Friday, April 3, 2009

Trans-Atlantic stimulus debate

The fundamental difference between the Europeans and Americans in addressing the economic crisis revolves around the divergence in opinion about the importance of fiscal stimulus measures. The Europeans, with their stronger and comprehensive social security systems and labor rules that makes lay-offs difficult, all of which act as automatic fiscal stabilizers, naturally see limited utility in any fiscal stimulus. Instead they feel that the opportunity presented by the crisis and the need of the hour is more stronger trans-national regulation of the financial markets to prevent future outbreaks of such bubbles and distortions. Americans, in contrast, with their minimal social safety cushions, attach greater importance to government spending to drive the economy out of recession.

The Europeans feel that thanks to these automatic stabilizers, they have no need for further stimulus right now because their social safety nets, derided in good times by free market disciples as sclerotic impediments to growth, are automatically providing the spending programs that the United States Congress has to legislate. They also claim that their extensive job protection and unemployment insurances (calibrated to keep people on the rolls till bad times are tided over), while criticised as being bad during the boom times, are of great value during the downside.

There are three more reasons for the Europeans reluctance to pursue large government spending. One, the Euopeans have limited ability fo indulge in fiscal spending given their tight European Union Stability Pact norms that places stringent restrictions on the ability of individual nation states to run up debts. Second, the legacy of the inter-war years, when the hyper-inflation and crippling debts, fuelled by the massive government spending in the preceding years, was one of the reasons for the rise of fascist movements in parts of the continent.

Finally, unlike the US, whose financial institutions indulged in reckless and greedy lending and borrowing, the European banks were relatively prudent and well regulated and relatively unaffected by the events in Wall Street (except the inevitable contagion). Neither did they experience the same levels of rise in home prices and mortgage lending. Further, the major European economies have lived well within their means and do not suffer from the gross macroeconomic imbalances that bedevil America. The more visible signs of distress like unemployment, have moved by about a percentage point to about 8-8.5%, unlike the US, where it has increased by over three percentage points over the past year. Their economic problems stem mainly from the collapse in global demand, which has adversely affected domestic businesses. Therefore they see little reason to indulge in any domestic spending, and prefer to wait for those responsible for causing the crisis to get their house in order.

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