What America Must Learn from the Euro Crisis

With the fiscal cliff approaching both the left and right are ready to misinterpret Europe's economic woes.

With the so-called fiscal cliff looming, policy makers in Washington are preparing for debate and, perhaps, some compromise. Across the Atlantic economic collapse is unfolding, and on both sides of the economic spectrum the fiasco in Europe is being used as rhetorical ammunition by pundits and politicians. On the right the eurozone crisis is being portrayed as the inevitable future of the United States if spending is not curbed. On the left the failure of so-called austerity is all the evidence that is needed for Congress and the White House to avoid spending cuts and lower taxes. Indeed even President Barack Obama has tried to persuade some European leaders into spending more. Both of these interpretations are misguided, however, and each one threatens to endanger fiscal and monetary reform in the United States.

Much of Europe was relieved by Obama's re-election. The German newspaper Der Spiegel ran a piece on what Obama's re-election means for the eurozone in the midst of the euro crisis. The piece included an observation on how Democrats view many of the austerity programs being implemented in the eurozone nations:

For the Democrats, Europe has pursued a tin-eared draconian policy of cutting deeply in the euro-zone South. The result has been economic pain and political unrest with little prospect of near-term growth. This critique holds that the current institutional set-up within the euro zone robs governments in Greece, Spain, and Italy of the policy tools necessary to animate their economies, put vast swaths of unemployed workers back to work, and, consequently, reignite growth. This stance sees the euro-zone crisis as vindication for the Troubled Asset Relief Program (TARP). 

This is an accurate portrayal of how many liberals view the euro crisis: Austerity has failed, government intervention and fiscal activism is required to return to growth. One of the left's most vocal supporters of this sort of argument is the neo-Keynesian economst and New York Times columnist Paul Krugman, who has been criticizing European attempts at austerity. For those of Krugman's persuasion, economic stimulus can help provide the growth needed for economic recovery. Such a theory views wars and natural disasters as opportunities to grow the economy, not massive drains on productivity.   

It is true that the economic progress made by governments that have been explicitly pro-austerity, like the British government, has been disappointing. However, what many on the American left do not understand is that there have been very few spending cuts in the U.K. and other countries in Europe, and in fact the British government has increased taxes. What meager cuts have been made to the British budget are in large part thanks to inflation; nominally the British budget has been increased. A New York Times editorial (which mentions Britain specifically) from October codifies this misunderstanding while criticizing Romney's thoughts on Greece.

One of the most important recent developments in Europe has been the 2013 Greek "austerity" budget. To most people "austerity" means a reduction in spending. However, the 2013 Greek budget projects that the Greek debt to GDP will be 191.6 percent in 2014 (up from the 144.3 percent debt to GDP rate proposed in the 2010 bailout plan). European politicians and policy makers had hoped to have the Greek debt to GDP down to 120 percent by 2020, something that the IMF still supports. However, it now seems that the deadline could be extended to 2022. When the prime minister of Luxembourg announced this possible change in deadline it was greeted by laughter.

On the American right we can expect the anti-European rhetoric to continue. Throughout Obama's first presidency he was accused, especially during the health care reform debate, of trying to implement "European-style socialism." To most Europeans this characterization is confusing (especially considering the levels of government spending under Republican presidents), and any digging into many of these criticisms leaves only empty politically useful rhetoric to be found.

Given the closeness of the fiscal cliff, chances are that Republicans, who claim to favor small government and lower taxes, will invoke what is happening in Europe as a good reason to cuts spending. During the campaign Mitt Romney made sure to mention Spain and Greece.

Unfortunately, to call the euro crisis a problem of spending is too simplistic. Although Greece certainly spent too much money in the years before the recent crash other countries on the brink of fiscal collapse are in their situation for reasons other than government overspending.

Spain is perhaps the best example of a country in the eurozone in crisis for reasons other than overspending. In 2008 Germany had a higher debt to GDP than Spain and Ireland, two countries that have been among the hardest hit by the recent crash. Germany, by comparison, has become the European powerhouse that is the source of much of the rest of the eurozone's bailout money. If government spending alone were the cause of Ireland and Spain's present unfortunate situation we would expect Germany to be in a similar mess.  

There are lessons to be learned from the crisis in the eurozone, but is too simplistic to say that the main takeaway from the euro crisis is that overspending can wreck an economy.

What is happening in Europe can teach American policy makers the perils of not only overspending, but also the dangerous situation that bad banking and monetary policy inflict can inflict on a country. The real lesson from Europe is that the institutions that allow citizens to use and store money are in need of reform as much as the government's attitudes towards spending.

Going forward the American left must acknowledge reality and recognize that no European country is practicing true fiscal austerity. The right, on the other hand, must accept that what is happening in Europe is not just a spending problem. There's no hope of tackling the fiscal crisis at home until politicians and policy makers on both sides of the aisle understand what's happening abroad. Needless to say, I'm not getting my hopes up.