If you’re wondering why public faith in the ability of the policy elite to fix the global economy is so low, consider the childish flap that has flared up among them over Europe’s austerity push.
It turns out that the 2010 study that provided the theoretical basis for forcing bailed-out European economies (and those on the verge of it) to slash spending and raise taxes got it wrong. The work by U.S. economists Kenneth Rogoff and Carmen Reinhart had concluded that growth plummets once a country’s level of public debt exceeds 90 per cent of its GDP. The implication was that Greece, Italy, Portugal and other sickly European economies could not recover as long they ran massive budget deficits.
Thus was born the age of austerity. Or so its critics alleged.
No wonder excitable Keynesians were gloating last week after economists at the University of Massachusetts revealed that the Rogoff-Reinhart study contained “a series of data errors and unsupportable statistical techniques” that undermined its findings. They called for a reversal of the austerity policies that, so far, only seem to have worsened Europe’s pain.
Suffice it to say that Mr. Rogoff and Ms. Reinhart, who acknowledged their methodological error but defended the tenor of their study, are unlikely to be up for a Nobel Prize in economics any time soon. Their mistake is a perfect example of the dangers of relying on “big data” to dictate policy decisions. Whatever happened to common sense?
You don’t need an economics PhD to understand that the link between debt and growth can move in both directions. The recession proved that, as a cratering economy prompted massive public spending that drove debt levels to new highs. Ottawa alone has borrowed $150-billion since 2008.
Simple intuition also tells us that high debt will eventually smother growth. As more and more tax revenue goes to pay interest, less and less gets invested in the creation of growth-enhancing public goods. In the case of Europe, too much spending goes toward supporting those over 60. Countries ended up taxing their active citizens simply to pay for the past profligacy and unsustainable pensions of others.
Keynesians point out that neither Ireland nor Spain had high public debt levels before they needed outside help. But when the state has to bail out the banks, the distinction between public and private debt is quickly erased. Markets anticipated the bank bailouts in Ireland and Spain and made it prohibitively expensive for their governments to borrow.
The debate over austerity versus stimulus oversimplifies what’s really at issue in Europe. The question is whether its weaker economies can ever become competitive again – at least as long as they remain part of the euro zone. No amount of austerity will do the trick unless structural reforms needed to spur entrepreneurship and private investment are implemented – starting with an overhaul of labour laws that protect entrenched workers at the expense of young graduates.
The youth unemployment rate is approaching 60 per cent in Greece and exceeds 50 per cent in Spain. It’s nearing 40 per cent in Italy and Portugal. Short-term stimulus will not provide this lost generation with stable employment. Only labour reforms and investor confidence can do that.
Unfortunately, the political backlash against austerity that made most of Europe ungovernable has all but snuffed out prospects for real reform. As long as austerity – a term that evokes Protestant asceticism – is seen as imposed by Germany, it’s an impossible sell among exhausted voters.
“While this policy is fundamentally right, I think it has reached its limits,” European Commission president José Manuel Barroso said this week. “A policy to be successful not only has to be properly designed. It has to have the minimum of political and social support.”
Short-term economic growth, even at the expense of long-term competitiveness, has become a political imperative in Europe. As last week’s cover of the the French newsmagazine Le Point asked: “Are we in 1789?” President François Hollande, eager to forestall the revolution, declared: “The solution to the crisis isn’t austerity, but credibility and sustainability.”
Statistics released this week revealed that France surpassed the 90-per-cent debt-to-GDP ratio in 2012. Only days ago, such news would have sparked much hand-wringing. But in the aftermath of the Rogoff-Reinhart foul-up, it had all the bite of a poor pinot noir.
Apparently, a simple data error has given Europe licence to spend again.