The famous CEPR economic research policy portal VoxEU.org started a debate last month on austerity, entitled "Has austerity gone too far?", with a leading comment from the moderator Giancarlo Corsetti, from the University of Cambridge. This was followed by an article from Alesina and Giavazzi (Harvard and Bocconi), making the case in favor of austerity measures, and a counter-argument from Brad DeLong (Berkeley). The debate has since featured many prominent economists (from the IMF, EC, German Bundesbank, LSE, Chicago, NIESR etc.) and I am grateful and honored to be among them.
"Europe needs to move on beyond austerity and stimulus, and focus on reforming its institutional system that will address the misplaced incentives and the dependency mentality, and restore proper market signalization that will enable new patterns of specialization and increase productivity.
There has been too much backlash between proponents of austerity and proponents of a fiscal stimulus. In a wide array of evidence from either sides of the debate (Alesina and Giavazzi leading the argument on one side and DeLong on the other in the VoxEU debate), they all certainly have merit, but they seem to miss an important point.
The debate needs an approach from another side of the political economy spectrum – the new institutional and free-market perspective calling for institutional reforms. Reforms that will address misplaced incentives in the labour market, the dependency mentality, and the non-functioning of basic state institutions. By doing so they could be able to restore proper market signalization that will enable new patterns of specialization and increase productivity.
Structural reforms are being called for by both sides of the argument, but no one really puts too much emphasis on them. They are pictured as a natural outcome of the respective policy in place, whether austerity or expansion. Alesina, for example, calls for “spending-based consolidation accompanied by the right policies”. These right policies include “easy money policy, liberalization of goods and labour markets, and other structural reforms”. On the other hand, DeLong emphasises the importance of “credible plans for long-run fiscal balance, structural reforms to free-up enterprise and increase opportunity, along with reforms of the social-insurance state”, all to come as a consequence of consolidation after the economy gets injected with more funds and the state supports its growth.
But so far, no one has been precise in how to achieve these structural reforms. They won’t follow automatically after austerity or fiscal expansion; they must be initiated by “market-augmenting governments” (Olson, 2000).
Where to start from? Political stability."
...Read the whole thing here.