Smart Austerity – its just the same dumb austerity

“In its current form, EMU is not viable in the long run”. That quote comes from a Report – Repair and Prepare – Strengthening Europe’s Economies after the Crisis – jointly published by the – Jacques Delors Institut (located in Berlin) – and the Bertelsmann Stiftung – (located in Gütersloh, Germany). The Report purports to lay out a blueprint to prepare Europe for the “next potential threat to its very existence”. It proposes a “path towards renovation” to create an “ever closer union”. They claim that they have taken up this task because there is “extensive ‘crisis fatigue’ and ‘euro area debate fatigue’ in “in governmental circles and the media”. I would call it adherence to ideological Groupthink rather than fatigue. There has been a major failure yet none of those who created the failure have put their hands up to take responsibility. Once they dismissed the problem as being caused by “profligate and fat Greeks (insert vilified nationality as to your preference)”, various policy makers and media commentators resorted to the even more amorphous “structural problems” to explain the on-going crisis. The media has been full of captive writers who just reiterate press releases from neo-liberal politicians and/or mainstream economists. So is this new Report different? Is their plan viable?

Before you get too excited, you might also like to know that the former organisation was founderd by the French politician after he finished his time as European President.

Delors will be remembered as the French neo-liberal (despite his socialist affiliation) who oversaw the disastrous Delors Report that informed the Treaty of Maastricht. It is clearly pro-Eurozone.

The German outfit is an off-shoot of the Paris-based – Notre Europe – Jacques Delors Institute. It is run by one Henrik Enderlein who is pro-Eurozone.

Meanwhile, the Bertelsmann Stiftung has a history of advocating neo-liberal changes to public education and labour market reform in Germany.

So you might expect my answers to the initial questions are No and No.

Remember that the Delors Report (1989), which informed the Maastricht conference, disregarded the conclusions of the previous Werner and MacDougall Reports about the need for a strong federal fiscal function.

The earlier reports were dismissed as representing ‘old-fashioned’ Keynesian thinking, which was no longer tolerable within the Monetarist Groupthink that had taken over European debate at the time and remains dominant.

The new breed of financial elites, who stood to gain massively from the deregulation that they demanded, promoted the re-emergence of the free market ideology that had been discredited during the Great Depression.

The shift from a Keynesian collective vision of full employment and equity to this new individualistic mob rule was driven by ideological bullying and narrow sectional interests rather than insights arising from a superior appeal to evidential authority and a concern for societal prosperity.

The Monetarist (neo-liberal) disdain for government intervention meant that the EMU would suppress the capacity of fiscal policy and no amount of argument or evidence, which indicated that such a choice would lead to crisis, would distract Delors and his team from that aim.

Delors knew that he could appease the French political need to avoid handing over policy discretion to Brussels by shrouding that aim in the retention of national responsibility for economic policy making.

He also knew that the harsh fiscal rules he proposed that restricted the latitude of the national governments would satisfy the Germans. Monetarism had bridged the two camps.

That is the ideology that the Delors Institute inherited.

The new Report resembles the 1989 Delors Report in some ways. It proposes “a three-phase reform plan to be implemented over a period of approximately 10 years” which was the same sort of transition that the introduction of the euro followed.

The Director of the Delors Institut in Berlin, Henrik Enderlein was a co-author on a 2012 report, which proposed boosting the automatic ‘cyclical response’ capacity in Europe.

[Reference: Enderlein, H., Bofinger, P., Boone, L., de Grauwe, P., Piris, J-C., Pisani-Ferry, J., Rodrigues, M.J., Sapir, A. and Vitorino, A (2012) ‘Completing the Euro. A road map towards fiscal union in Europe’, Notre Europe, Jacques Delors Institute, June].

Their reasoning was symptomatic of the Groupthink among European economists that led to the problem in the first place.

Many of the authors of that report were involved in various studies that gave rise to the design of the EMU. Now, as the system they lauded has failed, they proposed to patch it up with various ad hoc measures, all of which are ring-fenced by the austerity mentality.

They refused to “even consider the option to abandon the euro” (p.3) and are, instead, guided by the principle: “As much political and economic union as necessary, but as little as possible” (p.3).

They continue to maintain that the “principle of subsidiarity”, justifies this minimalist approach to fiscal union. Subsidiarity means that the responsibility for action should be at the level where it is most effective. Of course, that should mean that fiscal policy should be at the level of the currency-issuer.

But the neo-liberals determined that it should remain at the national state level despite the governments being stripped of their currency-issuing capacity.

Further, the Stability and Growth Pact (SGP) and the subsequent austerity packages forced onto many of the Eurozone economies during the crisis severely compromised the so-called fiscal autonomy of these nations.

It seems that democracy and autonomy can be violated when the Troika is imposing the terms, but then in other cases, it is upheld as a sacrosanct principle that cannot be compromised.

This sort of hypocrisy has woven its way through the entire debate about economic and monetary integration in Europe and will continue to deliver sub-par outcomes.

Enderlein et al. (2012: 7) proposed a simple rule for the limits of democracy – “sovereignty ends when solvency ends”, which is astounding if you think about it.

The application of this rule inevitably leads to a violation of democracy because the risk of insolvency is intrinsic to the flawed design of the monetary system.

Member States are forced to issue debt in a currency they have no control over and the ECB is formally precluded from giving any guarantees (although of course it has violated that prohibition via programs such as the SMP and will do so again with its latest QE announcement).

But default risk and insolvency are always lurking, waiting for the next major economic downturn to arrive

Thus as soon as a nation falls into crisis, its citizens lose the capacity to influence their own destiny and are, instead, at the behest of unelected officials in the European Commission, the ECB and the IMF. That doesn’t appear to be a road map for a sustainable and prosperous Europe.

Their preferred approach to “cyclical divergences” (Enderlein et al., 2012: 26) is to “enhance the real exchange rate channel” (p.28), which is code for making internal devaluation more responsive through increased labour mobility and wage cuts in declining regions.

The authors thus invoke the standard neo-liberal approach – workers from recessed regions should move to growing regions and those who stay should worker harder for less pay.

The virtue of stable social communities built on family structures and community spirit is ignored. The economy rules and workers are considered meagre pawns in the decisions by management on where to locate industry.

One would think a primary aim for any durable solution to the European crisis is to keep regions viable, especially as the authors recognise that “Linguistic and cultural barriers are certainly important” (p.8).

Labour mobility is also unlikely to be of sufficient magnitude to provide any semblance of equalisation in unemployment rates within the Eurozone.

A recent OECD study found that between 2009 and 2011 there was no discernible movement among citizens who were already resident within the Eurozone.

To supplement their ‘structural’ emphasis, which they admit would be “unlikely to solve the inherent difficulties” (p.30), Enderlein et al. (2012) proposed ‘a cyclical adjustment insurance fund’.

This fund would be managed by Eurozone finance ministers and build its kitty from contributions from nations experiencing above the Eurozone growth rates and pay out to nations in crisis, to “reduce pressure on public finances” (p.31).

The scheme would thus force nations to reduce their domestic spending in times of buoyant economic growth and provide some relief in bad times.

Significantly, the authors stress the “the system cannot become a hidden instrument for permanent transfers” (p.31) and nations might only be permitted to “take out what they once paid in” (p.32).

Once again the presumption is that the ‘federal’ redistribution would be neutral across the economic cycle and across space, a proposition for which there is no rationale other than fiscal conservatism.

So, now in early 2015, have these authors learned anything that might allow them to break with their past Groupthink-type analysis?

The current Report suggests not!

On page 1, they introduce what they call “smart austerity” which would create a European-level investment strategy while hacking into public spending at the national level.

But obviously austerity is austerity, however we might like to define it. An output gap can be estimated in terms of the extra spending that is required to close it, to produce the new orders and sales, and promote extra employment.

The extra spending might take the form of investment or consumption spending (recurrent). The former builds extra productive capacity, while the latter better exploits the existing productive capacity.

An economy can shift spending away from consumption towards investment spending over time but there will be adjustment problems – moving labour from producing consumption goods and services into capital goods production. But it can be done.

But if there are large total output gaps, cutting public consumption spending and replacing it with investment spending, however sourced (public or private) will not close the output and income gap. It just shifts spending. Austerity implies that overall public spending is being cut.

There is no such thing as smart austerity when an economy is is need of significantly higher levels of spending (however it might be composed). Austerity is austerity. In those cases it is always dumb.

So it seems that the current Report is still locked into the austerity mindset and trying to ‘sex it up’ by calling it smart as opposed to dumb.

They also coin the term the “True EMU” (TEMU) as opposed to the EMU, which by implication, they are now acknowledging was ‘untrue’ or deeply flawed and unworkable. They call the existing EMU a “Minimalist Monetary Union (MMU)”.

They present some “Recent developments” where they document the on-going failure of the existing structure. In summary, they conclude that “no full-fledged recovery is in sight” and “popular discontent is rising quickly”. The Greek election results are testament that one nation’s people reject a significant proportion of the existing orthodoxy.

The Report concludes that:

… the crisis has given rise to economic and political developments that, if left unchecked, pose a grave threat to European prosperity and stability …

They also understand that spending is the key to growth and a failure to invest in new productive capacity undermines the long-term prosperity of the Member States.

So what is the Roadmap they propose?

They summarise it as being defined by two steps: Repair “the massive economic and political damages” and prepare (eradication of “systemic weaknesses”).

They claim the crisis caused the damage but fail to admit that the fiscal austerity has caused the most damage after an early recovery was engendered by expanding fiscal deficits.

The crisis hit the US economy hard too but the on-going fiscal stimulus there led to a return to growth. The Eurozone has been stuck in stagnation since 2010 because of fiscal austerity – nothing else.

What do they think are the “roots of the euro area’s troubles”? Essentially, “crucial elements of a sustainable currency union were missing” from the MMU. Definitely!

They claim that the 3-percent rule in the SGP failed to provide sufficient scope for nations beset with inflationary circumstances (real estate bubbles driven by the unitary interest rate rule) to invoke “anti-cyclical fiscal policy”. It was “too lax in good times”.

This claim invokes the underlying theme that the crisis was caused by the peripheral nations going into excessive debt. But the real estate booms in Spain were accompanied by fiscal surpluses. Further, Ireland, another real estate boom nation, ran very tight fiscal positions.

They also acknowledge that the SGP was “too tight in difficult” times, a fact that is self-evident.

The Report invokes the concept of “optimum currency areas” (OCA) and states what we have known for years (and was rejected by the Delors Report and its feeder studies).

They say that:

… the benefits of a currency union can be expected to outweigh its costs when it encompasses a homogeneous economic area … the euro area has never been an ‘optimum currency area’.

I analysed the issue of OCAs in these blogs:

In terms of the debate leading up to Maastricht, there was a clear divide among the US-based studies which rejected the viability of the proposed design and thought it unlikely that it would proceed to fruition, on the one hand; and the European-based studies, particularly those sponsored in one way or another by the Commission, that were generally positive overall.

The OCA concept became an organising framework for the debate over the viability of the proposed EMU.

OCA theory purports to define the conditions under which several independent countries will be better off sharing a currency, or alternatively, fixing their exchange rates.

Optimal refers to the collection of geographic units (in the case of the EMU, Member States) that would most effectively enter a monetary union. Too few ‘geographical areas’ or too many will deliver a sub- or non-optimal arrangement.

Refer back to those blogs for detailed analysis of the three defining conditions. They are in summary:

1. The economic cycles of the countries move together (up and down) and they face common consequences if hit by a negative shock.

2. There should be a high degree of labour mobility and/or wage flexibility within the group of countries such that if unemployment rose in one country, workers could quickly move elsewhere to find jobs.

3. There is a common risk-sharing structure so that fiscal policy can transfer resources from better performing to poorly performing countries without constraints.

The EMU proponents in the late 1980s did not consider the requirements set out in the OCA literature to be significant for their plans.

The Maastricht Treaty was more about making progress towards the adoption of the single currency and the requisite institutional changes that would be required to accommodate this process rather than a deep analysis of whether it would be optimal.

Why was the existing economic framework (OCA), which specifically dealt with the issue of when union is desirable and when it is not, ignored?

In its 1990 – One Market, one money. An evaluation of the potential benefits and costs of forming an economic and monetary union – publication (it is a 20mb download), the European Commission (1990a: 46) concluded that the OCA literature provided a:

… rather limited framework whose adequacy for today’s analysis is questionable.

They claimed that the “whole approach ignores policy credibility issues which have been stressed by recent macroeconomic theory” (p.46), which was code for OCA being associated with the Keynesian view that fiscal policy provides an effective means of stabilising economies hit with private spending fluctuations.

The ‘policy credibility issues’ related to the unproven Monetarist assertions that fiscal policy was ineffective and caused inflation, which can only be controlled with tight monetary policy.

Any serious application of the OCA theory would have been highly inconvenient to the proponents of the EMU.

For example, the Treaty deliberately negated the capacity for a federal fiscal capacity to redress regional unemployment and there was no sense that labour was mobile.

Whichever way you wish to interpret the OCA theory, it is very obvious that the group of nations that entered the EMU did not remotely satisfy the conditions required to ensure that the adoption of a common currency would be beneficial overall.

The result was that the only adjustments open to them once a major private spending collapse occurred would be very costly, a point ignored by the EMU proponents.

The 2008 crisis has demonstrated what was already known during the OCA debate in the early 1990s. The ability to absorb external spending shocks, such as the one that arose from the housing collapse in the US in 2007, is very different across the Eurozone countries.

The stronger industrial countries like Germany and the Netherlands, which also have the capacity to generate external surpluses, are in totally different situations to the capital importers such as Spain and Greece. The stronger nations can absorb spending shocks much better than the weaker nations of the union.

Financial Times chief economist Martin Wolf noted in 2010 that:

The crisis in the Eurozone’s periphery is not an accident: it is inherent in the system. The weaker members have to find an escape from the trap they are in. They will receive little help: the zone has no willing spender of last resort; and the euro itself is also very strong. But they must succeed. When the Eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters.

Despite the various interpretations that have been made of OCA theory, the fundamental prediction that emerges from it is that if the essential conditions are not in place, then unemployment will rise significantly in some Member States in the face of a large asymmetric decline in spending.

This prediction has clearly come to fruition.

In other words, the designers of the EMU would have been better advised to heed the general message from OCA before pushing on regardless. Ideology ruled and millions have suffered.

The malevolence goes further though. The neo-liberal economists now use OCA theory as a means to justify attacking labour protections and wage security. They argue that while the requirements for establishing an OCA were irrelevant to the decision to create a monetary union, once the union has been created, there is a need to ensure that the requirements are in place.

Suddenly, all the pro-EMU economists started to recognise OCA theory because, in this form, it was now supportive of their neo-liberal intentions.

The whole emphasis on the need for ‘structural’ reforms is just code for cutting worker entitlements and creating an environment of income and job insecurity.

In this context, the current Report suggests the following “missing elements” from the MMU:

1. “Completion of the single market and policy convergence” to reduce national boundaries to labour mobility and different regulatory conditions. But, national language and cultural barriers have always made it difficult for labour to move within Europe.

2. “EMU-wide coordination of demand management” to achieve “Business-cycle synchronisation” – in other words, introduce a Europe-wide fiscal capacity. The devil is in the detail. The authors do not envisage a federal fiscal capacity that can issue its own debt and not be constrained in the size of the deficits they might run.

3. Need for Europe-wide assistance fund to help struggling nations and the commensurate development of the political processes to ensure such assistance is speedy.

In effect, if a truly federal fiscal capacity is introduced and the responsibility vested in the European Parliament as is befitting a democratic allocation of federal resources, then the need for ‘bailout’ funds is no longer there.

The fact that the Report continues to consider a European Stability Mechanism suggests they are not in favour of a truly federal fiscal capacity.

We learn that when they introduce their so-called True Economic and Monetary Union (TEMU), which would construct (in their view) “a monetary union able to cope with endogenously arising imbalances as well as exogenous shocks”.

But their prescription is just a repeat of the convergence disaster which followed the signing of the Treaty of Maastricht and paved the way for nations to adopt the common currency. The Report claims that process was “extraordinarily successful”.

Various accounting fudges were used by nations to satisfy the criteria. Very few nations went close but that was papered over because the European Commission was intent on ramming the common currency through.

The current Report claims that their Roadmap would be based around “structural reforms” and the consolidation of “public finances” (code for cutting deficits) and a commitment to “legal obligations” (code for reinforced SGP).

While the Maastricht convergence process was marked by “sanctions” to engender obedience (they were not enforced as no-one was denied entry), the Report claims entry into the TEMU would be motivated by positive incentives.

What might they be?

As an additional incentive for countries struggling with high budget deficits, the Commission could make clear that efforts to reach the agreed-upon indicators will be taken into account when considering the setting and extension of budget-deficit reduction deadlines.

So the same sort of fiscal rules – just applied a little more flexibly, if the nation demonstrates they are scorching their economies with structural reforms (code for cutting wages, pensions, employment protections, public welfare etc).

Their fiscal transfers proposal amounts to a system where there would be “no net transfers over the medium term” but a struggling nation could “receive payments during cyclical downturns”. That is, they would have to pay them back.

But this implies that fiscal deficits would have to be matched over some medium-term period by surpluses. That is the old mantra which ignores that for nations with external deficits, and a desire to save overall by the private domestic sector, on-going fiscal deficits are required to maintain growth.

Even with external surpluses, the desire to save overall by the private domestic sector, might require on-going fiscal deficits.

There is no economic rationale for a balanced budget rule over the economic cycle.

In a truly functional federation, some nations might have to run permanent deficits. In fact, it is highly likely that most European nations would be in that situation.

So their cyclical stabilisation scheme fails for the same reason that the current EMU fails.

And then we get to more detail on the “smart austerity” proposal.

They claim that:

In order to ensure the sustainability of euro-area governments’ budgets even in the face of higher levels of investment expenditure, each country would pledge to engage in “smart austerity.”

What is it? It involves:

… reorienting fiscal policy away from public consumption and towards investment. This option may be politically challenging because it would likely include cutting expenditures on social transfers and public sector employees … But even countries that are constrained by fiscal rules and market expectations can reasonably hope to lower debt-to-GDP ratios by performing a budget-neutral reorientation of their spending.

See the arguments above about output gaps. Note the use of the word “hope” rather than can. This is the same nonsense that we have been getting from these pro-Euro think tanks for the duration of the crisis and before.

Suddenly the market will love a nation that is enduring rising mass unemployment, declining sales and recession.

It gets worse though. Because the proposal involves cutting public spending and trying to induce the private sector to undertake the increased investment.


Another pro-Eurozone Report that is locked into the same neo-liberal mindset about the need for balanced fiscal positions and tight discipline.

And it introduces another indecency into the nomenclature – “smart austerity”.

Greek elections

The results in the Greek elections were very good. I have received a lot of E-mail criticising my skepticism about Syriza’s capacity to honour its title – radical coalition. The signs were that it was slipping towards the centre to assuage the voters. Time will tell.

The main problem is that has continually claimed it is pro-Euro. I cannot see Greece sustaining prosperity in a monetary union with the likes of Germany and the neo-liberal fiscal rules that are imposed on all Member States.

It might be that the ‘re-negotiation’ of the debt will create a major dynamic that allows fiscal policy flexibility. I doubt that will happen, which explains my skepticism.

But getting rid of the vandals that had rendered Greece a poorly performing colony of Germany is very welcome. I hope that now they are in power they can introduce some truly radical plans, which would provoke Germany into forcing them out of the union.

That is enough for today!

(c) Copyright 2015 Bill Mitchell. All Rights Reserved.

This Post Has 11 Comments

  1. timeless article again, cheers bill! Living “inside” the EMU-area you just really can feel the impact of the mindlessness of current fanatics of orthodox agenda

  2. The sooner the whole EU currency disaster crashes and burns the better (peacefully I hope of course!)

    It makes me think all the bureaucrats involved in the whole design of the EU plan are simply treading water for their pension plan if it even exists at the end if all this. Madness on a mass scale.

    Shame on them all fir the human suffering in their names!

  3. Global late stage capitalism under US and EU hegemony allows no alternatives. If Greece attempted to leave the EU under Syriza and the Independent Greeks (which seems unlikely in any case), the Greek military would stage a coup backed and fomented by the US.

    Of course, global late stage capitalism cannot last indefinitely. It is unsustainable politically, economically and environmentally. But again, one cannot say too much on a dedicated MMT blog. It would be off-topic.

  4. Dear Prof. Mitchell,

    I complete agree with your post. Unfortunately, here in Spain, the elites, the media and the politicians are convinced that the Euro is a project that has to be saved at whatever the cost. Public opinion hardly gets to hear dissenting opinions. Even the new party Podemos, in an effort to appear “respectable” has now toned down their opposition to the Euro. I am happy for the electoral victory of Syriza but they have stated that they want to negotiate their debt (it’s not the debt, it’s the currency that is a problem). My efforts to convince my fellow citizens about the futility of persisting in this madness fall on deaf ears. However I will persevere in spreading the message. Either you get a complete integration with a real federal government or it is better to undo this crazy monetary union before it destroys everything else. But for most people in Spain this message is taboo. I need help.

    I find that your post provides a complete review of the failings of the Euro. Would it be acceptable if I translated it into Spanish and publish it in my blog, your blog or both?

  5. When the suffering becomes great enough, change will occur. My concern is whether that change will be real reform, or whether it will be a new form of tyranny and dictatorship.

  6. One should be, but unfortunately we can’t be – considering the track record, astonished at the inability of the EU councils to see how money works, what I prefer to call Modern Monetary Mechanics. It’s straight out explanation of what is actually the mechanism of macroeconomics all over the world. All plain facts. Yet those who should know hold their tongue and those who don’t shouldn’t be in jobs that really require knowing.
    I hope The new government in Greece exposes the bankruptcy so evident in EU policies. Fingers crossed there.
    I hope someone knowing about MMT gets the Government’s ear. It will be vital ammunition for the anti austerity cause.
    IMO the EU should pay Greece the entire cosy of their losses due to Austerity. It’s “only Money” and free for the EU as well!

  7. Tsipras was on newsnight last night, essentially telling us that they may well leave the euro, and stating that was certainly HIS position, whilst intimating it was that of many party members but had been considered unpalatable by the electorate at the time of election.

    All very bright notes, and Im a little more confident now that they may take Greece down some more positive pathways.

  8. But again, one cannot say too much on a dedicated MMT blog. It would be off-topic.

    Au contraire. The insights of MMT map the route out of the mess we find ourselves in.

  9. Incidentally, what needs to be done about the Greek situation is widely understood by most heterodox economists, not only MMT advocates (in any case, I would regard MMT as being an important subdivision of postKeynesian economics).

    Even people on the liberal fringe of the economic orthodoxy, like “nobel” lauriates Paul Krugman and Joseph Stiglitz, are becoming highly vocal about the desperate need to increase aggregate demand in the southern European countries via the fiscal route. And if this requires exiting the Eurozone, so be it.

  10. First of all it most certainly is not dumb.
    The wealth concentration experiment is working quite well.

    “. The goods balance fell to a record deficit of 7.1% of GDP in Q3 2014, indicating that the value of UK goods exports is substantially lower than the value of UK goods imports. In geographical terms, the UK’s substantial deficit with European and Asian countries is partially offset by surpluses with nations in the Americas.”

  11. National government is run by the global usury machine.
    There is no salvation in national government unless groups such as the Canadian action party take control.
    Its best to form village cooperative structures that do not engage in global trade which is really nothing more then a effort to concentrate energy rather then trade goods based on comparative advantage.
    Syriza is yet another globalist conspiracy.
    Its leaders writings is enough evidence of that.
    Stating that Europe is a nation for example.

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