Saturday, August 30, 2014

Budget Austerity in the E.U.: Turning the Russian Invasion of Ukraine into an Advantage

With economic growth in the E.U. flat-lining in mid-2014 after a modest recovery, pressure mounted to relax the federal "austerity" constraints on the state budgets. According to The New York Times at the time, "(p)olitical and financial instability related to Russia's confrontation with Ukraine and the effects of escalating economic sanctions between [the E.U.] and Russia have further clouded the economic outlook."[1] Mired in the austerity vs. fiscal stimulus dichotomy, E.U. leaders may have been missing an opportunity here.

With yet another round of sanctions in the works on the heels of a recent Russian invasion and unemployment at a stubborn 11.5 percent, and the threat of runaway deflation hitting wages in particular, the E.U.'s economy looked poised for an ongoing onslaught of stag-deflation. The E.U. "is menaced by long and possibly interminable stagnation if we don't act," Francois Hollande of the state of France warned.[2]  He had in mind some movement along the ongoing relaxation vs. austerity dichotomy in the direction of larger state deficits--something the governor over in Germany was still fiercely resisting. We "really must question whether we can go on receiving less than we spend, so that our debts keep on growing. Indeed," Angela Merkel pointed out, "a whole crisis of confidence has grown out of that."[3] Such a basic imbalance in state finance undercuts the equilibrium that is so vital to the survival of the macro system in the long run.

So, it would appear that the well-worn dichotomy had reached a dead-end, or the proverbial brick wall. I contend that in such a case thinking beyond the either/or strictures is advisable. To illustrate my point, I present a thought-experiment of sorts (i.e., unrealistic, but it gets the point across).

Let's imagine that the president of Ukraine met with the European Council as Russian troops were crossing the border into Ukraine with the eventual aim of separating the eastern half of the independent state from Kiev.

"I come before you with an admittedly unorthodox suggestion," President Poroshenko might have told the Council. "Without a massive infusion of support from the E.U., my country will split apart and Russia will gain the eastern half."

"What kind of support do you have in mind," the Council's Van Rompuy might has asked.

"Well, the sort that would make your fast-track accession process look like a snail's pace," Ukraine's head of state might have replied with a curious grin that told of something very new coming. "Make Ukraine a state; my government will accept all of your conditions without reservation. Send in your Commission's bureaucrats right away to implement the conditions. To protect them, I recommend that you send along military troops from your state militias as well as the small federal army you have. We could even request that U.N. peace-keepers come along. Putin is already in hot water at the U.N. for continuing his KGB tactics as president."

"What if he keeps sending in Russian troops?" Merkel might have asked.

"This is why speed would be so vital, both in Ukraine's accession, which could be of a limited term if that is easier for you, and the influx of bureaucrats and others doing the E.U.'s business and protecting them. Ukraine would agree to the Schengen Agreement on open borders, and I would request that the E.U. attend immediately to the external border--meaning that which we share with Russia. Securing that border has precedent for the E.U., does it not?" In fact, the need to protect the E.U. bureaucrats pouring into the eastern parts of Ukraine with troops from the state armies would mean that NATO would be relevant. This point, if made explicit, could deter Putin from sending in still more military hardware and troops.

"Please excuse us as we discuss this proposal," Van Rompuy might have politely yet curtly told the Ukrainian head of state. After all, the E.U. leaders do their best work behind closed doors. The point is that their minds need not be closed either. Lemons can indeed be made into lemonade.

Even if this scenario is too outlandish to be taken seriously in a world so wetted to the status quo as its default, thinking in such terms "outside the box" could stimulate more realistic policy prescriptions going beyond the austerity vs. fiscal stimulus dichotomy. For example, the notion of troops and hardware from state militias in the E.U. going along to protect federal bureaucrats might prompt an E.U. leader to suggest that the state armies transfer even more to the small federal army of 60,000 troops. Doing so would enable the state budgets to accommodate both more fiscal stimulus and lower deficits as less military spending would be needed. I am assuming the E.U. would pick up the tab for the operation of the added hardware and the salaries of the additional troops. From the perspective of the E.U., the shift would mean less duplication. How likely is it really that Belgium and Portugal, for example, would need to use their respective armies anyway? In the context of continued stag-deflation, such nationalist luxuries are difficult to justify, especially considering the opportunity cost in terms of stimulating the economy.

In short, the E.U. need not have faced a future of stagnation. Ideas hitherto undiscovered can indeed have great value in practical results. The key is to think beyond the confines of what are presumed to be the only possibilities. The human brain has a tendency to shrink the possible in a way that cuts off many potentially fruitful possibilities without any recognition of doing so. The advisable condition of receptivity is to welcome such ideas into the public discourse rather than going with the knee-jerk reaction of "that's too radical!" or "that would never see the light of day." We might be surprised what could see the dawn and beyond.

1. Liz Alderman and Alison Smale, "Divisions Grow as a Downturn Rocks Europe," August 29, 2014.
2. Ibid.
3. Ibid.