Europe is going about fixing its crisis in entirely the wrong way, wrote Harvard Professor and former Treasury Secretary Larry Summers in the Financial Times yesterday.Summers built upon mounting enthusiasm for growth- rather than austerity-focused programs, arguing that “Europe has misdiagnosed its problems and set the wrong strategic course.”
EU leaders are hoping that more credible fiscal policies will return market confidence to countries like Italy and Spain, but the idea that a forced end to perceived financial profligacy will restore investor faith misunderstands the problems that caused the crisis in the first place:
Unfortunately, Europe has misdiagnosed its problems and set the wrong strategic course. Outside Greece, which represents only 2 per cent of the eurozone, profligacy is not the root cause of problems. Spain and Ireland stood out for their low ratios of debt to gross domestic product five years ago with ratios well below Germany. Italy had a high debt ratio but a very favourable deficit position. Europe’s problem countries are in trouble because the financial crisis under way since 2008 has damaged their financial systems and led to a collapse in growth. High deficits are much more a symptom than a cause of their problems.
This does not necessarily mean an end to economic reforms outright, Summers writes. Indeed, timely reforms will be necessary to restore competitiveness in the long term. However, emphasising austerity at the expense of growth helps no one:
Since for a country income is determined by spending, a country that pursues austerity to the point where its economy is driven into a downward spiral does its creditors no favour. Yes, there will ultimately be a need to raise retirement ages, reform sclerosis-inducing regulations and restructure benefit programmes. Phased in, commitments in these areas would be constructive. But the prospect for success, politically and economically depends on the restoration of growth.
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