Wednesday, February 15, 2012

European Recession

After the first European recession in 2009, the EU is heading back into another recession only three years later. But, this recession is much more worrying. There is less room for maneouvre, attempts to solve the debt crisis have failed, and have left countries with both low growth, but continuing debt problems.

The cause of the second recession is depressingly simple.
  • Austerity policies really do cause a fall in aggregate demand, higher unemployment and lower economic growth
  • If you cut government spending, you need something else to boost demand in the economy. This could be devaluation, loose monetary policy, higher exports or stronger private sector demand and investment. 
  • However, Europe has only deflationary policies. There is no devaluation for southern economies, no loosening of monetary policy and with very low confidence, the private sector has not compensated for even minor spending cuts. 
  • The German economy is doing relatively well (though GDP still fell 0.2% in the last quarter). But, the German economy is helped by very strong export demand. Germany has a current account surplus of 6% of GDP. The problem is that some feel everyone should follow German's model of exports and high current account surplus. But, not everyone can have a current account surplus! 
  • The flipside of strong German exports is a current account deficit in Greece and Portugal of 10% of GDP. To help economic growth in Greece and Portugal, there needs to be a revaluation of trade within the EU - but that is very slow to occur with a single currency.
  • In a liquidity trap and period of very low private confidence, the private sector haven't taken the place of spending cuts. It is why Italy has gone into recession with GDP falling 0.7% in last three months of 2011, following 0.4% contraction in three months before.

Austerity and Lower Tax Receipts

Since Greece increased taxes, and cut spending, VAT receipts have fallen 18% in 201. Simply because 60,000 firms went out of business. This is an example of how austerity policies can be self-defeating in a recession. (Tragedy of Greece)

Yet, Daniel Mitchell, of the libertarian-minded Cato Institute, argues that Europe has not been austere enough and that much more is needed. "European countries talk about austerity but they don't mean cuts," he says. (Guardian Link). At least the IMF are aware that there can be too much of a necessary thing. (IMF blog)

Youth unemployment of 50% - just cut government spending a bit more. This is the logical policy of free market economics.

Yet, despite all the austerity of Greece, Italy and Ireland, they have failed to solve the 'debt crisis'

Depressed with the European economy, I had a look at the Indian economy in 2012 - at quite a different stage of the economic cycle. What India needs is to reduce its budget deficit and liberalise its complex bureaucracy. If India can lears anything from Europe - don't wait for an economic downturn to try and solve persistent budget deficits.

Keynesian economics may support fiscal expansion during a recession, but in India's case, a very different approach is needed.


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