When viewing the US fiscal stand-off from Europe, it all looks eerily familiar. The US has become very European. But for me the main problem is not an inability to deal with the structural deficit, as The Economist argued in its latest cover story, but rather the contrary. I fear that the US is blindly rushing into semi-automated austerity, which is exactly the mistake we have made in Europe. The problem is not the size of the national debt as such, which is manageable in both cases, but our policies in dealing with it.
The various measures in last week’s US budget deal imply revenue increases in the order of about 2 per cent of gross domestic product. This is the absolute size of the agreed measures. It does not include any further spending cuts that may, or may not, come as part of an agreement on a debt ceiling. The gross fiscal contraction of the US will be larger than the UK’s in 2013, though not as large as that in Spain, Portugal or Greece. Still, this would make the US an honorary member of Europe’s austerity club.
If there has been an overriding lesson from the eurozone crisis, then it must be that the fiscal multipliers – the effect of austerity on growth – become very high when monetary policy has reached the zero bound, and when everyone pursues austerity at the same time. The International Monetary Fund started a debate on the multiplier last year, culminating in a recent paper by Olivier Blanchard and Daniel Leigh, explaining why economic forecasts have been so persistently wrong during the crisis. Just how large the multiplier will be this year is difficult to say exactly and may vary across countries, but it is certainly higher now than before the crisis.
I would expect the multiplier to become smaller as the economy returns to normal, but that has not happened yet and will probably not happen for a while. In Europe, a recession started in the middle of 2012 and is likely to persist for most of this year. The latest US data show that manufacturers may have come out of recession and that employment is rising modestly. But the size of these fiscal measures may well undo this incipient recovery.
The medium-term dynamics are even worse. This is because austerity is not a one-off shock, whose negative effects would dissipate over time, but a multi-annual program. What spooks me is the likely austerity pursued even in a moderated form over longer periods. That is already happening, at least in Europe. The German finance ministry is already planning an austerity budget for 2014 to meet the constitutional target of a structurally balanced budget. The eurozone’s fiscal pact will have exactly the same effect on the other countries. Its prescription of a near-zero structural deficit will force everybody to continue austerity indefinitely. It leaves room for automatic stabilisers, but only up to a point. If long-run growth falls, as I would expect, the structural deficit would be revised upwards, requiring further austerity.
In Europe, "perma-austerity” comes primarily in the form of social entitlements cuts. In most countries, the scope for tax increases is relatively small. There are a few genuine structural fiscal reforms that may well be worth undertaking – cuts in levels of regional government, plugging tax loopholes, or ending subsidies. But these are hard to do, and governments find it more expedient to cut welfare benefits, which is what European conservatives usually mean when they talk about "economic reforms”.
In southern Europe, austerity has already led to a big increase in poverty and inequality. A report by Oxfam in Spain says that if the current policies are not reversed, Spain could see an increase in the percentage of the population below the poverty line from 27 per cent to 40 per cent in a decade. I find it hard to see how Spain could maintain its current course politically if that prediction turns out to be true.
All over Europe, governments have pushed themselves into a corner where austerity has become the default choice. George Osborne, the UK chancellor, said recently he expected austerity to continue until 2018. I would take this as a ballpark estimate for most of the North Atlantic region. This is not an environment in which companies invest, or in which consumers step up spending. My conclusion is that we are not going to see a return to pre-crisis growth rates in the austerity club for a several years. If the US becomes a fully-paid subscriber to this club, then I would expect the same to happen there.
There is a deeper reason why we are all in this mess. It has become more difficult for political systems to defend the collective interest – which I would define as the pursuit of policies to end the recession – and then deal with the debt overhang vigorously afterwards. The collective action problem is a natural deficiency of a monetary union with decentralised decision making. But it can also occur at the level of sovereign nation states when society lacks broad consensus over economic policy. In their respective pathologies, the US and the eurozone have become remarkably similar.
Copyright The Financial Times Limited 2013.