Fiscal Austerity is Not the Answer

Robin Hahnel is Professor Emeritus of Economics at American University, Washington DC. His most recent books include Economic Justice and Democracy and The ABCs of Political Economy, and he is co-author with Michael Albert of The Political Economy of Participatory Economics.


In this interview he and Joona-Hermanni Mäkinen from Parecon Finland – an organization focused on ideas for a more participatory, democratic economy –  discuss the continuing mismanagement of the economic crisis in Europe, the economic policy behind the rhetoric of Timo Soini as well the deepening problems created by the austerity measures promoted across political spectrum in Europe, most recently by True Finns in Finland.


In Finland some claim that fiscal austerity measures must be strengthened as a condition for the Portuguese bailout package because Portugal has run out of money, and therefore the state has to start saving money by cutting spending and by selling assets. Are budget cuts and privatization of state owned assets really necessary?


Budget cuts and privatization are going to do nothing but aggravate the recessionary pressures within Portugal and increase unemployment there. When the government reduces spending this throws public sector workers and private sector employees working on public contracts out of work, lowers their income, and leads to a drop in consumption demand many times larger than the initial fall in government spending. The first thing new owners of formerly state enterprises do after acquiring them – often at fire sale prices — is layoff a sizable portion of their workforce, with the same effect.


In a context where businesses will not produce more because they have good reason to believe they will not be able to sell more, and will not investment to increase the size of their plants and facilities because there is currently a great deal of excess capacity, fiscal austerity simply aggravates the recessionary dynamic that is the principle economic problem in Portugal. 


What does fiscal austerity mean for the economy?


Fiscal austerity means that unemployment will rise further, production will drop further, and therefore income will drop further in Portugal. And when income drops so will tax revenues, making it even more difficult for the Portuguese government to honor its debts in the future. Simply put, fiscal austerity is not going to solve the Portuguese government budget problem, but instead aggravate the problem. More importantly it will create a tremendous amount of pain — unnecessary and pointless pain — for the Portuguese population.


Any other examples of this?


The proof that fiscal austerity in exchange for stingy bailouts does not work is staring any who care to look straight in the face. Over a year ago Greece imposed severe fiscal austerity in exchange for a loan that was too small with an interest rate that was too high. After a year of even worse recessionary pain Greece has now returned to the EU needing a further bailout. Fiscal austerity didn’t work last time for Greece. A stronger dose won’t work for Greece now. And fiscal austerity is not the answer for Portugal either.


What are the likely consequences of decisions made by the Finnish government?


The fact that the Finnish government, responding to political pressure from the True Finn Party flush from electoral gains, used the veto power EU rules give every member government to insist on even more draconian austerity measures as a condition for an EU bailout for Portugal is particularly disappointing. And threatening to refuse member states any help in rolling over their debts on reasonable terms in the future is a ticket to destroying the EU not saving it.


What form of support should these countries receive in order to best help their citizens in a durable way?


The former, conservative Greek government did indulge in fiscal imprudence. It reduced taxes for its wealthy supporters and corporations, hired Goldman-Sachs to help it disguise the true size of its budget deficits from bond buyers, and left a fiscal mess for the PASOK government that succeeded it. When the global recession hit income and taxes fell further while spending on unemployment insurance and welfare programs increased, aggravating the Greek budget crisis. What the new Greek government needed to do was borrow on reasonable terms to roll over its debts to avoid reducing spending which only aggravates recessionary dynamics while it increased taxes on the wealthy to rectify its long-term budget woes.  The PASOK government’s immediate problem was that major global financial corporations who Nobel Laureate Paul Krugman calls the “bond vigilantes,” were speculating heavily against Greek debt, driving interest rates through the roof, and making it impossible for the Greek government to roll over its debts on reasonable terms.


What course of action the EU should have taken with Greece?


What Greece needed from the EU, and the EU should have been happy to provide, was effective backing for new Greek debt on reasonable terms. At the time the German government was borrowing at roughly 3% and Greece was being charged 10% and higher. The German government could have borrowed to loan to Greece at 4 or 5%, made a profit 1 or 2% for the German taxpayer, and helped Greece grow out of its crisis. No finger pointing. No charge that the German taxpayer is subsidizing Greek consumption. No chauvinistic moralizing about lazy, greedy, unproductive Greek workers that erodes the slender bonds of European solidarity. No counterproductive austerity conditionals that guaranteed that production, income, and taxes would continue to fall and soon bring Greece back to the table to beg for more help.


Coming back to Portugal, what in your view are the main reasons for the Portuguese budget deficit?


The Portuguese budget deficit is not due to imprudent policy but instead the result of the global recession, and if the recession in Portugal and elsewhere were cured Portugal would have no budgetary problems. This is even more true for Spain which had a budget surplus before the global financial crisis hit and triggered the Great Recession. So to insist on subjecting Portugal and Spain to the same counterproductive medicine as Greece makes even less sense. What all the so-called PIGS – Portugal, Ireland, Greece, Spain – need is for the EU to serve, at least for the present, as their financial co-signer on loans to reduce their borrowing costs to reasonable levels, i.e. protect them from the speculative excesses of the bond vigilantes. In the long-run they will also need the EU to help orchestrate some way to reduce their trade deficits with Germany. Providing financial help – at no cost to German or Finnish tax payers — is the easy part, and should have been a no-brainer. Reducing trade imbalances inside the EU when all are tied to a single currency is admittedly more difficult. Instead, the EU has provided loans that are too small, charging interest rates that are much too high – and effectively become the bond vigilantes. Worse still, unlike bond vigilantes who cannot negotiate painful, counterproductive conditions directly with governments, the EU has seen fit to use its leverage to impose sadistic austerity, and apparently the True Finn Party wants the EU to become even more punitive in the future.


Which would entail even deeper crisis, as you explained. What then should be done?


The only way to save the EU is for the EU to use its considerable powers to do what is necessary to engineer an economic recovery. The EU needs to be insisting on meaningful international financial reform at IMF and G-20 meetings, and imposing restraints on those who would speculate at the expense of European governments who merely want to roll over their sovereign debts on reasonable terms. Unlike a PIGS government, or the government of a small third world country, the EU has the power to stare down financial markets. What it lacks is the will to do so. The reason it lacks the will is because so far EU governing institutions are more beholden to financial interests than they are to the EU citizens they are supposed to represent.


What possible first steps should be taken to recover from this recession, and what can small countries such as Finland do?


Portugal, Greece, Ireland, and Spain need fiscal stimulus not fiscal austerity to pull their economies out of the recession. Moreover, the world needs fiscal stimulus not fiscal austerity to end the Great Recession. Governments everywhere, including the PIGS, should engage in aggressive fiscal stimulus. The PIGS have every reason to be angry at Germany and other stronger European economies for not engaging in more fiscal stimulus, while those countries have little reason to criticize the PIGS for running budget deficits — since they should be! PIGS should unite and (a) refuse to accede to counterproductive demands that they engage in useless fiscal austerity, (b) demand that the stronger European economies like Germany launch strong fiscal stimuli as the best way to reduce unsustainable trade imbalances within the EU, and (c) demand underwriting protection from the EU sufficient to earn smaller EU countries reasonable interest rates to refinance their debt. Moreover, other small EU countries like Finland should be supporting this agenda inside the EU, instead of supporting the likes of Angela Merkel and other finger pointing politicians calling for greater fiscal austerity. Finns should be saying to themselves: “There, but for the grace of God, go I.” If things continue as they are we may be speaking of  F—PIGS in another year or two!


Timo Soini took a strong stance against bailout packages in his opinion piece published in Wall Street Journal. If no support is given — what Soini calls the"market principle of freedom to fail" – what will happen to countries currently in debt crisis, and what are the consequences for the European economy?


As I have tried to explain, Timo Soini and the True Finn Party are dead wrong about what economic policies are best for the EU and for Finland as well. Moreover, their appeals to national chauvinism and calls for even more punitive fiscal austerity in the smaller, weaker EU countries will eventually lead to the dissolution of the EU if unchecked. However, they do make one good point, which justifiably resonates with the general populace. Bailing out the banks is intolerable.


It was the reckless behavior of the banks and a poorly regulated international financial industry that brought on the crisis in the first place. For those who profited mightily over the previous decades to be bailed out without serious conditions, while those who neither caused nor profited from the crisis are subjected to punitive conditions and asked to bear the costs of putting broken economies back together again is more than any of us should tolerate. But it is crucial to differentiated between bank bailouts and providing financial cover for governments in distress. They are not the same thing at all, even though Tea Party  politicians in the US and Timo Soini would have people believe so.


The condition the EU should be insisting on in exchange for helpful financial cover for governments working to grow their economies out of recession is that banks and bondholders take a haircut. Instead of insisting that governments get tough with public employees and poor beneficiaries of government programs the EU should be helping governments get tough with the banks and bondholders! Stockholders in banks should not be bailed out. Those who have profited from high “risk premiums” on bonds should not be bailed out when those risks turned out to be real. Popular sentiment to this effect is what politicians like Soini are playing to. But of course for the EU to insist on that kind of conditionality would require the EU to no longer represent the interests of banks and bondholders at the bargaining table in these kinds of negotiations, and instead represent the interests of the citizens of Europe. Meanwhile, for the True Finn Party to call for greater austerity when this means greater austerity for ordinary citizens, not banks and wealthy bondholders, only punishes innocent victims while playing to the crowd’s justified resentment against financial elites without doing anything effective to reign in the banks or make them pay their fair share to solve a problem they created. 

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