What Should Europe's Crisis Teach the U.S.? NothingBy
As European Commission President Jose Manuel Barroso arrived at the Los Cabos meeting of the G-20 last week, he made one thing clear: “We’re not coming here to receive lessons … in terms of how to handle the economy.” That’s because “the European Union has a model that we may be very proud of.” After all, Barroso noted, the crisis in the euro system all started because of “unorthodox practices” in the U.S. financial sector.
Even if Barroso didn’t want lectures while in North America, politicians from both parties in the U.S. are awfully keen to draw cautionary lessons from Europe. “People aren’t clamoring to invest in Greece today,” says House Speaker John Boehner, and “we’re not going to have many options” either, if the U.S. fails to reduce the deficit. Meanwhile, Bill Clinton has drawn the opposite conclusion from Europe’s travails: Austerity doesn’t work. “Europe is in trouble,” but “the Republican Congress has adopted the European economic policy,” he complains. Apparently, Europe isn’t a very clear teacher for the U.S. Maybe that’s because the student is from a completely different species.
What, after all, can the U.S. learn from the Greek economy? “Don’t borrow more than you can afford to repay” might be considered a rather pedestrian lesson; yet it’s about the best you can do. It is hard to imagine an economic situation that looks much less like America’s than that of Greece, as pointed out by Ezra Klein in a Bloomberg View column. The country that can claim to have invented the very subject of economics—thank you Aristotle—got itself into a bind by borrowing at cheap rates on the basis that it shared a common currency with Germany. Investors then realized that Greece wasn’t actually Germany and indeed looked as reliable an investment as a balloon mortgage in Vegas. They started wanting a higher interest rate to cover their risk.
The world’s first economist has a solution to Greece’s problems: Default on the interest. (Aristotle thought interest payments were immoral.) That wouldn’t really work if Greece wants to stay in the Euro, so the country’s politicians have grudgingly accepted budget cuts, with all the pleasure of a vegetarian eating haggis.
Now compare Greece’s predicament to that of the U.S., which has its very own currency that happens to be doing very well so far, thank you—and remains the most common component of global reserves. U.S. interest rates are so low that investors are effectively paying the government to look after their money. If the Greek government could borrow at 0.25 percent, as the U.S. Treasury can, there’d be no talk of crisis in Greece, either. It’s true that the U.S. can’t simply go on borrowing at current levels forever. Net interest payments on the federal debt accounted for 18 percent of revenues in the early 1990s; they’re below 10 percent now but could easily climb back up as rates rise. Still, America’s debt ‘crisis’ over the long term is one of balance between revenue growth and expenditure growth. Unlike Greece (and contra House Speaker John Boehner), it is not one that requires slashing budgets today.
Which brings us to the whipping boy of American Keynesians: the United Kingdom, where Prime Minister David Cameron’s coalition government implemented an austerity package pretty much as soon as it took power. Here’s the big lesson to be learned from Britain: If you cut government spending when the economy is in the doldrums, your growth will suffer in the short term. Frankly, if you needed a further lesson to understand that, basic math must have escaped you the first time around. Government spending accounts for nearly half the U.K.’s economy—slash that and you’re hardly likely to see overall growth in gross domestic product leap like a salmon that’s won the lottery.
Even so, the short-term effects of Cameron’s austerity measures don’t really tell you anything about Britain’s long-term prospects for growth. It may be that austerity really helps make the country more competitive, raising the growth trend line over time. Or it may be that that the country never recovers the lost output growth of the last two years. Perhaps more likely, it will have next to no effect either way in the long term. That would be in line with the average impact of IMF and World Bank-sponsored adjustment programs in the last two decades of the 20th century, according to (PDF) New York University’s Bill Easterly.
Another of Easterly’s findings is that bouts of inflation have little impact on long-term economic performance; a recent paper highlighted by Klein, meanwhile, found that there’s little-to-no connection between a country’s level of debt and growth. Given all that, global experience suggests that, if anything, it is time for a second round of fiscal stimulus backed by more quantitative easing from the Fed. Of course, averages from the rest of the world may be no more useful a guide for U.S. economic policy than Greece is. The one thing that we’ve really learned from 20 years of cross-country analysis of patterns of long-term growth is that there is no simple and universal set of answers.
If fail-safe blueprints for kick-starting growth existed, we would have tried them already. The U.S. briefly slashed borrowing while enjoying high growth in the 1990s, but this doesn’t prove that harsh austerity leads to economic recovery. In fact, government expenditure kept going up during the Greenspan bubble—it’s just that revenues went up even faster. Regardless, we’re not in a period of rapid growth and we all know where the last one ended. So while we are avoiding inapplicable lessons from abroad, it would be best to avoid learning the wrong ones from U.S. history as well.