The Austerity Misdirection

The Austerity Misdirection
Fixed exchange rates are especially unforgiving of welfare states that destroy their ability to create wealth
Updated May 4, 2012, 7:17 p.m. ET
By HOLMAN W. JENKINS, JR.

You might think there exists, among onlookers to Europe's struggles, a debate between fans and critics of austerity. There's not.

Across the spectrum, most have believed from the beginning that it was a very bad idea to squeeze economies with higher taxes and sharply reduced outlays to pay back debts that were unpayable.

Almost universal has been agreement that policy should focus on cutting debt, even if it means default, and restoring growth, not squeezing blood from a stone. What difference has existed is the old difference between Keynesians and their critics. Keynesians advocate (even in the circumstances) increased government borrowing and spending as the way to restore growth. Their supply-side critics favor tackling impediments to growth with more efficient tax codes, deregulation and privatization of state-owned assets.

Cutting crosswise through these groups, too, are degrees of willingness to advocate a measure of inflation to help the adjustment.

So how did we end up where Europe's solution has consisted mostly of tax hiking and spending contraction? Put aside those whose polemics are shaped by a need constantly to construct and reconstruct their mental worlds so all their "enemies" are on the wrong side of every debate.

Even among the non-deranged is a habit of ignoring constraints. Good ideas that can't be put into effect aren't good ideas. Bluntly put, the Keynesian remedies (borrow, spend, adjust later) require things of Germany that German politicians cannot deliver.

Governments engage in austerity not because they want to, but because they have nowhere to get the money they'd like to spend and spend. The German people don't want to tax themselves—or indirectly tax themselves with inflation—so Spaniards, Greeks and Italians can spend the money.

And inevitable is the half-spoken argument about the size of government. Whether or not Europe's governments are too big, they are certainly too big for the euro. Fixed exchange rates between sovereign, democratic countries may be practical in a world of atomized businesses and individuals who don't conceive of an alternative to organizing their lives by price signals. The gold standard certainly worked well for the better part of a century.

But that's not our world and never will be again. In France, 56% of national income is controlled by the state. Across Europe, the first recourse of every interest group and voting bloc is to expect the state to protect them from inconvenient adjustments dictated by mere price signals.

To say Europe walked blindly into monetary union is an exaggeration. Bureaucratic Europhiles hoped it would necessitate a march toward a United States of Europe. Pro-business Europhiles hoped it would force a return to the market.

The inchoate answer coming from Europe's voters, however, was "we want neither." It may be today that the message coming from voters is "we don't want the euro." Much depends on Germany. To choose not to choose (the current path) is probably to concede a chaotic version of the inflationist-Keynesian program. The European Central Bank will print money. Governments will spend it. Any commitment to pro-growth reform will be problematic and haphazard at best.

The alternative, assuming Berlin won't lead a forced march into a United States of Europe, would be for Germany, and any countries desirous of being in a currency bloc with Germany, to drop out of the euro. Their new currency would rise versus the remaining euro countries, costing them a painful short-term adjustment. This would be sad. It would strike many Germans as an unfair reward for their competitiveness, though they'd also be well-positioned to benefit from an asset fire sale in Europe. But if Germans hate inflation as much as they say they do, leaving may be the only alternative to losing a war (already begun in this weekend's French election) for control of the European Central Bank. On the current path, it's only a matter of time until the ECB surrenders and makes its contribution to adjustment by debasing the euro. Can we admit now the simple lesson is against excessive debt? Don't be impressed by those who protest that Spain and Ireland were brought down by private-sector extravagance. If we've learned anything, in a debt crisis the distinction between public and private disappears. Too, a closer look shows the Irish state an intimate participant in Ireland's housing boom, collecting 40% of the price of every new home in taxes. In Spain, regional governments owned or controlled the lenders that financed the construction binge.

A fixed exchange rate system is an especially unforgiving environment for a welfare state that destroys its ability to create wealth. But the universal lesson is: Don't be a welfare state that destroys its ability to create wealth.

A version of this article appeared May 5, 2012, on page A15 in some U.S. editions of The Wall Street Journal, with the headline: The Austerity Misdirection.