Is US a model for austerity-wary Europe?

Despite its sluggishness, the US economy is growing while Europe's is contracting. A rising number of policymakers blame Europe's austerity moves.

By , Business editor

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    A man walks past official campaign posters for Socialist Party candidate Francois Hollande (L) and French President and UMP political party candidate Nicolas Sarkozy (R) which are displayed on electoral panels in Tulle, France, May 5, 2012. France goes to the polls on Sunday for the second round of their presidential election, which in some ways is a referendum on the austerity measures that Europe has begun to take.
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America's poor jobs report has rattled world markets. Germany's DAX index fell 2 percent Friday. Wall Street saw its worst week of the year, as slowing job growth stoked fears that recovery in the United States is faltering. Last month, the economy added only 115,000 jobs.

But the more telling number is 169,000. That's the number of jobs lost in the euro zone in March. For all its sluggishness, the US economy is still growing and its unemployment rate is down to 8.1 percent. The euro zone appears to be contracting and its unemployment rate has risen to 10.9 percent, a 15-year high.

There are myriad structural reasons for this dichotomy. But the distinction getting the most attention these days is a policy difference: America has chosen growth. Europe has chosen austerity. And it looks like the Europeans are losing the argument.

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 Everyone recognizes that austerity is hard. But what if it's wrong, too? This is boosting calls for more growth-oriented policies – on both sides of the Atlantic – which is having important political repercussions.

On Sunday, millions of voters in France and Greece go to the polls and are likely to throw out the leaders who have backed austerity and spending cuts. In France, Socialist Francois Hollande is expected to win the presidency and has pledged to renegotiate the austere European Union treaty that would cap national deficit and debt levels. In Greece, both major parties are so discredited by the cuts that they have begun to initiate that it's not clear that they can win a majority of parliament even in coalition.

In the Netherlands, which is in far better economic shape than Greece, the government collapsed over the debate about austerity. Even German Chancellor Angela Merkel, who has been the face of German insistence on budget cutting and spending reform, is beginning to talk about the need for growth as part of those reforms.

That growth-vs.-austerity debate is also moving to the forefront in the US. It was behind the brinksmanship over raising the federal debt ceiling last year. It is a prime mover in the various congressional attempts at tax reform. It could crystallize this fall in the election, depending on how closely presumed GOP presidential nominee Mitt Romney ties himself to GOP budget-cutters in the US House.

So far, austerity has not fallen into disrepute in the US the way it has in Europe (perhaps because Americans have not felt its bite). An ABC News/Washington Post poll last month found that support for the tea party movement has slipped somewhat since last September but remains at a still-high 41 percent. The fate of tea party candidates in the US House in this fall's elections will be an important bellwether. After the election, a lame duck Congress must decide what to do about several tax and budget cuts that expire at the end of the year, which represent some $500 billion in federal stimulus.

If they decide to withdraw that stimulus, US growth will slow.

No one denies that the US and other indebted nations will have to embrace austerity at some point to reduce their rising pool of red ink. The big debate has always been about timing. Here's the problem with starting austerity too early when the economy is still too weak, according to Lawrence Summers, a former economic adviser to President Obama, writing Monday in The Washington Post. When official interest rates are near zero, every 1 percent cut in government spending reduces the size of its economic output by 1 percent to 1.5 percent. So trying to reduce your debt-to-asset ratio through spending cuts just reduces your assets, so the ratio never goes down.

Take Greece's austerity plan: In exchange for a bailout, it has agreed to cut spending so that it will average a budget surplus of 4.5 percent of gross domestic product (GDP) per year between 2014 and 2020 (before debt payments). Under official projections, Greece will be able to reduce its debt-to-GDP ratio from 160 percent to 120 percent by the end of the period. Private forecasters are skeptical. For example, Greece's GDP will fall 5 percent this year, according to Standard & Poor's, not 4.3 percent as the official forecast calls for. Realistically, according to the Royal Bank of Scotland, Greece's actual debt-to-GDP ratio will be no better off in 2020 than it is today.

Of course, embracing growth doesn't mean that a nation can keep up piling on debt. At some point private investors lose confidence and quit financing its operations at reasonable interest rates, as happened with Greece. So how can a nation cut its debt without shrinking its economy?

By backloading the cuts for a period when the economy is growing more robustly, argues Christina Romer,  another former Obama economic adviser who now teaches economics at the University of California, Berkeley.

"The core of a more sensible approach is to pass the needed budget measures now, but to phase in the actual tax increases and spending cuts only gradually – as economies recover," she wrote in an op-ed for The New York Times last Sunday. "What's to stop policy makers from promising the moon and not delivering? History shows that countries have done such gradual consolidations before. In 1983, for example, the United States passed a Social Security reform plan that was backloaded in the extreme: it specified tough changes, including higher taxes and increases in the retirement age, to be phased in over almost three decades."

Of course, history also shows that lawmakers often don't follow through on making the tough cuts that they've agreed to. If the US fails to reduce its unsustainable deficits, then the holders of its debt eventually will lose confidence, forcing far harsher taxes and spending cuts than US politicians are contemplating.

Congress mush also overcome the sharp partisan divide over how to rein in spending: through spending cuts or tax increases or both, which will play out in the upcoming debate over tax reform. Optimists on the left and the right think Republicans and Democrats can strike a grand bargain on tax reform, perhaps as early as the lame duck session of Congress right after the election.

That's not only achievable, it would be a signal accomplishment, Forbes magazine publisher Steve Forbes told an audience in Boston earlier this week. If the US can get the tax and spending balance right, it will be an example for Europe and the world to follow.

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