Political Paralysis Worsens European Debt Crisis

Nov 11, 2011
Originally published on November 11, 2011 8:48 am

Barely two weeks ago, it appeared that European leaders had a package to contain their debt crisis. Greece's problems would be managed, with private bondholders taking a hit on their investments and a new bailout to help the government meet its obligations. A European rescue fund would protect Italy and Spain from any risk spreading from Greece.

Markets soared. And then, this week, they crashed.

Italy was not safe after all. Investors suddenly stopped buying Italian government debt. The cost of government borrowing skyrocketed, rising to levels that in some countries prompted calls for a bailout by the International Monetary Fund.

It's not so much that the European debt relief turned out to be inadequate — it's the politics that proved unrealistic.

Are Leaders Up To The Challenge?

The Greeks and Italians promised to enact austerity measures, but all of a sudden it seemed they might not. Leaders of other European governments didn't seem to know what to do. Panic set in.

"The worry is that the politicians in Europe really aren't up to those challenges," says Nariman Behravesh, chief economist at IHS Global Insight. "That's the concern here, that that strong political leadership is just not there yet."

In Athens and in Rome, politicians squabbled for days over who would be responsible for keeping the governments on a path of austerity. At the Europe-wide level, the harmony achieved two weeks ago broke down, with French and German leaders once again arguing over the design of a bailout fund.

The Group of 20, which includes the United States, China and other countries, held a summit in France, but the meeting broke up without any commitment to help the European governments. Just when international cooperation was needed to confront the debt crisis, it couldn't be maintained.

Kemal Dervis, director of the Global Economy and Development program at the Brookings Institution, says political leaders and global institutions may not be up to the challenges of the 21st century.

"The mistake that shouldn't be made — and that leaders shouldn't make — is to raise expectations in a way that disappointment becomes unavoidable," he says. "Again and again, unfortunately, leaders are doing that."

The economic necessity in Europe right now is to reduce government debt and deficits. There will be pain. Politicians have to decide how it will be shared, and it won't be easy.

"It's always tough for politicians to cut spending and raise taxes," Behravesh says. "It's a lot harder to do that than to give things away, to increase spending and cut taxes. And unfortunately that's the politics right now. Really tough choices have to be made, and politicians are particularly bad at making those choices."

This may be the central lesson of the European debt crisis: Political leadership is critical.

A Note For America

It's also a lesson that applies directly on this side of the Atlantic. The Standard & Poors agency made that point in August when it cited political dysfunction in Washington as a major reason it was downgrading the U.S. credit rating. The developments in Europe, showing how political paralysis can indeed worsen a financial crisis, may now be vindicating the S&P thinking.

In the U.S. Congress, the tough choices now fall to the joint "supercommittee" that in two weeks has to come up with a deficit-reduction plan. Democrats and Republicans are divided over whether to emphasize spending cuts or tax increases.

Committee members have been put on notice that America's economic health may depend on their reaching an agreement, but that doesn't necessarily make it more likely. The Senate Republican leader, Mitch McConnell of Kentucky, said this week that comments from Democrats predicting an impasse may indicate they intend to cast the Republicans as intransigent.

"It does raise your suspicion that the folks down at the White House are pulling for failure," McConnell said. "Because, you see, if the joint committee succeeds, it steps on the storyline they've been peddling that you can't do anything with the Republicans in Congress."

However, it may not be obvious who voters would finally blame for a failure to reach an agreement. That uncertainty could prompt both sides to show flexibility.

The alternative could well be a U.S. debt crisis not unlike Europe's, because the recent developments in Europe suggest that without political cooperation, economic problems are likely to just get worse.

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Transcript

STEVE INSKEEP, HOST:

It's MORNING EDITION from NPR News. I'm Steve Inskeep.

The debt crisis in Europe is a political problem, as well as an economic one. We've seen vivid reminders of that in the past few weeks, as Europeans leaders have struggled to respond. One prime minister has lost his job, in Greece, and another in Italy says he's going. The trouble in Greece spread to Italy this week. The cost of financing Italian government debt rose to dangerous new highs. Italian lawmakers today, are debating austerity measures demanded by the European Union, but investors apparently doubt that leaders will keep their commitments. In all this political chaos, there may be a lesson for Washington, as we hear from NPR's Tom Gjelten.

TOM GJELTEN, BYLINE: Just two weeks ago, it appeared European leaders had a package to contain their debt crisis. Greece would be managed. Italy and Spain would be protected. Markets soared. And then, this week, they crashed.

Italy was not safe after all. Investors stopped buying Italian government debt. Italy's borrowing costs rose to levels that in some countries have prompted calls for an IMF bailout. It wasn't so much that the European package was inadequate, it was the politics that proved un-doable.

The Greeks and Italians promised to enact austerity measures, but all of the sudden it seemed they might not. Leaders of other European governments didn't seem to know what to do.

Nariman Behravesh is chief economist at IHS Global Insight.

DR. NARIMAN BEHRAVESH: The worry is that the politicians in Europe really aren't up to those challenges. And that's the concern here, is that that strong political leadership is just not there yet.

GJELTEN: In Athens and in Rome, politicians squabbled for days over who'd be responsible for keeping their governments on an austerity path. At the Europe-wide level, the harmony achieved two weeks ago broke down, with French and German leaders once again arguing over the design of a rescue fund.

The Group of 20, which includes the United States and China, had a summit in France, but the meeting broke up without any commitment to help. Just when international cooperation was needed to confront the debt crisis, it couldn't be maintained.

Kemal Dervis, of the Brookings Institution, says political leaders and global institutions may not be up to the challenges of the 21st century.

DR. KEMAL DERVISH: The mistake that shouldn't be made and that leaders shouldn't make, is to raise expectation, in a way that then disappointment becomes unavoidable. And again and again, unfortunately, leaders are doing that.

GJELTEN: The economic necessity in Europe right now is to reduce government debt and deficits. There will be pain and politicians have to decide how it will be shared. Never easy, says Nariman Behravesh of IHS Global Insight.

BEHRAVESH: It's always tough for politicians to cut - to cut spending, to raise taxes. It's a lot harder to do that than to give things away, than to increase spending and cut taxes. And unfortunately, that's the politics right now. Really tough choices have to be made, and politicians are particularly bad at those kinds of choices.

GJELTEN: This may be the central lesson of the European debt crisis: Political leadership is critical. And it's a lesson that applies directly on this side of the Atlantic. The Standard and Poor's agency made that point in August, when it cited political dysfunction in Washington as a major reason it was downgrading the U.S. credit rating.

The developments in Europe, showing how political paralysis can indeed worsen a financial crisis, may now be vindicating S&P thinking.

In the U.S. Congress, the tough choices now fall to the joint supercommittee, that in two weeks, has to come up with a deficit reduction plan. Democrats and Republicans are divided over whether to emphasize spending cuts or tax increases. Committee members have been put on notice that America's economic health may now depend on their reaching an agreement, but that doesn't necessarily make it more likely.

The Senate Republican leader, Mitch McConnell of Kentucky, said, this week, that comments from Democrats predicting an impasse may mean they intend to cast the Republicans as intransigent.

SENATOR MITCH MCCONNELL: It does raise your suspicion that the folks down at the White House are pulling for failure. Because you see if the joint committee succeeds, it steps on the storyline, which is that you can't do anything with the Republicans in Congress.

GJELTEN: But it may not be obvious who voters would finally blame for a failure to reach an agreement. That uncertainty could prompt both sides to show flexibility. The alternative could well be a U.S. debt crisis not unlike Europe's. Because these recent developments in Europe suggest that without political cooperation, economic problems just get worse.

Tom Gjelten, NPR News, Washington. Transcript provided by NPR, Copyright NPR.