Developing Economies. He served as Secretary of Labor in the Clinton administration, for which Time Magazine named him one of the ten most effective cabinet secretaries of the twentieth century. He has written 15 books, including the best sellers "Aftershock", "The Work of Nations," and"Beyond Outrage," and, his most recent, "The Common Good." He is also a founding editor of the American Prospect magazine, chairman of Common Cause, a member of the American Academy of Arts and Sciences, and co-creator of the award-winning documentary, "Inequality For All." He's also co-creator of the Netflix original documentary "Saving Capitalism."

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European Financial Crisis European Union U.s. Economy