Europeans Back Away From Keynesian Policy...Why Won't Obama?

The G-20 Summit has produced a division between Europe and the United States. When the Greek economy went belly up this past spring, Europe found that the welfare state has reached its logical end point. What transpired was a Europe separated into the haves and the haves-not, with the haves wondering if their fate will soon follow the have-nots. German voters, in a bipartisan manner, decided that they had enough of being the banker for their more profligate neighbors and rebelled against providing more resources as they rebuked Angela Merkel when she agreed to help the Greece bailout. Angela Merkel provided a more modest stimulus in 2009 than the United States and now the rest of Europe is following her lead in restricting spending and reducing their budget deficits. The new British government announced their own austerity program to deal with the mess left by the previous Labor Party.

As the Wall Street Journal observed,

The difference this time is that the Keynesian political consensus is cracking up. In Europe, the bond vigilantes have pulled the credit cards of Greece, Portugal and Spain, with Britain and Italy in their sights. Policy makers are now making a 180-degree turn from their own stimulus blowouts to cut spending and raise taxes. The austerity budget offered this month by the new British government is typical of Europe's new consensus.

Europeans are seeing the dead end of the Keyesian economics plan on steriods but the Obama administration have not.

For the past three years, we have seen the rebirth of Keysesian ecnomic ideas which began in the final Bush years when the Bush administration with its strength waning, surrendered to the new Democratic congressional majority elected in 2006. The first stimulus, with increased spending and tax rebates, did not prevent the recession or the finanical meltdown. The Obama adminstration and their Keyesian allies felt the nearly 170 billion dollar stimulus was not enough and the Obama stimulus was nearly five times the Bush plan but the results was essentially the same. The only job growth that has occurred has been in the government sector and the private sector even at this late date is still barely crawling. Recovery from past recession have shown more strength and some are fearing a double dip recession coming in 2011 when the Bush Tax cuts are due to expire.

For the Obama adminstration, they still believe in the game plan and feel that more spending is still required. Obama supporters like Paul Krugman believe the Obama administration haven’t spent enough. In a recent column, he declared that United States was headed toward a lost decade, similar to what the Japanese spent in the 90’s after a decade worth of stimulus spending. For Krugman, the Japanese failed because they didn’t spend enough and for many keyesian economists like Krugman, the New Deal was undermined in part due to insufficent spending. The recession of 1937 during the great depression was a depression within a depression. For many Keyesians, the 1937 recession was not proof of the failure of the New Deal but a recession caused by austerity program enacted to balance the budget. (One pundit observed that Paul Krugman was espousing one to drink until they were sober.)

We are witnessing a similar debate within the political left who are wondering what has gone wrong. For Krugman and many within the Obama adminstration, like Larry Summers, there is a need for another stimulus.  In their minds to put a stop to any further stimulus will only weaken the economy and the austerity programs proposed by the Europeans will stop the nascent economic growth occurring in the Untied States. The Obama dilemma was explained nicely by the Wall Street Journal when they observed,

What the world has now reached instead is a Keynesian dead end. We are told to let Congress continue to spend and borrow until the precise moment when Mr. Summers and Mark Zandi and the other architects of our current policy say it is time to raise taxes to reduce the huge deficits and debt that their spending has produced. Meanwhile, individuals and businesses are supposed to be unaffected by the prospect of future tax increases, higher interest rates, and more government control over nearly every area of the economy.

While the Europeans are now catching on to the spending dead end, they have yet to catch on the growth side of the equation. The recent British spending cuts were accompanied by an increase in the VAT tax. As the Wall Street Journal observed,

Notice that we aren't saying that spending restraint alone is a miracle economic cure. The spending cuts now in fashion in Europe are essential, but cuts by themselves won't balance annual deficits reaching 10% of GDP. That requires new revenues from faster growth, and there's a danger that the tax increases now sweeping Europe will dampen growth further.

Tax increases accompany the budget cuts will not lead to economic growth but tax cuts combined with budget cuts will.

What has been forgotten over the past three years is what caused the economic prospersity between 1980 thru 2007. For many of the left saw the 2008 election as not just repudiuation of Bush but of the Reagan era itself. The leftist mantra was "eliminate spending restraint, raise taxes and who cares about sound money." It was about establishing government control over the economy and allow it to direct the economy. It was about transformation of America. The lesson of economic growth was brushed aside and we are now paying that price.

The key is not just reducing the deficits, but to restore growth. The Obama adminstration belief is to imitate the socialist democratic states of Europe. For Obama, it is about fairness not growth. For the left, inequality of wealth can’t be tolerated and even if economy slows as a result, so be it. As the Wall Street Journal noted,

A better economic policy will have to await a new Congress, which we hope at a minimum can prevent punishing tax increases. But for now the good news is that voters and markets are telling politicians to stop doing what hasn't worked.

The election of 2010 (and 2012) is about the future of America. The path to Europe is a path of ruin and even the Europeans are starting to realize that. The real problem is that Obama adminstration have yet realize the ruination of the policy they endorsed.