How Austerity Policies Destroyed Economies

In the early years of this blog I was rather obsessed with what should be called the callous Greek austerity experiment.

It wasn't just Greece of course. The so called PIIGS countries (Portugal Italy, Ireland, Greece and Spain) all had to go through the same cruel process.

The blueprint was simple: banksters, facing excess liquidity, gave these countries what seemed like "free money" (in the case of Greece they even showed them how to hide it from the EU) and encouraged them to spend it on construction. The infamous real estate bubble.

When the bubble burst, they had a huge exposure, approximately $900 billion for PIIGS countries. So to get their money back without a "haircut" they put into motion a number of tactics.

They pushed their governments into pressuring PIIGS countries, they launched a PR campaign which insinuated that these greedy and lazy people grabbed hardworking taxpayers' money and were now refusing to pay it back.

They also tried to trick PIIGS governments to guarantee private banking debt. The con worked in Ireland and bankrupted the country overnight. As part of the racist campaign about lazy people stealing money, EU members, led by Germany began insisting that PIIGS countries should drastically cut their spending until they paid what they owe.

Any macroeconomist can tell you that when you face such a crisis you either spend more or cut interest rates to near zero as a way to stimulate your economy. In this case, the second option was not available to them as it was outsourced to Brussels. And cutting spending when your economy is contracting is a recipe for disaster.

In fact, this is how they (cough Germany cough) destroyed the healthy and diversified Spanish economy even though it had one of the lowest debt to GDP ratios in the EU.

But the Greek case was especially egregious.

After years of dumping money on its service-based not so diversified economy with the full knowledge that they could never pay it back, banksters were worried about their huge exposure. Deutsche Bank and Societe Generale alone were holding over one fifth of the Greek debt of $500 billion.

If, at the time, the Greek government simply announced that it could not pay this amount and it was defaulting, the EU and the Euro and especially would be in deep trouble. And nothing terrible would have happened to Greece. Actually, I was one of the early and lonely voices to advocate this solution.

It was quite clear that, if they could go back to Drachma, they could print their way out of the crisis. Especially since the crisis coincided with the growing terrorism problem in the Muslim-majority countries around the Mediterranean and Greece was well placed to become a huge tourist destination. It was a no-brainer.

Somehow Greek politicians chickened out or were blackmailed into submission. And despite howling protests from Krugman and a handful of economists, the conservative politicians and a few right wing economist made austerity into axiomatic measures that cannot be questioned.

Rubbish idioms like living within your means or tightening your belt coupled with overtly racist suggestions about lazy and greedy Greeks were used to convince everyone that austerity was the only logical way out of the debt crisis for Greece.

So they applied their painful medicine destroying its economy and a whole generation along with it. All of this might have been okay if the bitter pill led to recovery and lower debt burden.

Take a look at the chart below which I posted two years ago and it was already clear that austerity policies were producing very different results than the ones predicted by their proponents. The line above is IMF projections and the one below is what happened.



Now there is a new study that confirms these preliminary results and show what happened when austerity measures were implemented.

[A]usterity was as big a disaster as its biggest critics said it was.

That, at least, is what economists Christopher House and Linda Tesar of the University of Michigan and Christïan Proebsting of the École Polytechnique Fédérale de Lausanne found when they looked at Europe's budget-cutting experience the last eight years. It turns out that cutting spending right after the worst crisis in 80 years only led to a lower gross domestic product and, in the most extreme cases, higher debt-to-GDP ratios. That's right: trying to reduce debt levels sometimes increased debt burdens.

The study compares the actual results of PIIGS economies with realistic economic models if different policies were implemented or if they their own currencies.

According to this, the hardest-hit countries of Greece, Ireland, Italy, Portugal and Spain would have contracted by only 1 percent instead of the 18 percent they did if they hadn't slashed spending.

If they had their own currency that they could devalue, their economies would have shrunk by only 7 percent.

What about the debt-to-GDP ratio?

[They] would have seen their debt-to-GDP ratios rise by eight percentage points instead of the 16 they did if they hadn't tried to get their budgets closer to being balanced. In short, austerity hurt what it was supposed to help, and helped hurt the economy even more than a once-in-three-generations crisis already had.

The irony is that when the whole crisis started Greece's debt-to-GDP ratio was 130 percent.

Now it is 180 percent.

Its ratio of debt to GDP - how much it owes compares to how much it earns - stands at an eye-watering 180% and its long term hope has to be that at some point at least some of that debt will be written off.

And the funny part is that the Troika (European Commission (EC), IMF and European Central Bank(ECB)) still refuses to change its prescription.

After years of repeating the greedy, lazy Greeks meme, the EC or rather prominent member states are unable to tell their taxpayers that without debt reduction there is no way Greece can overcome the current crisis.

IMF is fine with debt reduction but it wants structural reforms, such as further cuts in Greek pension plans. And ECB is not sure how to fix a problem it helped create.

The only upside to this sordid tale is that, after Brexit, the destruction of the Greek economy might become a problem that EU member states can no longer ignore. With a serious risk of the Union unraveling and the pressures on Euro, Germany might finally relent.

But they might also go for a two-tier union and leave PIIGS and illiberal democracies of Eastern Europe behind.