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Op-ed: Calls for austerity—'tea parties' in Europe and the US

Tea Party activists cheer during the 'Exempt America from Obamacare' rally, on Capitol Hill.
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Tea Party activists cheer during the 'Exempt America from Obamacare' rally, on Capitol Hill.

The reopening of the U.S. government and the temporary restoration of its ability to borrow following an over two-week long partial shutdown are just emergency measures. People who read more than that in the agreement reached last Wednesday should realize that this is not the epilogue to the usual Washington skirmish.

This is a deadly serious political conflict that will be played out over America's next two electoral cycles; the first one in the run-up to midterm Congressional elections in November 2014, closely followed by party caucuses, primaries and presidential elections in November 2016. For all of these contests, the key topic of the Republican political platform will be the same: cutting down the size of the government by slashing spending on federally funded programs, including healthcare and pension benefits.

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Those who think that Republicans won't have popular support to continue the pursuit of their political goals through budget warfare should think again: on October 16 – one day before they were threatening to bankrupt the U.S. – an opinion poll conducted by Pew Research found that 38 percent of Americans still had a favorable opinion of Republicans. Remarkably, a Reuters/Ipsos poll conducted a week earlier found that 46 percent of Americans blamed both parties for the government shutdown.

"Draining the swamp … not feeding the alligators"

Republicans who want sweeping public finance cuts to push the country toward self-government speak of themselves as "real Americans," a divisive slogan where many people see thinly veiled racial and ethnic overtones. President Ronald Reagan is their hero, and their guiding light is a line from his weekly radio address in August 1985 when he told the Americans that "…you didn't send us to Washington to feed the alligators; you sent us to drain the swamp."

But there is something these Reagan fans are conveniently leaving out of their story. Yes, President Reagan was a true believer in small government, but in the second year of his presidency (1982) he had to fund the government's essential operations by introducing one of the largest tax hikes in American history.

Despite that, Reagan was a very popular president. He also worked effectively with a Democratic-controlled Congress and maintained a good relationship with the House Speaker, legendary Massachusetts Democrat Tip O'Neill, who shut down the government seven times during Reagan presidency. But, according to O'Neill's top aide, Chris Matthews, the president and the speaker compromised to keep their conflicts manageable; they even prayed together and shared birthday and St. Patrick's Day parties.

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This is a good example of comity that should prompt U.S. political leaders, especially Reagan fans, to avoid damaging the country through brinkmanship and refusal to compromise.

Omens are not good, though.

The full extent of the damage done to the American economy by the current dispute will only become apparent in the months ahead. Business already lost as a result of the prolonged closure of government services is only part of the story. The feeling of relief in the wake of the resumption of government operations is now giving way to uncertainty borne of fear that a similar – or even more severe – political clash next January will continue to cause job losses and falling incomes.

All these existential worries are unfolding during the time which is normally the busiest shopping and holiday season – starting with Halloween, Thanksgiving, and then Christmas and New Year celebrations – when the retail trade does two-thirds of its annual turnover.

The latest surveys are showing that consumers got the message: Indexes of consumer sentiment are now at their lowest levels since the beginning of the year. With an already high unemployment and stagnant real disposable incomes, threats and fears of a fading government are the last things consumers need to celebrate the season of hope and joy.

At any rate, consumer and business surveys and shopping mall traffic will be the most important U.S. economic indicators to watch in the weeks and months ahead.

(Read more: Lasting effects of the government shutdown)

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.

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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 @msiglobal9

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.