DAVOS, Switzerland -- As much of the globe grapples with lean economic prospects, and as Europe in particular sinks toward a recession that could spread to multiple shores, world leaders gathered here this week appear to be operating with a rough consensus over how to proceed: Attack budget deficits by cutting spending in a bid to sow confidence in bond markets.
The logic of austerity as curative assumes that the basic problem limiting economic growth is investor fears about the size of government budget deficits, and visions that the bond market may suddenly demand sharply higher rates of interest to enable lending. Governments could be forced to impose growth-killing tax increases to square their books. With such worries in mind, those in control of money are supposedly hewing to the sidelines, depriving economies of credit and investment.
Among finance ministers participating here at the annual World Economic Forum, the word “uncertainty” has been getting a vigorous workout. When times are troubled, goes the thinking, lack of clarity provokes investors to imagine the worst, and to act accordingly. They hold tight to their money, producing self-fulfilling prophesies of pullback.
“If you want to have more internal demand, you have to have confidence,” the German finance minister Wolfgang Schaeuble declared here Friday morning, during a discussion about the future of the eurozone. “If you make your deficit sustainable, people will gain confidence.”
But among some economists, deficit reduction as a growth strategy amounts to a wrong-headed leap of faith.
“Austerity won’t even prevent the next crisis, let alone solve the current one,” the Nobel laureate economist Joseph Stiglitz told The Huffington Post.
Cutting government spending in times of economic weakness further reduces demand for goods and services, he said, which reduces incentives for businesses to invest and hire -- a self-reinforcing dynamic of diminishing fortunes.
In a lunch address earlier this week, the billionaire investor George Soros delivered a withering critique of austerity, one that has become something of an official minority view among those concerned about the current policy trajectory. Warning that the continued embrace of austerity could result in many years of wrenching pain, Soros singled out Germany for imposing harsh fiscal discipline on its fellow eurozone members -- not least, Greece -- as condition for financial support needed to prevent default.
“The austerity that Germany wants to impose will push Europe into a deflationary debt spiral,” Soros said, referring to a cycle of falling prices, which deprive companies of an incentive to invest and hire, which in turn reduces vigor in the economy. “Reducing the budget deficit will put both wages and profits under downward pressure, the economy will contract and tax revenues will fall.”
Such a scenario, Soros added, would produce a result opposite from the policy aim -– larger budget deficits, “requiring further budget cuts, and setting in motion a vicious circle.”
Austerity seems like an odd word to be dominating a gathering held at an exclusive ski resort in the Swiss alps, where some of the world’s most powerful people commute between hotels and lavish dinners in chauffeured Audi sedans. But discussions here this week -- in conference centers, and at cocktail parties underwritten by global banking giants -- have confirmed the reality that austerity reigns among the policy-making set, with Germany far from isolated.
Asked whether Spain would meet deficit reduction targets imposed as part of a new fiscal compact among members of the eurozone, Luis de Guindos Jurado, the country’s new finance minister, declared: “The rule that we’re going to have for the Spanish government is going to be even stricter than in Brussels.”
Spain now suffers from 23 percent unemployment. “This is something we can not accept at all,” the finance minister said. But spending cuts were the only medicine he prescribed.
“The medicine is not working,” said Nouriel Roubini, the economist who famously predicted the financial crisis of 2008, in an interview with The Huffington Post. “In the eurozone, there’s too much talk about austerity and not enough about economic growth.”
Even France, which has been at odds with Germany over many aspects of economic policy, is leaning on deficit cutting as a source of growth.
“We have to reduce debt,” declared Francois Baroin, the French minister of economy and finance, during the discussion with his German and Spanish counterparts. “We will meet our targets.”
The words from Europe’s leaders have been so strikingly focused on deficit reduction that the American Treasury Secretary Timothy Geithner has by contrast sounded like a strident advocate for expansive spending to stimulate growth.
At home, Geithner is widely viewed as a deficit hawk. He has drawn criticism from economists such as Stiglitz and Paul Krugman for arguing against more aggressive efforts to attack unemployment and alleviate the foreclosure crisis, warning that too much spending risks upsetting the bond market. Here, in a shift that parallels President Barack Obama’s campaign season-championing of a more populist brand of economics, Geithner has pointedly rejected the idea that austerity is the answer to his own country's problems.
“Given the high level of unemployment, given the very bad outcomes for median incomes in the United States over the last thirty years, given the just the appallingly high rates levels of poverty in the United States, given the competitiveness challenge that we face that’s going to require pretty significant investment in infrastructure and education and innovation, you have to take a much broader approach,” he said. “We’re not going to solve our problems as a country by thinking that they are centrally about how we restore fiscal stability.”
Yet in discussing Europe -- whose problems loom as the single largest risk to an American economy that has been flashing signs of modest improvement -- Geithner reinforced the consensus view that the future is now colored in austerity.
“For parts of Europe, for a long period of time, there’s going to be no alternative to very substantial adjustment in budget deficits in the size of the commitments made,” he said. “There is no alternative to that.”