Euro area's massive 'tea parties'
Huge anti-austerity protests in Rome (Italy) and Lisbon (Portugal) on Saturday (October 19th) show that euro area's own "tea parties" – largely led by trade unions – have had enough of soaring poverty and destitution, with more than half of the youth jobless.
And yet austerity is what Italy and Portugal are offering their people with spending cuts and tax hikes to reduce next year's budget deficits to 2.5 percent and 4 percent of gross domestic product (GDP), respectively.
Facing social unrest in France, Italy, Spain, Portugal and Greece, the troika – the International Monetary Fund, European Union Commission and the European Central Bank – the stern enforcers of German austerity policies, is now trying to distance itself from these unnecessarily harsh crisis management tools.
They have belatedly realized that the export model is no longer working even in its country of origin. With flagging sales in the devastated euro area and shrinking world export markets, Germany's four economic research institutes recently halved their forecast for this year's GDP growth to 0.4 percent (from 0.8 percent they announced last April). For next year, they, and the German government, envisage that most of the growth should come from a stimulus to domestic demand.
(Read more: Kudlow: Watch out for Obama's hard-line strategy)
Germany can – and should – stimulate domestic demand, because its public sector accounts are balanced. France, Italy, Spain, Portugal and Greece cannot follow the same route since their budget deficits currently range from 3 percent to more than 7 percent of GDP. They are pushed into the German export model in a bizarre, externally-imposed contest of deficit reduction.
Here is how that model works. Once spending cuts and tax increases kill domestic demand, businesses have to step up their exports to survive. Rising exports are then expected to trigger investments in new machinery and bigger factory floors to satisfy foreign sales. That, in turn, should support employment growth, rising incomes and increasing household consumption.
But this whole process stops if and when exports continue to weaken, as has happened in Germany. In that case, growth has to be relayed by a stimulus to domestic demand – which is now the next step in German economic policy.
Where are France, Italy, Spain, Portugal and Greece in that export-led recovery cycle?
The answer is: they are nowhere near the point where accelerating exports could begin to steadily boost investment growth and employment creation in order to raise incomes and spur a sustainable recovery of household consumption.
At the moment, France, Portugal and Greece are recording declining trade deficits, while only Italy and Spain are seeing rising trade surpluses. But in both cases the contribution of net exports is still too weak to trigger a steady and sustained economic growth.
(Read more: Time to grow up, Washington: Morgan Stanley CEO)
In fact, the fear is that continued pressure to cut spending and raise taxes will overwhelm positive trade balance effects – which would anyway be hard to secure in a shrinking world economy.
The IMF's advice to fiscally-challenged euro area countries is also a non-starter. In a stunning departure from their earlier enthusiastic embrace of austerity policies, IMF advisors are no longer advocating budget cuts; they are now emphasizing that these European countries should be implementing sweeping structural reforms, a code word for liberal hiring and firing and for dismantling the essential features of their welfare system. Whatever their presumed long-term merits, these reforms are rightly resisted because they would just worsen an already devastating social impact of the ongoing fiscal adjustment.
The upshot is that the U.S. "tea party" and the euro area austerity will keep depressing economic activity for 35 percent of the global economy.
Follow the author on Twitter
Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.