Why the euro zone economy needs stimulus

Wednesday, 22 October 2014 17:07
Philippe Legrain

Philippe Legrain is the author of European Spring: Why Our Economies and Politics are in a Mess – and How to Put Them Right. From 2011 to 2014 he was economic adviser to European Commission President José Manuel Barroso.

Brussels is not a cheap city. So it might seem like good news that consumer prices fell in Belgium over the past twelve months. If inflation becomes negative, the euros in your pocket stretch further.
But while it is good news if the price of flat-screen televisions falls because technology has improved and competition forces producers to pass lower costs on to consumers, it is not so good news if prices in general are falling because spending in the eurozone is so weak. Deflation is not just a symptom of a sick economy; it makes the disease worse, because it pushes up the real cost of borrowing and makes debt burdens even harder to bear.

More than seven years after the first banks in the eurozone failed, the eurozone is still in crisis. Worse, what began as a financial crisis has become a much deeper economic and political one. The economy remains smaller than in early 2008 and continues to stagnate. One in nine workers – and one in four young people – are unemployed.

This never-ending misery has discredited establishment politicians and EU officials, who have not only failed to resolve the crisis, but have actually made matters worse. The record-low turnout and swing to the extremes in the European Parliament elections ought to be a wake-up call.

The main reason why the eurozone is slipping towards deflation is a lack of demand. Households that borrowed too much in the bubble years, when rising house prices made them feel wealthy, are now scrambling to pay down their debts. Since consumers aren’t spending, companies don’t want to invest.

And since Eurozone economies mostly export to each other, each country’s depressed domestic demand limits demand for others’ exports. The eurozone is relying entirely on demand from the rest of the world in order to grow, but the eurozone is too big and growth elsewhere too weak for that to generate a strong recovery.

That’s why governments and EU institutions ought to be investing more. At a time when households and businesses are cutting back, austerity is counterproductive: since one person’s spending is another’s income, if everyone tries to spend less at the same time, the result is a slump. That’s what happened between 2010 and 2012 when the European Commission enforced the German government’s demands for ever greater austerity.

Since then, austerity has been eased off and economies have stabilised. Now, governments need to go further and actually stimulate the economy with increased investment that would boost spending now as well as future growth.

None of the objections to stimulate the economy stand up. The EU’s fiscal rules don’t permit it? Then change them, or apply them flexibly. Rules should be a means to an end – the improved wellbeing of Europeans – not an end in themselves. It would discourage governments from reforming their economies? Actually, essential reforms can only succeed if they are accompanied by increased investment.

It would be “irresponsible” to borrow more? On the contrary, it is irresponsible not to borrow to invest. Interest rates are near zero which means that any project that yields a positive return is beneficial. Think how Brussels would benefit from more reliable trains, less congested roads, faster broadband internet and better schools. Failing to invest means incurring unnecessary suffering now and bequeathing a smaller economy with lower living standards to younger generations. That is deeply irresponsible.

The new president of the European Commission, Jean-Claude Juncker, has promised a €300 billion EU investment programme. But so far, no new money is available, as Jyrki Katainen, the Commission’s vice-president in charge of economic affairs, admitted in his confirmation hearing at the European Parliament. That needs to change. Boosting the lending capacity of the European Investment Bank is one way of delivering increased investment across the EU. And it needs to be matched by more vigorous efforts by national governments. Now.
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