Mark Blyth and Neil K. Shenai writing in the latest issue of Foreign Policy:
The global financial crisis has … taken an ironic turn. The same large multinational financial firms that sought government bailouts are now shocked and surprised by the spending of “profligate” governments. Indeed, these actors are now speculating against the very governments who brought them back to life by shorting their debt. As a consequence, governments across Europe are adopting austerity measures to outflank the positions of these speculators.
…in order to say that the global stimulus policy has failed, it is necessary to consider the counterfactual of no fiscal stimulus at all. There is already a natural experiment of this case: the countries of Eastern Europe that decided not to inject large amounts of liquidity into their national economies. For example, in May 2009, as the United States and Western European countries were consciously expanding public deficits, Latvian President Valdis Zatlers set his government on course for “severe budget stabilization measures” and several “structural reforms,” many of which resemble what the G20 is wishing upon itself today. Yet Latvian GDP fell more than 17 percent in the fourth quarter of 2009, while unemployment grew to more than 16 percent, and government finances — the theoretical beneficiary of all this belt-tightening — collapsed because of falling tax revenue. These results were replicated from Estonia to Romania with even worse results, suggesting that the G-20 member states should perhaps be careful what they wish for.
It is likely that France, Germany, and the United Kingdom will move to cut their deficits dramatically, which will lead to a rise in eurozone unemployment, a decrease in the purchase of U.S. exports, and a faltering of global economic recovery. Falling economic growth in the G-20 states will further lower consumption and increase unemployment. Meanwhile, the financial sector will see its equity holdings shrink and its balance sheets worsen once again. Such a scenario makes it quite possible that these same financial institutions will argue that the stimulus was not big enough and should be tried again — but now from a more leveraged position. To see a glimpse of such a future, look at Japan: seesawing between spending and retrenchment cost Japan 15 years of growth and employment between 1990 and 2005, when Japan’s economic policymakers were swayed by exactly the same sort of arguments that are ascendant in the G-20 today.
What lies ahead [as a result] is a harmful populism that allies U.S. Tea Party activists with Greek public-sector unions.