Analysis: Things can only get worse if the cult of austerity holds sway

The year 2011 will be remembered as the time when many ever-optimistic Americans began to give up hope. President John F Kennedy once said a rising tide lifts all boats.

But now, in the receding tide, Americans are beginning to see not only that those with taller masts had been lifted far higher, but also that many smaller boats had been dashed to pieces in their wake.

In that brief moment when the tide was indeed rising, millions of people believed they might have a fair chance of realising the “American Dream”. Now those dreams, too, are receding. By 2011, the savings of those who had lost their jobs in 2008 or 2009 had been spent. Headlines announcing new hiring meant little to the 50-year-olds with little hope of ever holding a job again.

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Indeed, middle-aged people who thought that they would be unemployed for a few months now realise they have been forcibly retired. Young people who graduated with tens of thousands of dollars of debt cannot find any jobs. People who moved in with friends and relatives have become homeless.

The dark underbelly of the previous decade’s boom has been exposed in Europe as well. Dithering over Greece and government devotion to austerity began to exact a heavy toll last year. Contagion spread to Italy. Spain’s unemployment, near 20 per cent since the start of the recession, crept higher. The unthinkable – the end of the euro – began to seem a possibility.

This year is set to be even worse. It is possible, of course, that the US will solve its political problems and finally adopt the stimulus measures it needs to bring down unemployment to 6-7 per cent (the pre-crisis level of 4-5 per cent is too much to hope for). But this is as unlikely as it is that Europe will figure out that austerity alone will not solve its problems. On the contrary, austerity will only exacerbate the slowdown. Without growth, the debt crisis – and the euro crisis – will only worsen. And the long crisis that began with the collapse of the housing bubble in 2007 and subsequent recession will continue.

Moreover, the major emerging-market countries, which steered through the storms of 2008 and 2009, may not cope as well with the problems on the horizon. Brazil’s growth has stalled, fuelling Latin American anxiety.

Meanwhile, long-term problems – including climate change and other environmental threats, and increasing inequality – have not gone away. Some have grown more severe. For example, high unemployment has depressed wages and increased poverty.

The good news is addressing these long-term problems would actually help solve the short-term problems. Increased investment to retrofit the economy for global warming would stimulate growth and job creation. More progressive taxation would simultaneously reduce inequality and increase employment by boosting demand. Higher taxes at the top could generate revenues to finance public investment, and provide some protection for the unemployed. Even without widening the fiscal deficit, such “balanced budget” increases in taxes and spending would lower unemployment and increase output. The worry, however, is that politics and ideology, especially in the US, will not allow this to occur. Fixation on the deficit will induce cutbacks in social spending, worsening inequality. Likewise, the enduring attraction of supply-side economics, despite all of the evidence against it (especially with high unemployment), will prevent raising taxes at the top.

Even before the crisis, there was a rebalancing of economic power – in fact, a correction of a 200-year historical anomaly, in which Asia’s share of global GDP fell from nearly 50 per cent to, at one point, below 10 per cent. The pragmatic commitment to growth one sees in Asia and other emerging markets stands in contrast to the West’s misguided policies, which, driven by a combination of ideology and vested interests, almost seem to reflect a commitment not to grow.

As a result, global economic rebalancing is likely to accelerate, almost inevitably giving rise to political tensions. With all of the problems confronting the global economy, we will be lucky if these strains do not begin to manifest themselves within the next 12 months.

Joseph E Stiglitz is a Nobel laureate in economics and member of the Scottish Government’s Council of Economic Advisers.