How Europe’s Double Dip Could Become America’s

Europe is in recession.

Britain’s Office for National Statistics confirmed on Wednesday that in the first quarter of this year Britain’s economy shrank .2 percent, after having contracted .3 percent in the fourth quarter of 2011. (Officially, two quarters of shrinkage make a recession). On Monday Spain officially fell into recession, for the second time in three years. Portugal, Italy, and Greece are already basket cases. It seems highly likely France and Germany are also contracting.

Why should we care? Because a recession in the world’s third-largest economy, combined with the current slowdown in the world’s second-largest (China), spells trouble for the world’s largest.

Remember – it’s a global economy. Money moves across borders at the speed of an electronic impulse. Wall Street banks are enmeshed into a global capital network extending from Frankfurt to Beijing. That means that notwithstanding their efforts to dress up balance sheets, the biggest U.S. banks are more fragile than they’ve been at any time since 2007.

Meanwhile, goods and services slosh across the globe. If there’s not enough demand for them coming from the second and third-largest economies in the world, demand in the U.S. can’t possibly make up the difference. That could mean higher unemployment here as well as elsewhere.

What’s the problem with Europe? Don’t blame it on the so-called “debt crisis.” There was no debt crisis in Britain, for example, which is now experiencing its first double-dip recession since the 1970s.

Blame it on austerity economics – the bizarre view that economic slowdowns are the products of excessive debt, so government should cut spending. Germany’s insistence on cutting public budgets has led Europe into a recession swamp.

German Chancellor Angela Merkel, who has led the austerity charge, and other European policy makers who have followed her, have forgotten two critical lessons.

First, that the real issue isn’t debt per se but the ratio of the debt to the size of the economy.

In their haste to cut the public debt, Europeans have overlooked the denominator of the equation. By reducing public budgets they’ve removed a critical source of demand — at a time when consumers and the private sector are still in the gravitational pull of the Great Recession and can’t make up the difference. The obvious result is a massive slowdown that has worsened the ratio of Europe’s debt to its total GDP, and is plunging the continent into recession.

A large debt with faster growth is preferable to a smaller debt sitting atop no growth at all. And it’s infinitely better than a smaller debt on top of a contracting economy.

The second lesson Merkel and others have overlooked is that the social costs of austerity economics can be huge. It’s one thing to cut a government budget when unemployment is low and wages are rising. But if you cut spending during a time of high unemployment and stagnant or declining wages, you’re not only causing unemployment to rise even further. You’re also removing the public services and safety nets people depend on, especially when times are tough.

And with high social costs comes political upheaval. On Monday, Netherlands Prime Minister Mark Rutte was forced to resign. U.K. Prime Minister David Cameron is on the ropes. The upcoming election in France is now a tossup – incumbent Nicolas Sarkozy might well be unseated by Francois Hollande, a Socialist. European fringe parties on the left and the right are gaining ground. Across Europe, record numbers of young people are unemployed – including many recent college graduates – and their anger and frustration is adding to the upheaval.

Social and political instability is itself a drag on growth, generating even more uncertainty about the future.

What European policy makers should do is set a target for growth and unemployment — and continue to increase government spending until those targets are met. Only then should they adopt austerity.

What are the chances that Merkel et al will see the light before Europe plunges into an even deeper recession? Approximately zero.

The danger here for the United States is clear, but there’s also a clear lesson. Republicans have become the U.S. party of Angela Merkel, demanding and getting spending cuts at the worst possible time – and ignoring the economic and social consequences.

Even if the U.S. economy (as well as President Obama’s reelection campaign) survives the global slowdown, we’re heading for a big dose of austerity economics next January – when drastic spending cuts are scheduled to kick in, as well as tax increases on the middle class. But the U.S. economy isn’t nearly healthy enough to bear this burden.

If nothing is done to reverse course in the interim, we’ll be following Europe into a double dip.

This post originally appeared at Robert Reich’s Blog and is posted with permission.

10 Responses to "How Europe’s Double Dip Could Become America’s"

  1. Erich   April 26, 2012 at 12:57 pm

    The problem with Europe is that an stop in austerity means more debt, and who should provide the money for that debt. The market would just ask for very much higher interest rates. So it will be of not help, if all the new debts has to be spent on the higher interest.

    And the German tax payers don't like to provide the extra money for the south. They know that it will never be payed back. Maybe in the US the situation will be different. If California goes bankrupt, the New Yorkers might provide an extra 10% VAT for them, but the US are a country with a common language.

    • juana   April 30, 2012 at 11:08 pm

      Make that "the midwest" will have to pay for bankrupt California, New Jersey and New York. Those states that got used to being a net receiver of fed revenue (Texas included), it will have to ponny up to help the coastal states. It's gonna be tough.

      • R. Coutinho   May 2, 2012 at 4:11 am

        California, from a source I saw, got only $0.75 for every $1.00 it gave in federal taxes.

  2. barf   April 27, 2012 at 7:45 am

    "common sense." Adam Smith.

  3. Ian Black   May 1, 2012 at 11:07 am

    You say "Why should we care? Because a recession in the world’s third-largest economy, combined with the current slowdown in the world’s second-largest (China), spells trouble for the world’s largest."

    I think you will find that Europe has the largest economy not the US. Eropean GDP is bigger. I know the US likes to think it's number one!

  4. Ian Black   May 1, 2012 at 11:12 am

    You also say "There was no debt crisis in Britain, for example, which is now experiencing its first double-dip recession since the 1970s."

    Firstly, there is a debt crisis in the UK – just as there is in most developed countries/regions. Secondly, this is not a double dip – the UK never left recession. I know in theory two quarters of "growth" mean exiting recession but the GDP highs of 2007 were never reached again.

    • R. Coutinho   May 2, 2012 at 4:13 am

      Umm…"…but the GDP highs of 2007 were never reached again."

      Isn't that the definition of "double dip"? I mean, double-dip is when you have another contraction before reaching the previous high, right? Otherwise it would simply be another recession…or am I getting something wrong here?

  5. Ian Black   May 1, 2012 at 11:22 am

    And lastly, you say "A large debt with faster growth is preferable to a smaller debt sitting atop no growth at all. And it’s infinitely better than a smaller debt on top of a contracting economy."

    Good old Keynes! Trouble is this game has been played once too often. There will be no lasting growth in developed economies, because they can't compete with the developing economies on cost. You can't inflate away the debt this time because Globalisation prevents wage inflation. Yes, Central Banks creating money from nowhere can give a temporary boost to a shrinking economy, but it won't last very long. The FED and ECB are now sitting on the toxic assets they bought from their banks and the banks are still insolvent. Keynes has a lot to answer for but even he said Governments should pay down debt in the good times, but they didn't. Now the debts are so large they cannot ever be repaid and we owe most of this money to ourselves (Pensions etc). Why should the unborn pay our debts? BIG changes are coming as people realise they won't get what politicains have been promising for decades.

  6. R. Coutinho   May 2, 2012 at 4:18 am

    The unborn can not be forced to pay our 'debts'. In fact, they can no more pay for our 'partying now' than we could pay for them partying later. We consume our goods and services. They will consume their goods and services. It may be that they can not purchase as much–simply because not as much is made, but it can not be that they can not purchase as much because they ship what they make into the past. That is, for practical and physical reasons, impossible.

    So…although inflation could hit in big ways, the debts (of sovereign issuers of currency) are only a burden by way of inflation–not by way of capacity to pay. Thus Keynes had it right. Meanwhile, inflation is a possible problem and needs to be watched carefully. Taxes are the real way to prevent the creation of money causing inflation (as taxes will take that money back out of circulation). The Fed does not have taxing authority (neither does ECB).

  7. Wanda Renee   May 19, 2012 at 1:21 am

    Point of concern is we have tried more than we needed to. It seems no one is concerned about the fact as we evolved in human population we seem to be getting more onerous and unconcerned about the next man. If we don't start to think about doing for others first we lose all conscience of the big picture. Do unto others as you would have them do unto you has been lost and now we face the piper. Global econo is important, but when no country has the right answer and the sh*t rolls down; it now will slowly but surely crawl upward and all the kings horses and all the kings men can't find the pieces to put it all together again – REAL TRUTH!