Europe trashed: The coming austerity implosion is a scary precedent

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World leaders are doing their best to provoke a global economic downturn of epic proportions. Of course, it is politically hazardous for leaders to admit this. Democratic accountability can be inconvenient when leaders are obsessed with imposing economic austerity policies.

The new Euro area agreement provides political cover for these unpopular measures. To appease financial markets, European leaders have submitted to the "new fiscal rule," a pledge to keep government budgets balanced or in surplus.

This new fiscal rule will have the force of law. Countries are required to enshrine this new fiscal rule in their national level constitutions.

If a country is in violation of the new fiscal rule, coercive measures can be taken. These countries will be subjected to the ominous "excessive deficit procedure," a structural adjustment program reminiscent of the IMF-style policies imposed on developing countries. These are the sort of austerity measures that have been sending desperate Greeks into the streets.

This fiscal compact is all about appeasing financial markets. They are worried that European banks loaned too much to some European countries. Might we point out that banks decided to lend to European countries? No one put a gun to their heads. But now banks want reassurance that they won't suffer much as a result of their own business decisions. Banks want assurances that their sovereign debt exposure will be made more palatable to financial markets

Financial markets have been subjecting these banks to intense pressure, and speculators are now gunning for countries throughout Europe (whether or not those countries have any severe debt problem). Since twitchy financial markets are spreading damage far and wide and threatening the survival of the Euro, world leaders pretty much give them what they want. They need some breathing space to sort out a number of problems plaguing the Euro area.

These legal shackles placed on governments diffuse the biggest threat to the imposition of the financial sector's austerity agenda: democratic accountability. Remember when former Prime Minister George Papandreou suggested that the Greek people be allowed to vote on the measures that were impoverishing them? Financiers and their political allies went ballistic.

The new fiscal rule is intended to make sure that governments can resist democratic pressures by forcing them to enact austerity measures, regardless of what their citizens want. If needed, countries can be coerced into the modern equivalent of debtor's prison, in which domestic economies are bled dry in order to channel every possible euro towards meeting whatever deficit or debt targets financial markets demand.

Worse still, this agreement is setting a scary precedent. Since anti-deficit credibility is what financial markets are looking for, countries will likely impose this fiscal discipline on themselves even before the coercive measure of the new fiscal compact are triggered. Even countries who are not party to this agreement will feel pressure to conform.

Economic implosion: The big risk of the new fiscal compact

Not only are these anti-deficit pledges anti-democratic, they may backfire big time. If countries ramp up economic austerity measures, this agreement may very well parlay an economic recession into a global depression.

Austerity measures always increase the likelihood of economic downturn. But austerity measures in many countries simultaneously are a different kettle of fish than austerity measures in a single country. In a best case scenario, a single country might move through economic austerity measures fairly quickly and get on the road to recovery. There is certainly no guarantee of this, but an individual country might survive the short-term pain if other factors soften the blow of the austerity measures.

But if all countries pursue austerity measures at the same time, the worst case scenario is much more likely: a prolonged and severe international economic downward spiral that threatens to end in a genuine global depression.

Why? Consider the austerity in one country. This country's outlook will be grim if overall spending in the domestic economic contracts as government spending contracts. But in the best case scenario, the shrinkage in government spending will be counteracted by some other kind of spending.

There are three possible ways to compensate for the reduction in government spending when a country pursues austerity programs:

1) Domestic consumers may spend more, but this is unlikely. As economies face tough times, unemployment rises, leaving folks with less money to spend. Meanwhile nervous consumers are also hit by cutbacks in government programs. Plus today's households are so plagued with their own debt problems that they really can't borrow much more to buttress their spending. All of these pressures on regular folks mean that consumer spending is not likely to be able to pick up the slack once government austerity kicks in.

2) Domestic businesses might spend money to counterbalance the retrenchment of government spending. The problem businesses are reluctant to ramp up production in this economic environment. Who will buy their output, now that governments are cutting back what they buy and consumers are also under pressure?

3) The last hope is that exports will soften the blow of austerity measures. If other countries are doing well, those countries may buy the stuff that this country produces. To meet export demand, businesses will spend money, thereby employing people who in turn will be more inclined to go shopping. Thus vigorous exports will support both business and consumer spending to soften domestic government austerity.

If all European nations submit to the austerity measures at the same time, the possibility of exports saving the day evaporates. Your neighbouring nations can't buy your exports because they are going through austerity measures too.

Exports certainly helped Canada survive the punishing budget cuts of the mid-1990s. But Canada had a crucial advantage: all of its potential export customers were not simultaneously engaged in their own austerity measures.

Today's rush to appease financial markets with austerity measures is moving us all closer to economic implosion. If all countries were to embrace austerity measures at once, the resulting economic downturn would be cataclysmic.

Unfortunately, lots of countries outside Europe are also joining the austerity craze. Tea Partiers in United States would love to impose a fiscal straight jacket in American government spending, and they just might use the European constraints to demand similar measures at home. No doubt Stephen Harper would love to seize on any pretext to accelerate his downsizing of government in Canada.

Maybe China and other countries will be able to buy all of the stuff that that Europe, U.S. and Canada will no longer buy while they impose austerity policies, but that is an awfully big gamble. After all, those countries need to sell what they produce back to Europe and North America, so they will be affected by the austerity squeeze too.

Embracing austerity to appease financial markets is a huge threat to the global economy. If our politicians succumb to this austerity mania, we may be in for an unparalleled economic implosion. And despite this threat, financial markets may still not be satisfied that the fiscal compact is punitive enough! Never was democratic debate more needed, because the financial and political elites are pointing us precisely in the wrong direction.

Economist Ellen Russell is a research associate with the Canadian Centre of Policy Alternatives. Her column comes out monthly in rabble.ca.

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