Euro Crisis

Europe Is Stuck: It Can't Cut and Grow at the Same Time


Europe Is Stuck: It Can't Cut and Grow at the Same Time

Photograph by Zhuo Lei/xh/Xinhua Press/Corbis

European leaders are looking for ways to get growth going again, but tough deficit-reduction rules prevent them from using the most obvious tool: government stimulus. The Europeans could learn from the Obama administration, which despite the occasional misstep has gotten the recovery formula correct: Gas now, brakes later.

Europe is choking off its own recovery by insisting on premature austerity. The first mistake was to agree on unrealistically tough deficit-reduction targets. The second mistake was—rather, is—to insist on compliance with those targets even though they are doing serious damage to Europe’s economy.

“For the credibility of the whole operation, I think it is necessary that we maintain these budgetary targets,” European Union President Herman Van Rompuy said on Mar. 2 at a summit meeting in Brussels. “If we don’t do that in a consistent fashion, then we will be punished by the markets.”

Rompuy, a true believer in a strong union, was elected to a second 2 1/2-year term at the summit. But the organization’s hard line, far from pulling nations together, is splitting them apart. Spanish Prime Minister Mariano Rajoy waited until the summit was over to announce that he was raising Spain’s budget-deficit target for this year to 5.8 percent from 4.4 percent. Spain’s deficits are rising because the economy is weak—the latest unemployment rate is 23 percent. But after what were politely described as “talks” with Italian Prime Minister Mario Monti, Rajoy changed his tune again and said Spain would stick to the EU goal. Rajoy, a People’s Party representative elected in December, didn’t completely back down. He said Spain will unveil a “reasonable” spending plan on Mar. 30 based on “prudent” forecasts.

Europe did better than the U.S. in the early stages of the financial crisis. But it did too little to strengthen its banks, and it dialed back on stimulus too soon. Now the policies followed by the U.S. look good by comparison—the U.S. unemployment rate fell in January to 8.3 percent. Europe’s 27 countries had a blended rate of 10.1 percent in January.

Europe’s most indebted countries don’t have the financial wherewithal to stimulate their economies, but creditor nations such as Germany do. Instead, they are joining in the austerity—compounding the problem instead of alleviating it. Germany managed to slash its budget deficit to 1 percent of GDP last year.

No country can run big budget deficits forever. But by aiming for fiscal rectitude when the economy is weak, Europe is causing an economic contraction that depresses tax revenue, forcing governments to cut spending even further in a lethal downward spiral.

Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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