When other Group of 8 nations pressed Angela Merkel to support measures to stimulate euro-area economies at a summit over the weekend, it wasn’t because of a mere philosophical difference between the German chancellor and other G-8 leaders.
Since 2008, the United States and Europe have put into practice two radically different theories of how indebted governments should respond to economic duress. On this side of the Atlantic, the Obama administration relied on stimulus to keep a deep recession from turning into a long depression. Meanwhile, much of Europe has chosen the course the Tea Party movement has urged the US Congress to follow: Countries such as Britain, Greece, Italy, and Spain have all slashed public-sector expenditures now — in many cases at Germany’s instigation — in the hope of reassuring spooked financial markets.
The results of these experiments are becoming clear: If the sluggish pace of US growth speaks to continuing unease about the American economy — where growing entitlement expenses loom large over public finances — European nations’ recent plunge back into recession shows that simply hacking away at government expenditures causes grave damage.
The grain of truth behind the austerity-now push in Europe is that, in mature industrial democracies, the electorate often has expectations of government — for instance, low retirement ages, generous pensions, and a hefty supply of government jobs — that it fails to pay for up front, and that the underlying economy isn’t growing fast enough to sustain. But like some diets, austerity plans can demand too much weight loss too quickly. Even in countries where an oversized public sector holds back growth, the sudden abolition of vast numbers of government jobs has traumatic effects on the economy.
Even as Republicans in Congress decried it as wasteful, the Obama stimulus plan wasn’t generous enough to keep state and local governments, which generally lack the ability to run deficits, from laying off employees in vast numbers. The persistence of demands for more austerity now is all the more tragic because, at least for the United States, there is a far better, and less immediately painful, way to restore confidence in American finances: Simply by dealing honestly with future liabilities through gradual tax hikes and Social Security and Medicare changes, Congress and the Obama administration could reduce future liabilities far more effectively than by ostentatiously abolishing, say, the Department of Energy or the Department of Education. That entitlement-protecting Democrats and tax-averse Republicans have their own political reasons to resist such a compromise only underscores the urgency of striking one as soon as possible.
The ability to endure some sacrifices is a credible indication that a government can stick to a budget over time. But at a certain point, slashing short-term government spending looks more like a purgative ritual than a sound basis for economic policy-making.