COMMENTARY

Summer 2010

by Edin Mujagic

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Jean-Paul Fitoussi’s message is that the crisis won’t really be over until we’ve understood its origins, and that we’re still a long way from doing so. He is right to point out that it would be naïve to think the current crisis is only a hiccough, albeit a major one, for the world economy. It is clearly not a brief interlude in our otherwise happy times but a structural break. The post-crisis economic world is not going to resemble the one before the crisis.

That doesn’t mean, though, that the current crisis can’t be misunderstood. Fitoussi defends governments from what he sees as unfair criticisms that they amassed unsustainable debts, and therefore became responsible for the crisis when it came. The first part, that governments amassed unsustainable debts, is however more fact than opinion, something that is supported by economic theory and practice. There are, so to speak, good and bad debt levels. Debt becomes bad in the sense that it slows economic growth when it reaches around 90% of a country’s GDP. Many European nations have either passed that ‘point of no return’ or are about to do so in the very near future, because of looming deficits for years to come and the impact of ageing on public finances as of next year already. The criticism on the governments is therefore fair.

What is unfair is to put the blame only on rating agencies. Whatever one might think of the quality and competence of rating agencies, that is hardly relevant to this particular point. If the various European governments had put their deficits and public debt in order before the crisis, during the good times, we would not now be having this discussion. The danger of sovereign defaults would be on no one’s radar screen. But the fact is that a large majority of European governments neglected the consolidation of their finances during the good times. And it’s not only Greece we’re talking about as almost every eurozone country is in the same trouble; only the degree of difficulty differs. Finland is the one country that has done its job properly. Year after year it has actually run a surplus and paid down its debt. Sadly it is the exception in Europe.

It is therefore to be applauded, not lamented as does Fitoussi, that the European Commission is saying that many European Union member states have unsustainable deficits and debts, so that Brussels is putting pressure on those governments to correct this in the near future. Doing nothing would cause a new crisis, whereas trying to prevent public finances from being derailed, would not.

Depending on how various governments handle the situation, Europe may yet experience a new (inflation) crisis, which would most likely be longer and deeper than the current one. The overarching theme of Fitoussi’s article is that financial markets do not always perform well. True, but that does not mean the role of a government in the economy should increase. Governments do not always perform well, and in fact they tend to go awry much more often than do markets.

The Fitoussi prescription for more government involvement but no measures to correct either high deficits or fast-increasing public debt in Europe, along with putting the blame on everyone else (rating agencies) for self-inflicted wounds and arguing that the drive to become more competitive will aggravate the crisis, boils down to a call for less competition. It is not the right prescription an economic doctor should be suggesting to Europe’s governments.