The outcome of the Italian elections should send a clear message to Europe’s leaders: The austerity policies that they have pursued are being rejected by voters.
The European project, as idealistic as it was, was always a top-down endeavor, but it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery.
While Europe’s leaders shy away from the word, the reality is that much of the EU is in depression.
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930s. Greece’s youth unemployment rate now exceeds 60 percent and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing and its future is being thrown into jeopardy.
The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled populists. The reality, though, is that the cure is not working and there is no hope that it will — that is, without being worse than the disease. Indeed, it will take a decade or more to recover the losses incurred in this austerity process.
In short, it is neither populism nor shortsightedness that has led citizens to reject the policies that have been imposed on them. It is an understanding that these policies are deeply misguided.
Europe’s talents and resources — its physical, human and natural capital — are the same today as they were before the crisis began. The problem is that the prescriptions being imposed are leading to massive under-utilization of these resources. Whatever Europe’s problem, a response that entails waste on this scale cannot be the solution.
The simplistic diagnosis of Europe’s woes — that the crisis countries were living beyond their means — is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
An alternative set of well-discussed policies could work. Europe needs greater fiscal federalism, not just centralized oversight of national budgets.
To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the US, but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (which has been whittled down further by austerity advocates).
A banking union is also needed, but it needs to be a real union, with common deposit insurance and common resolution procedures, as well as common supervision. There will also have to be Eurobonds, or an equivalent instrument.
European leaders recognize that, without growth, debt burdens will continue to grow and that austerity by itself is an anti-growth strategy. Yet years have gone by and no growth strategy is on the table, though its components are well-known: policies that address Europe’s internal imbalances and Germany’s huge external surplus, which is now on par with China’s (and more than twice as high relative to GDP).
Concretely, that means wage increases in Germany and industrial policies that promote exports and productivity in Europe’s peripheral economies.
What will not work, at least for most eurozone countries, is internal devaluation — that is, forcing down wages and prices — as this would increase the debt burden for households, firms and governments (which overwhelmingly hold euro-denominated debt). With adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.