Gideon Rachman takes on Krugman on Eur-austerity

Since the fullest flush of the financial crisis, Paul Krugman has been a relentless voice for stimulus, infrastructure spending and all-out war against high unemployment. Throughout his tenure at the Times, he has been so often right on fundamentals -- the Bush tax cuts, the housing bubble, the size of the 2009 stimulus -- that I would guess his credibility is unsurpassed among lay liberal readers.

So it's interesting to see a fact-based, more or nonideological commentator take on Krugman with regard to Euro-austerity. The dissenter is the Financial Times'  Gideon Rachman, repeat winner of xpostfactoid's Wolf Munch Rock award, so named because the truth is hard to digest.  Krugman calls European austerity policies "insane," Rachman notes, "with characteristic understatement."  There's a bit of a tonal joke there, methinks, because for Rachman, understatement really is characteristic.

Rachman shares the FT Comment page with Martin Wolf, Wolfgang Munchau and others who have lamented the slow-motion Eurozone train wreck these past two years -- and the drastic effects of cutting spending as economies contract. He recognizes the basic Keynesian equation. But his argument about stimulus in Europe is a kind of mirror image of progressives' take on tax cuts for the wealthy in the US: we are tapped out on that front. So is much of Europe, he argues, on infrastructure spending, government payrolls and social services:

Spending on infrastructure – “shovel-ready” projects, as President Barack Obama has called them – is, of course, a standard Keynesian solution for an economy that is caught in a downward recessionary spiral. Under normal circumstances, such spending might be a great idea.

In Europe, however, there are plenty of reasons to be sceptical. If building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming. The past 30 years have seen a huge splurge in infrastructure spending, often funded by the EU. The Athens metro is excellent. The AVE fast-trains in Spain are a marvel. But this kind of spending has done very little to change the fundamental problems that now plague both Greece and Spain – in particular, youth unemployment...

As for Italy and Spain, they are not cutting their budgets out of some crazed desire to drive their own economies into the ground. Their austerity drives were a reaction to the fact that markets were demanding unsustainably high interest rates to lend to them. There is no reason to believe that the markets are now suddenly prepared to fund wider deficits in southern Europe. The “end austerity now” crowd respond that it is the responsibility of Europe’s dwindling band of triple A rated countries to go on a consumption binge and so pull their neighbours out of the mire. But the assumption of unlimited Dutch and German creditworthiness is unconvincing – as the market reaction to the Dutch failure to agree a budget, last week, illustrated.

The nothing-left-to-spend argument leads Rachman to a defense, rare on the FT Comment page, of German austerity:

...while the Germans are often portrayed as knuckleheaded advocates of endless austerity, their real message is more sophisticated and convincing. It is that the drive to balance budgets within Europe must be combined with reforms that will encourage private-sector job creation.

Rachman does allow that there's room for argument about the pace and timing of structural reform.  But as such debate is playing out in the U.K. and France, he argues, it's "small-scale quibbling – masquerading as a major doctrinal dispute."

I suspect that Krugman's "quibble" would be in the designation of this room for dispute as "quibbling." Also,  while Rachman yokes Italy and Spain into one borrowing bind, Krugman likes to point out that they came to crisis from different places: before the financial bust, Spain and Ireland had balanced budgets. In fact, I think Krugman has also argued that Italy wasn't in such bad budgetary shape before the bust -- Greece was the only real basket case, and the EU needn't have let the Greek contagion spread. 

Over to you, Krugman. Right or wrong, there's no insanity in this defense.

Update: Responding to Rachman, Andrew Sullivan adds a more concrete caveat than mine: "Labor market reforms are vital. But I don't see why the ECB cannot be a lender of last resort to avoid a depressive cycle."