Why is the response to economic crisis not more serious?
The state of the world economy these days reminds me of the famous telegram from an Austrian general, responding to his German counterpart toward the end of World War One. The German described the situation in his sector of the Eastern front as “serious but not catastrophic”. In the Austrian sector, the reply came, “the situation is catastrophic but not serious”. In much of the world today the economic situation is verging on catastrophic, but “not serious” seems a perfect description of the political response.
Four years after the Lehman crisis, economic activity and employment in the OECD has not yet returned to its pre-crisis level. Unemployment is at postwar highs in every major European country apart from Germany and, while the U.S. jobless rate is now a little below its postwar record, it has been stuck above 8 percent for longer than at any time since the Great Depression. And in Britain, the long-term loss of output assumed by the government’s latest budget forecasts implies, according to Goldman Sachs calculations, that the six months of the post-Lehman crisis did greater permanent damage to the country’s productive capacity than the Great Depression or World War Two.
Now consider the response. In the U.S., the four years since Lehman have been dominated by economic debates among politicians, media commentators and business leaders on issues that are almost totally irrelevant to unemployment and the pace of economic recovery: how to reduce long-term budget deficits and whether to tweak the top rate of income tax from 36 percent to 39.6 percent. In Britain, the biggest economic controversy this year has been the extension of value added tax to hot pies. Europe’s response to the deepest economic depression in living memory – and an even more alarming xenophobic nationalism that threatens the literal disintegration of the euro and the European Union – has been to debate the bureaucratic “modalities” of bank regulations, fiscal treaties and pension reforms in the next decade.
How to explain this insouciance in the face of the gravest threat to the Western world since the height of the Cold War? In the U.S. and Britain the answer is straightforward, if unappealing: party politics. In Britain, the Conservative-Liberal coalition has managed to lay all the blame for the country’s economic troubles on Labour’s Gordon Brown, so far at least. Thus there has been very little public pressure on the Cameron government to change its economic policies, and no political advantage in doing so.
In the U.S., the Obama administration’s efforts to revive the economy with public spending have been stifled by congressional Republicans, while Democrats have thwarted conservative ideas about using tax cuts to stimulate enterprise, investment and consumption. Business leaders and media opinion-formers have aggravated this political impasse by whipping up fears about budget deficits, despite the record-low yields set by the markets on U.S. Treasury bonds.
The good news is that U.S. politics created a self-stabilizing feedback of sorts. If the U.S. economy continues to deteriorate, the Republicans will probably win both the presidential and congressional elections and would then be free to pursue an aggressive tax-cutting policy modeled on Reaganomics. Big tax cuts would doubtless increase budget deficits, but they might well pull the U.S. out of recession as they did in 1983. If, on the other hand, the U.S. resumes tolerable levels of economic growth and employment creation, then a re-elected Obama administration would have a strong mandate to overcome or co-opt what would then be a chastened Republican opposition.
Now for the bad news, which comes, of course, from Europe. The euro zone, in contrast to the U.S. and Britain, is paralyzed not by cynical political calculations but by profound misunderstandings of economics and finance. European leaders do not seem to understand that the fiscal and banking unions they are relying on to save the euro can only work under a very specific political condition: Restrictions on national sovereignty over budgets and bank regulation (as demanded by Germany and resisted by France, Italy and Spain) have to be agreed on at the same time as mutual support for debts (as demanded by France, Italy and Spain, and resisted by Germany). Moreover, the banking and fiscal unions can only work if they are backed by a central bank commitment to buy government bonds and thereby maintain near-zero interest rates for a long period, as in the U.S. and Britain.
German politicians and voters believe, however, that centralized control over national budgets and banks is sufficient to resolve the euro crisis – and until this control is fully established, Germany refuses even to discuss mutualizing or monetizing national debts. On the other hand, Mediterranean politicians – and certainly their voters – refuse to cede national sovereignty unless Germany offers them the quid pro quo of support for their national debt burdens explicitly and in advance.
This stubborn opposition of national interests and philosophies in Europe, unlike the political gridlock in Washington, will not be overcome just by elections. It seems to take more than a mere economic catastrophe for politicians to get serious in Europe.
PHOTO: A structure showing the euro currency sign is seen in front of European Central Bank (ECB) headquarters in Frankfurt July 11, 2012. REUTERS/Alex Domanski