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Summer's fix for Europe

Nils ZimmermannMay 29, 2015

Larry Summers, who was Bill Clinton's finance minister and Barack Obama's chief economic advisor, doesn't believe austerity can fix the eurozone. Instead, he proposes a massive infrastructure spending push.

Lawrence 'Larry' Summers / USA / Ex-Finanzminister
Image: picture-alliance/abaca

Speaking to a full house at the American Academy's elegant villa on the Wannsee lakeshore in southwest Berlin, Summers said massive public investment was the best medicine for the ailing eurozone economy.

"There's a compelling case for expanded public investment in many parts of Europe," said Summers, who returned to an economics professorship at Harvard University after leaving the Obama administration at the end of 2010.

The benefits of pouring public money into infrastructure would include more jobs and stronger demand, an expansion in Europe's productive capacity, and a reduced burden on the next generation.

Summers said that research by the International Monetary Fund (IMF) had shown that "appropriate public investment" leads to a lower public debt-to-GDP ratio after five years than occurs in the absence of such investment. In other words: Done right, infrastructure investment more than pays for itself.

Long-term stagnation

Summers attributed weak economic growth and very low interest rates in Europe and other developed countries to "secular stagnation" - which he described as a chronic excess of savings over investment.

Several factors - including rising inequality and cheaper technology, among others - had led to a situation where wealthy savers had a great deal of money available to invest, but too few profitable projects to invest in. The result: Chronically low interest rates and weak GDP growth.

That's why governments should step in to soak up excess savings and put them to good use by building infrastructure, Summers argued.

Easy money

"With Germany able to borrow money for 10 years at 50 basis points [half a percent per annum], it makes eminent sense for the government to borrow and spend more in the interests of its citizens," he said, adding that other European countries also had room to invest: "Even Italy and Spain currently pay just 2 percent interest on sovereign debt - that's less than the US pays."

Summers says investment is key to overcoming the eurozone crisis
Image: DW/B. Riegert

Summers expressed support for the ECB's loose monetary policy. "The risk of deflation is much greater than any risk of inflation," he said, adding it was essential for the ECB to "do what's necessary to achieve 2-percent inflation in order to restore growth."

Structural reforms: The details matter

German Finance Minister Wolfgang Schäuble and other eurozone economic policymakers have pushed hard for governments of high-unemployment regions to make "structural reforms" in order to "regain competitiveness" - by emulating the tough "Agenda 2010" labor market reforms Germany made in the early 2000s.

The reform package prioritizes cutbacks in government spending and structural reforms aimed at pushing wages down in high-unemployment regions.

Lower wages are meant to improve "competitiveness" by reducing the prices of products and services, thereby boosting exports. Government spending cutbacks are supposed to signal that taxes and interest rates will remain low, thereby boosting "business confidence" and motivating private investors to invest in new, job-generating ventures.

It's a package that has been called "growth-oriented consolidation policy" by its supporters. In addition to Wolfgang Schäuble, these include several other northern European finance ministers and many German economists - but not Larry Summers.

Germany's export surplus can't be emulated

Summers conceded that the Agenda 2010 reforms had been successful in transforming Germany into the most competitive economy in Europe - but argued the Agenda was "not a viable template for other eurozone countries."

The reason: "Reforms that suppress labor costs merely tend to shift expenditures from one country to another," in a zero-sum beggar-thy-neighbor game. Undercutting neighbors on wages leads to trade surpluses in one country and corresponding trade deficits in another, but no growth in total employment or GDP.

Giant EU Investment Scheme - What Can Juncker's Billions Achieve?

"There's a clear case for proper structural reforms, but I think it's a mistake to overestimate their potential impact," Summers said. "The biggest structural reform Europe could ever make was to create a single market - and we already have that."

Summers argued in favor of reforms that "increase growth and total investment on a global basis" by encouraging private investment, reducing corruption, improving education and skills, and making it easier to form new businesses.

Hiring and firing

"Flexibilization" of labor markets - making it easier and cheaper to hire and fire workers - is another favorite theme for European policymakers, but Summers warned against expecting too much from that, either.

Even though it's notoriously difficult to fire workers in France, whereas US job markets are famously flexible, Summers said, 15 percent of US men of prime working age - 25 to 55 years old - were unemployed in 2014, compared to just 12 percent in France.

"Excessive job security isn't good, but labor flexibility isn't all it's cracked up to be," he said.