Ireland’s rapid growth these days obscures persistent economic weakness in the wider euro zone, albeit with exceptions. Against this sorry backdrop, a growing body of research points to serious flaws in the response to crisis.
The mistakes made are too numerous to list here. Still, huge criticism centres on the damaging repercussions of prolonged fiscal retrenchment as governments across the euro zone curtailed spending and increased taxes. The core complaint is simple: the austerity drive may have imposed order on public finances but it strangled growth.
We live with the consequences. Even as the European Central Bank gears up to deepen its (belated) quantitative easing programme, its chief, Mario Draghi, has been urging political leaders in the euro zone to do their bit by deploying “fiscal policies” to support recovery. “Monetary policy shouldn’t be the only game in town,” he said last week.
Retrenchment
One must point out here, of course, that the ECB was in the vanguard of the institutions pushing for more and more retrenchment in struggling countries as the debt crisis raged. When European officials weren’t fretting about the survival of the single currency, however, they were complaining about Germany’s decided reluctance to spend even a little more money in its own economy.
Note also that Europe’s complex new fiscal rulebook bears the disciplinarian imprint of German thinking. Nobody doubts the requirement for fiscal rigour in a currency union which came all too close to falling apart. But the question remains as to whether there is sufficent flexibility in the rules to foster growth as well.
The dangers of excessive fiscal consolidation at the general level are summed up rather neatly in new research this week from former US treasury secretary Larry Summers and Antonio Fatás, economics professor at the Insead business school in Paris. Published by the Centre for Economic Policy Research in London, their paper supports the notion of “self-defeating” consolidation which perpetuates economic depression. This is hardly the first examination of this vexed topic but the findings, based on seven years of data, are quite clear.
“Our estimates suggest that the fiscal contraction in European economies reduced output not only in the short term but also in the medium term and possibly on a permanent basis,” said Summers and Fatás.
“This reduction in output makes the goal of the fiscal consolidation harder as it raises the ratio of debt to GDP and it reduces tax revenues.”
There are caveats, of course, not least in the particular circumstances of Ireland’s advancing recovery after years of turmoil. But these findings chime with plenty of other research. Former International Monetary Fund official Ashoka Mody, mission chief to Ireland during the bailout, has written this year of how “growth was hurt” when fiscal austerity became the norm, thereby undermining the primary objective of lowering the debt burden.
Kieran McQuinn of the ESRI reached a similar conclusion in a paper last month. While saying the Irish authorities had little choice but to pursue a contractionary fiscal policy after the crash, he took issue with the lack of a European stimulus programme .
“With the country priced out of sovereign bond markets and forced into a programme of support, there was little option, given the European policy framework, other than to correct the fiscal accounts,” said McQuinn.
“Even with the strong growth rates, it is evident that the Irish economy will not be back to its pre-crisis income levels until 2016 or 2017 at the earliest. This illustrates the lost capacity of the economy and, hence, the potential for policy at the European level to have ameliorated the decline in output and general activity experienced in the Irish case.”
Political endurance
The argument is clear. It is as well to point out, however, that the steps actually taken at European level to tackle the crisis pushed European leaders to the limits of their political endurance. Everything done was done at the very last minute and, worse, it was all done within the narrow confines of emergency debate on what was required to forestall imminent collapse and minimise the repair bill.
True, it may be a little tart to say there’s no scope for long-term thinking when the ship is sinking. A durable solution to any problem, however, always requires something more than a quick fix. It also requires the capacity to recognise errors made and do something about them.
