February 23, 2012

On the Brink: Fiscal Austerity Threatens a Global Recession

Dr. Heiner Flassbeck, Director, Division on Globalization and Development Strategies, UNCTAD: European austerity policies past the point of no return, driving global economy towards deep and lengthy recession
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Dr. Heiner Flassbeck graduated in April 1976 in economics from Saarland University, Germany, concentrating on money and credit, business cycle theory and general philosophy of science; obtained a Ph.D. in Economics from the Free University, Berlin, Germany in July 1987. 2005 he was appointed honorary professor at the University of Hamburg.

Employment started at the German Council of Economic Experts, Wiesbaden between 1976 and 1980, followed by the Federal Ministry of Economics, Bonn until January 1986; chief macroeconomist in the German Institute for Economic Research (DIW) in Berlin between 1988 and 1998, and State Secretary (Vice Minister) from October 1998 to April 1999 at the Federal Ministry of Finance, Bonn, responsible for international affairs, the EU and IMF.

Worked at UNCTAD since 2000; from 2003 to December 2012 he was Director of the Division on Globalisation and Development Strategies. He was the principal author of the team preparing UNCTAD's Trade and Development Report, with specialization in macroeconomics, exchange rate policies, and international finance. Since January 2013 he is Director of Flassbeck-Economics, a consultancy for global macroeconomic questions ( Co-authored ACT NOW! The Global Manifesto for Economic Policy published in 2013 in Germany.


On the Brink: Fiscal Austerity Threatens a Global RecessionPAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington.

In December 2011, the United Nations Conference on Trade and Development issued a document. It contained a rather dire warning. Here's a little bit of what that document said:

"The world stands on the brink of a double-dip recession and a 'lost decade' for many countries. UNCTAD calls for a concerted and co-ordinated expansionary policy alternative including the following key elements:

"The countries threatened by recession and deflation should avoid intensified austerity measures because these are unlikely to produce the intended outcomes and could propel the world into a renewed bout of recession, or even into an outright depression. Without an increase in domestic demand, employment and wages in the surplus countries, the most likely outcome would be a new round of global economic contraction. This is likely to trigger a ripple of adverse effects at the international level, including a collapse in trade and investment and growing pressures for protectionism."

Now joining us is one of the authors of that report, Heiner Flassbeck. Heiner is director of Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development. He's an expert on global finance. Thanks very much for joining us, Heiner.

HEINER FLASSBECK, UNCTAD: Thank you for inviting me.

JAY: So that's a pretty serious warning. In fact, the title of the document is "On the Brink". Why do you think the situation is so serious? And certainly in Europe, and probably most other places, at least North America, we're not seeing stimulus and we're seeing quite the opposite, we're seeing pressures for austerity, especially in Europe.

FLASSBECK: Well, in Europe the situation is surely worse than the one we had expected in December. Europe is on the verge, really, of going into a downward spiral. We see cuts, deficit cuts in all countries. We see dramatic wage cuts. Minimum wages in Greece were just cut or to be cut in a couple of weeks by 20 percent. This will all lead to a dramatic fall in domestic demand in Southern Europe. In the north of Europe we do not have much domestic demand. Germany is flat as ever. And so far there is really a big, big danger that Europe's going into a deep recession, whereas at the same time, the United States is still quite fragile. It's not yet in a recovery, really. So—Japan is in recession. Still the situation is very fragile.

JAY: Now, it's not like this is happening because it's bad weather. It's not a natural phenomena. The policymakers of European finance and political elite are sitting down. They're making these demands. The banks are making these demands. They know this is where it's headed. What's their objective here?

FLASSBECK: Well, the point is, I think even the banks are smarter than the politicians here. If you look at Standard & Poor's latest downgrading of some European countries, then you read between the lines that they say austerity is not enough—even they say austerity is not enough. So the politicians are really stubborn here in Europe, and it's an uphill struggle to convince them that they cannot go on like this. I wonder how long the recession will take them to learn that this is the wrong way. In Greece, in a deep recession now for two years, they have not learned that they're going for a more dramatic package of cutting.

And so I really am running out of fantasy how we can change course. There are a number of economists all around the world, in Germany as well, who are fighting against this, but at this moment of time there is no way that we can change course. The European Commission is fully on the German line. Most of the big countries on the north are on German line. So—and Germany is not willing to move a bit. So this is going to be, really, a test in economic theory, unfortunately, but with dramatic negative results for a lot of people, for people who are starving in Greece already and people who are desperate about their futures.

JAY: Now, in your report you said that wage deflation is actually the underlying problem, or at least one of the underlying problems of the crisis. But here wage deflation seems to be part of the objective, to actually have, you know, a more intensified wage deflation. And I guess add to that privatization. I mean, has the financial elite of Europe simply decided that, okay, we're going to go through this "catharsis", quote-unquote, and see what we can make of it, lower wages, and pick the bones of the welfare state, and privatize as much as possible? I mean, is that actually what the game plan is here?

FLASSBECK: Yeah, but if it is the game plan, then it's the wrong game and they will not achieve what they get—what they want, because in the end this means faltering demand, domestic demand, in all the countries and in United States, is only due to the fact that people have again reduced dramatically their savings ratio. That cannot go on forever. People need expectations for rising income; otherwise, they will never consume as much as is needed to even—to uphold the profits that the people are expecting. So if there is a game plan, it's the wrong one, it's a deeply flawed game plan, because this cannot work out.

Look at Japan. Japan is a classical example of falling wages for 20 years. We just have new data this week that showed us that Japan is really deflating from the wage side. So they're deflating the wage side, and then they're getting falling prices. Then economic policy doesn't work anymore. This is the game plan. But it's not by design, so to say. It's by—more, in my view, by stupidity than design that we're running into such an exercise.

JAY: So what should the governments be doing? I mean, it sounds like you're suggesting virtually the exact opposite course.

FLASSBECK: Yeah, we need an intervention into the labor market. The people do not understand that the labor markets are not working like a market for potatoes are other simple things. The market for labor is tremendously different, it's totally different, fundamentally different, because falling wages mean—in the first round mean falling demand, mean falling domestic demand, and not rising employment that would compensate for the fall of demand of the people, of the single person. So this is fundamentally flawed. And this is still the most valid, so to say, or the most acknowledged theoretical model, that we have a neoclassical labor market where flexible wages are a good thing.

If you look now at Europe or you look at the OECD report, recent OECD report, they all say, well, you can cut—in the government budget, you cut government expenditure, but if you—at the same time you cut wages, you get a positive effect on growth, which is in my view absolute nonsense, which is based on the flawed view that if you cut wages you increase your competitiveness. But against whom are we going to increase our competitiveness? Against another planet or what? The European Union is much too big to cut wages in an attempt to beggar their neighbors in the United States or elsewhere. That will never work.

So this is a flawed idea from the beginning that did work for the last ten years in Germany, because their neighbors, German neighbors, were sleeping, so to say, did not realize what was happening inside the Monetary Union. But that cannot be repeated on a global scale. And so competitive—increasing [competitiveness] does not work. If you cut wages, the only thing that you will get is fall in domestic demand and no growth and no rise in employment.

JAY: What I don't get about Germany's interests here is I thought Germany had been competing with China for being the number-one exporter in the world. But the majority of their exports, if I understand correctly, were going within Europe, and to a large extent into the peripheral countries. How—what happens to Germany if the countries they've been exporting to, people can't buy anything anymore?

FLASSBECK: Yeah, that's—that's the point. That's the perspective that we are—that we have. Germany has, so to say, competed with its clients. That they never understood. But it was really never understood in Germany economic policy discussion of the last 20 years. We had a discussion that we have to increase—indeed, as a nation, not for companies, but as a nation we have to increase our competitiveness. We have to fight China and other nations.

Inside the Monetary Union, many people said, oh, this gives a golden opportunity to cut our wages and then to—so to say, to defeat our neighbors finally, and so that we have the market shares and we'll never give them back. What they forgot is the simple little thing that if your clients are economically dead, they will not be good clients anymore. And this is what comes now to the fore, that Germany had, really, a wrong strategy. And even those people who benefited from the beginning will in the end suffer. The German export industries was clearly the main beneficiary of this policy. They are swimming in money at this moment of time. But let's go another two years, and you said it, with the huge export share of the European Monetary Union, it will be a plain disaster.

JAY: So the demand in Greece to get out of the eurozone is getting more. We're hearing that the people are suggesting the only possible way out for Greece is to dump the euro and have a drachma and lower the exchange rates, and so Greece gets more competitive. I mean, first of all, is that an answer for Greece, do you think? And does that then start to spread to some of the other countries in similar crises?

FLASSBECK: Well, let's not underestimate the problems of such an exit. If you exit such a currency union, it is extremely difficult politically and economically to get your feet on the ground, so to say, to stop the economy from contracting in the first round. You need, then, someone who stabilizes your currency—the currency, the new currency, will drop like a stone. And if you then have to call the IMF in, again, with conditionality or other things, or your neighbors in, it's not better than it is now. Then you have a depreciation, but you're nevertheless—you're not, so to say, the master of your own universe.

And so far it's politically extremely difficult. It can endanger democracy, because this whole process process to manage technically is not easy and the people are not used to it. So it's a very, very, very, very risky experiment that it would go into. But the point is the desperation grows on the other side. If you push them into another year of recession, at a certain point there will be no party anymore in Greece that will be electable, that will be in a position to promise to the people that they will change things. And at such a point of time, then the impossible may happen or the things that you could not imagine will happen, as happened in Argentina, for example. But we should not forget in Argentina it was a big mess. It was—Argentina was very close to a failed state. There were riots on the street. The political system was in shatters. So it's really, really very risky.

JAY: But people do point to Argentina as sort of a success story about default, that in the final analysis it worked for them.

FLASSBECK: Yeah, but it was not mainly default. In Argentina what really worked was the devaluation. We should not forget that Argentina was in a good situation insofar as it devalued into a booming global economy. That is a very important advantage. But on the other hand, we should take into account Argentina devalued (we calculated that on a weighted, trade-weighted average) by 65 percent against the rest of the world, 65 percent devaluation of the currency against the rest of the world. If this would happen in Europe with, say, a number of Southern European countries, the whole trade patterns would collapse in a very short time. The countries would get out better in the end, in the end they would come out of their recession, but for the world as a whole, given the size of these countries we're talking about, Italy and Spain and so on, for the world as a whole it would be a shock against which Lehman and all these things were really ridiculous events.

JAY: So I hate to give a subjective interpretation of this, but you're sounding pessimistic, in the sense that the kind of policy you're suggesting in Europe is not seem to be on anyone's agenda that has the power to enact it.

FLASSBECK: Yeah. We—at this moment of time there is no turnaround. As I said, there may be a change sometime further down the road. When we have election in France, that may change the game plan a bit, because a new president, if there will be a new president, would clearly be on a politically different—well, it would be neutral at first and would be not burdened by past wrong decisions, and would maybe negotiate a bit tougher with Germany and would understand that France's position, from the substantive point of view, is more with the Southern Europeans than with the Germans. So this may change a bit.

But this all will take months, and the months that are ahead of us are really grim, give a grim outlook, because, as I said, big countries like Italy and Spain are cutting. They are in recession already. They have two months of falling GDP. They are cutting nevertheless. They're doing the biggest wage cuts that we ever have seen in these countries. So the outcome for the next half-year, in my view, in Europe can only be a deep, deep recession.

JAY: And what's this, finally, the role of the Americans in this whole debate about what to do in Europe? Obviously, they have enormous interest, not the least of which is all the interconnectedness of the finance institutions. But, of course, if there's a deepening recession in Europe, it's hard to see there's going to be growth, and likely there'll be—you know, it could well be more recession in United States. As well as the Obama administration, if this thing starts to unravel just before an election, this ain't going to be good for President Obama. But they don't seem to—they seem rather quiet about it all.

FLASSBECK: Well, at least there were some interventions. I mean, Tim Geithner flew to Poland to meet finance ministers for one day to convince them not to go into that direction. So there is a bit more reasonable economic policymaking in Washington still and some considerations looking at the global risk. But at this moment of time, I think nobody can change the course.

There has to be a crisis, there has to be more opposition inside Europe, inside those countries that are vulnerable, inside those countries that are under pressure, that are, so to say, not allowed to go their own way anymore, that are under certain very strict conditionality from Brussels and from the International Monetary Fund. Only if these countries begin to understand and discuss seriously that this is no way out, but that they have to change course, they can have structural changes over the long-term but first of all they need growth, only if this discussion takes momentum, then we have a chance to turn it around.

JAY: So the report was titled "On the Brink". It sounds like we're on—we're not just on the verge of the brink, we're kind of going over the brink, and where we're headed, then, is mass protests and opposition to all of this.

FLASSBECK: Yeah, I think more, more like it, we will see more like that. And we will see it even in France, in my view, once people understand what is expected from them. We will see it in other Southern European countries on a really broader scale. And then I think any kind of political leadership, any kind of government has to be impressed and will be impressed in the end, and they will understand that it cannot go on like this.

JAY: Thanks very much for joining us, Heiner.

FLASSBECK: You're welcome.

JAY: And thank you for joining us on The Real News Network.


DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.


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