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Austerity, Strong Medicine or Just Plain Bad Medicine?

March 7, 2012


In a recent New York Times article, Holger Schmieding, chief economist at Berenberg Bank in London is quoted as saying, “Austerity is like every potent medicine; an overdose of it can kill the patient.  The tragedy of Greece is that they overdelivered on the austerity and underdelivered on the structural reforms; as a result, Greece is in a big mess.”

Schmieding’s statement is indicative of a new trend in commentary on the Eurozone economic crisis.  Not even the most stalwart advocate of Chicago School economics can claim that the doctrine of “expansionary austerity” is working in Europe.  Even in countries where this prescription was implemented with comparative ease and cooperation, like Portugal and Ireland, its results have been chilling.  Growth has been stymied, and the markets, looking at the growth projections, have further raised the interest rates, creating a vicious circle in which future debt projects rise as well.  Faced with a wealth of evidence mitigating against austerity, analysts are trying to explain the failure of the Troika’s economic policy mandates in Greece by separating structural reform, which is defined as beneficial, from austerity, which is defined as bad, particularly when done in excess. 

The problem here is that there is a failure to recognize that demands for structural reform have also contributed to this downward spiral.  Structural reform is a crucial part of Greece’s economic health moving forward.  It does not, however, create short-term economic benefits for an economy as a whole.  This is demonstrated by the attempt to break up Greece’s closed professions.  Greece has some 120 closed professions, professions in other words where membership is limited by either the issuance of government permits or guild memberships.  These closed professions were some of the first areas targeted for structural reform in the wake of the troika’s initial intervention in the Greek economy in May 2010. 

Two of the first closed professions to be targeted were taxi drivers and tanker drivers.  These were exclusive clubs.  To drive a taxi or tanker required possession of one of a limited number of government-issued permits.  The permit wasn’t annual or biennial.  It was permanent.  It was basically a license to work and, as such, it acquired value, often times a lot of value.  Tanker permits were rumored to be worth in the neighborhood of €250,000 on the market, and those who possessed them saw them as either inheritance to be passed on to children or a source of income for retirement.  Taxi permits were not worth quite as much, somewhere in the neighborhood of €150,000-$200,000, which is still a very large chunk of change.

Clearly, this is an illogical system, but unwinding it is not an easy proposition, particularly in a period of financial crisis and particularly when demands for structural reform are being accompanied by demands for austerity.  When the government informed tanker and taxi drivers that their permits were being done away with and consequently no longer held value and that their jobs were no longer secure, the waves of protest nearly tore civil society apart. 

On top of that, the push for this type of structural reform now doesn’t make a lot of sense.  The benefits of structural reform are not immediate.  They are amortized over decades.  In the short run structural reform can actually further economic downturns.  The push for structural reforms, in Greece, has actually contributed significantly to the economic crisis, and while they may, at some point in the future, lead to a sustained period of economic health for the country, their benefits are too distant and too gradual to contribute to the resolution of the current crisis. . . . at least let’s hope so, though the insistence on austerity may be dragging Greece into a downward spiral that will last 5-10 years.

Structural reforms should be implemented, but they should be implemented within a 10-year window that will minimize their negative impact on the current economy.  They also need to be implemented in a matter that takes into account the specificities of the Greek economy.  Every economy has its idiosyncrasies.  Some of these idiosyncrasies damage the overall output and productivity of an economy.  Others are, quite simply, just a different way of doing business.  Critical, strategic changes need to be made.  Change for the sake of change needs to be avoided.

The other problem with Schmieding’s statement is that it seeks to thrust the onus of the current policy quagmire back on the Greeks instead of admitting the failure of Chicago School dogma to address the current economic environment.  “Silly Greeks,” he seems to be saying, “we gave them the right recipe, but they have failed to get the proportions right.”

The problem isn’t with the execution of the recipe; it’s with the recipe itself.  The Greek government, to be sure, has a less the perfect record on implementing structural reforms. For that matter, they have a less than perfect record on implementing the austerity demands.  I want to open up another possibility here: that the government’s foot-dragging on structural reforms and austerity, by seeking to mediate the negative repercussions of wrongheaded policy, has actually prevented the crisis from being worse than it is. 

I am not against structural reforms, and I am not against paying down debt.  I am against doing these in the midst of an economic downturn and when a country has no ability to devalue its currency.  I am also against doing these when there are other, more humane and enlightened alternatives available.  Austerity in times of economic downturn and without the support of a free-floating currency isn’t strong medicine shocking the system to health.  It’s bad medicine plain and simple.

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