A new Keynesianism in Europe

Europe simply can't afford to implement Keynesianism as an antidote to the current crisis, caused in the first place by debt and out-of-control spending

Keynes in colour?
Dr. Emanuele Canegrati
On 17 May 2012 12:56

In the last weeks, a wind of political change has blown across Europe. Bad news: it’s a socialist one.

The recent general and local elections in Greece, France, Germany and Italy, together with the fall of the Dutch government, show how the sovereign debt crisis is falling over the politics of the EU member states. They also show how the European electorate, weary of having to pay the high price of a financial crisis that never seems to end, decided to punish those politicians who have been shown to believe in the German rigor, moving towards more promising politicians, at least on paper, who declared a willingness to take more Keynesian-oriented economic policies.

After losing a far-too-loyal ally in the now ousted, Nicolas Sarkozy, German Chancellor, Angela Merkel is now in a position of great weakness when she has to discuss with the new Socialist President, Francois Hollande, about how to find the right fine-tuning between rigor and growth. Even the Greek situation is in sharp decline and the possibility of a return to the drachma is anything but abstract.

In this extremely convoluted political landscape, the German-imposed fiscal compact risks not being ratified, an event that may force European leaders to find new solutions, probably more cautious than the previous ones, to the problem of Western European public finances.

Now, looking at the historical trends of the debt-to-GDP ratio of the European Union and the Euro area (Figure 1), we can hardly blame the orthodox economists for their concerns. The coefficient, in fact, has increased significantly in recent years, moving from a value below 75 percent in 1996 to a value greater than 80 percent in 2011. A sharp increase has been identified as from 2008, when the international financial crisis has exploded in all its fury. The situation of European public deficits (Figure 2) has deteriorated considerably. In fact, if in 2000 the EU countries as a whole, had achieved a net surplus from that moment onwards the trend has deteriorated significantly and touched a deficit of -7 percent in 2009 and then gradually climb up to -4 percent in 2011.

The new European politicians who have appeared on the scene, including recently sworn-in French President and the Italian premier, Mario Monti, are once again offering a recipe for the crisis based on the implementation of the Keynesian philosophy of deficit spending, intended to bring the EU members’ public finances to their final hour.

The Keynesian doctrine teaches that, in an economic recession, the government should intervene by increasing government spending and lowering taxes, that is by creating deficits to be financed with debt. But Europe simply can't afford to implement Keynesianism as an antidote to the current crisis, caused in the first place by debt and out-of-control spending. As once wrote one of the founders of the economic doctrine of the  Public Choice, James Buchanan, in his essay "Democracy in deficit," the consequences of the Keynesian paradigm can only be those of systematic deficits, high inflation and an over-empowerment of the public sector – the exact opposite of what Europe needs right now, i.e. a return to small government, where the real empowerment goes to the market and the competition, once again entrusted with the levers to create growth and prosperity for the Europeans.

Keynesianism is not the boon that its apologists believe to be, but it is, and it has definitely been in Europe, a disease that threatens to destabilize the proper functioning of the democractic process. In the past, when Keynesianism was the fashion in the United States, it created a dangerous gap-inflation spiral, despite the fact that the more orthodox monetarist school denied, and still do, such a close interrelation, asserting that the inflation was caused by a faulty control of the money supply.

The increases in the government expenditure-to-GDP ratio and the size of the state bureaucracy are the natural consequences of the Keynes-inspired policies, whereby the state bureaucrats have assumed a growing importance, while limiting freedoms of citizens and the functioning of the private sector.

In today’s Europe, liberal and old-school socialist politicians, who do oppose the advance of neo-socialism, are few and far between. Only a crippled German Chancellor, who has never been liberal, but at least believes in constitutionalism, and a British prime minister who can’t, and perhaps doesn’t even want to impose, his ideas on the European stage, remain. For Europe, the blessed market economy may well remain, for the decades ahead, a mere utopia. 

Dr. Emanuele Canegrati is economic advisor for the Budget Office at the Italian Senate 

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