Greece does battle with creationist economics: can Germany be brought into the 21st Century?

from Dean Baker

Europeans have been amused in recent weeks by the difficulty that Republican presidential candidates have with the theory of evolution. But these cognitive problems will only matter if one of these people gets into the White House and still finds himself unable to distinguish myth from reality. By contrast, Europe is already suffering enormous pain because the people setting economic policy prefer morality tales to economic reality.

This is the story of the confrontation between Greece and the leadership of the European Union. The northern European countries, most importantly Germany, insist on punishing Greece as a profligate spender. They insist on massive debt payments from Greece to the European Union and other official creditors to make up for excessive borrowing in prior years.

The current program requires that Greece’s tax revenues exceed non-interest government spending by 4.0 percent of GDP, the equivalent of $720 billion a year in the United States. This money is pulled out of Greece’s economy and sent to its creditors. Making matters worse, because Greece is locked into the euro at present, it is not able to regain competitiveness by lowering the value of its currency relative to the richer countries in Europe.

The result of the German program for Greece has been an economic downturn that makes the Great Depression in the United States look like a bad day. Seven years after the start of the downturn Greece’s economy is more than 23 percent smaller than its peak in 2007.

By comparison, at the trough of the Great Depression in 1933 the U.S. economy was 26 percent below its pre-recession peak in 1929, but it grew 10 percent the following year and had made up all the lost ground by 1936. On its current path Greece will be lucky if it returns to its pre-crash GDP by the middle of the next decade, twenty years after the crash.

The tales of hardship are endless: an unemployment rate of more than 25 percent, a youth unemployment rate of more than 50 percent, a collapsed health care system. The European Union folks may not know much economics, but they sure know how to destroy a country.

Interestingly, even their morality tale is at best half-true. Greece was a profligate spender, but what about punishing the reckless lenders? They were largely bailed out by the European Union, the International Monetary Fund and the European Central Bank, who now hold the vast majority of Greek debt. What about punishing Goldman Sachs, which designed the swap that allowed Greece to hide its debt so it could get into the euro in the first place?

Apparently the desire to punish sin only applies to the weak, not the rich and powerful who commit transgressions. The double standard is even clearer when applied to crisis countries like Spain and Ireland who had not been profligate borrowers. They had been running budget surpluses before the crisis. This was entirely a story of reckless lenders in Germany and elsewhere making bad loans to the private sector in these countries. Yet, the austerity policies being imposed ensure that the people of Spain and Ireland suffer even if the pain is not quite bad as in Greece.

The absurdity is that if the northern Europeans could get over their need to inflict pain, it would be easy to design policies which would allow the whole continent to benefit from more growth. If the deficit target for Greece was relaxed, it would be able to grow more rapidly. For example, assuming a multiplier of 1.5 (GDP grows one and a half times any increase in government spending), if Greece was required to run a primary budget surplus of 1.0 percent of GDP rather than 4.0 percent of GDP, its GDP could expand by 4.5 percent due to additional government spending. In fact, since the additional growth would lead to additional tax revenue, Greece’s economy would likely expand by more than 6.0 percent with this lower target.

The obvious complaint from the northern countries is that if Greece gets this concession other crisis countries will demand the same. That is correct, and they should get similar relief. The net effect will be much stronger growth in southern Europe, which will lead to increased demand and more growth in northern Europe as well. What exactly is the problem?

Since the crash, which incredibly caught all the economic “experts” by surprise, we have seen one myth after another destroyed by the evidence. Deficit reduction did not lead to a surge in investment due to increased confidence. Printing money in a badly depressed economy did not lead to runaway inflation or plunging currency values.

The time has come for the European Union to stop running economic policy based on silly myths. If German Chancellor Angela Merkel and other leaders in the European Union cannot accept reality then Greece and southern Europe would be far better off breaking free of the euro and leave Germany to wallow in its 19th century economic fairy tales.