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What Happened to Europe?

Democracy and the decisions of bankers.

ABOUT FIFTY YEARS AGO, in 1961, Jean-Paul Sartre complained about the state of Europe. “Europe is springing leaks everywhere,” he wrote. He went on to remark that “it simply is that in the past we made history and now history is being made of us.” Sartre was undoubtedly too pessimistic. Many major achievements of great significance have occurred in the last half a century in Europe, since Sartre’s lament, including the emergence of the European Union, the reunification of Germany, the extension of democracy to Eastern Europe, the consolidation and improvement of national health services and of the welfare state, and the legalization and enforcement of some human rights. All this went with a rapidly expanding European economy, which comprehensively re-built and massively expanded its industrial base and infrastructure, which had been devastated during World War II. 

There is indeed a long-run historical contrast to which Sartre could have pointed. For centuries preceding World War II, a lot of world history was actually made in Europe. And this generated much admiration, mixed with some fear, around the world. But the situation changed rapidly in the second half of the twentieth century. When I first arrived in Cambridge as a student from India in the early 1950s, I remember asking whether there were any lectures given on the economic history of Asia, Africa, and Latin America. I was told that there were indeed such lectures—and that they were given for a paper called “Expansion of Europe.” That view of the non-European world would seem a little archaic now, not merely because the grand European empires have ended, but also because the balance of political prominence and economic strength has radically changed in the world. Europe is no longer larger than life. 

There is, of course, nothing particularly remarkable—or lamentable—in the changing role of the different regions of the world. This has happened again and again. What is really striking is not the historical re-balancing of the different parts of the world, but the mess that Europe has managed to get into in the last decade or so, particularly over the last couple of years. There is a lot of discussion right now—appropriately enough—about how Europe is going to liberate itself from its financial disarray, economic misery, and political chaos. “What to do now” is certainly an important issue today, but “what not to do” is no less important in looking at Europe’s immediate past. This is so not just because past mistakes are relevant in deciding on what to do in Europe (even though what has been done cannot be readily undone—there is no automatic translation from past follies into present rectifications), but also because the negative lessons are essential if we are to avoid similar adversities in the rest of the world.

SO WHAT HAS GONE WRONG in Europe in recent years? I shall divide my analysis into three broad subjects: the challenge of European unity; the requirements of democracy; and the demands of sound economic policy. These are all related to each other, analytically as well as empirically. 

The unification of Europe is an old dream. It is not quite as ancient as it is sometimes suggested—the dream is not of classical antiquity. Alexander and other ancient Greeks were less interested in chatting with Goths, Vikings, Angles, and Saxons than they were in conversing with ancient Iranians, Bactrians, and Indians, and Julius Caesar and Mark Antony identified more readily with ancient Egyptians than with Europeans located to the north of Rome. But Europe went through successive waves of cultural and political integration, greatly helped by the powerful spread of Christianity; and by 1464 King George of Poděbrady in Bohemia was talking about pan-European unity. He was followed by many others in the centuries to come, and by the eighteenth century, even George Washington wrote to the Marquis de La Fayette that “one day, on the model of the United States of America, a United States of Europe will come into being.” 

But it was the terrible sequence of the two World Wars in the twentieth century, with its floods of European blood, which firmly established the urgent need for political unity in Europe. As Auden wrote in early 1939, on the eve of World War II:

In the nightmare of the dark
All the dogs of Europe bark,
And the living nations wait,
Each sequestered in its hate.

The events that followed only confirmed the poet’s worst expectations. The terrible fear of a repeat of what European countries had seen in the World Wars continued to haunt a great many Europeans. It is important in this context to appreciate that the movement for European unification began as a crusade for political unity, rather than for financial unification and a common currency. 

The birth of the European federalist movement was motivated strongly by wanting a political unity free from selfdestructive wars, as the content both of the Ventotene Manifesto in 1941 and the Milan declaration of 1943 brings out very clearly. There was no hostility to economic integration and not even to a financial union; but the uppermost priority was not banking and currency. It was peace and goodwill and a gradually evolving political integration. The fact that political unification has fallen way behind financial incorporation was a later development, and the problems generated by that oddly chosen sequencing are not irrelevant to understanding the present economic crisis in Europe. 

One point is particularly important to note in this historical context, especially since it is often missed. The problems created in the euro zone by going for the integration of currency and a monetary union without the prior supportive presence of a closer political union and a fiscal union extend well beyond economic mishaps into social adversities in the relations between people in different European countries. Anger and frustration, in many different forms, have generated tension among countries with different fortunes within the euro zone, and have also empowered extremist politics of a kind that Europe expected to leave behind. 

There is nothing particularly surprising about the problems of balance of payments and other economic adversities that many of the European countries––Greece, Spain, Portugal—have faced, given the inflexibility of the euro zone restrictions on exchange rate adjustment and monetary policies. The consequent crises and rescues involving demands for draconian cuts in public services have also frayed people’s tempers on both sides of the divide. They have strongly exacerbated internecine disaffections within Europe, as is clear from the political rhetoric coming in recent days in very different forms, from the north as well as the south of Europe—with pejorative anger targeted at objects of contempt that vary from “lazy Greeks” to “imperial Germans.” 

The often-invoked “analogy” with German sacrifices to achieve the unification of East and West Germany clouds at least some European thinking, and is thoroughly misleading. This is partly because the sense of national unity that prompted the German sacrifice does not exist now between the different European nations, and also because the sacrifice in that remarkable exercise of national unity fell mostly on the richer part of Germany in the west, not on the poorer areas as is being demanded now from many of the afflicted European countries, from Greece to Spain. 

The costs of failed economic policies extend well beyond the statistics of unemployment, real income, and poverty (important as they are). The grand vision of a union with a cementing sense of European unity is itself threatened by what is taking place in the economic arena. Those who advocated the “unity of a European currency” as a “first step” toward a united Europe have in fact pushed much of Europe into an entirely counterproductive direction for achieving European unity. There is, of course, no danger of a return to 1939, but, to use Auden’s analogy of the “dogs of Europe,” barking from sequestered regional bases of resentment and contempt does immense harm to the cause of cultivating European amity and unity.

I TURN NOW TO DEMOCRACY. The founders of European unity whose ideas led the European movement wanted a “united democratic Europe.” The Europe that emerged from World War II had learned certain things from bitter experience that it was not going to forget. Perhaps the foremost idea was the importance of democracy, giving each person not only a vote but also a voice. If democracy in the form of regular elections is firmly instituted in the constitutions of most European countries, the commitment to have preparatory public discussion before making large policy decisions is no less ingrained in contemporary European values. Walter Bagehot defined democracy as “government by discussion”—following a line of political analysis that John Stuart Mill had done much to clarify and to champion—and the visionary leaders initiating the quest for European unity never wavered in this dedication. 

Some of the policies that were chosen by the financial leaders and economic powers of Europe were certainly mistimed, if not downright mistaken; but even if the policy decisions taken by the financial experts were exactly correct and rightly timed, an important question of democratic process would have remained. The decimation of something as fundamental as the public services that are essential pillars of the European welfare state could not be appropriately left to the unilateral judgments of central bankers and financial experts (not to mention the error-prone rating agencies), without public reasoning and the informed consent of the people of the countries involved. It is true, of course, that financial institutions are extremely important for the success and failure of economies, but if their views are to have democratic legitimacy, and not amount to technocratic rule, then they must be subject to a process of evolving public discussion and persuasion, involving arguments, counter-arguments, and counter-counter-arguments. 

If democracy has been one of the strong commitments with which Europe emerged in the 1940s, an understanding of the necessity of social security and the avoidance of intense social deprivation was surely another. Even if savage cuts in the foundations of the European systems of social justice had been financially inescapable (I do not believe that they were), there was still a need to persuade people that this is indeed the case, rather than trying to carry out such cuts by fiat. The disdain for the public could hardly have been more transparent in many of the chosen ways of European policy-making. 

Quite aside from the question of democratic legitimacy, there is also an important issue here of political practicality—the practice of the “art of the possible” that politics is meant to be. People could be denied their voices, but with democratic institutions they could not be denied their votes in periodic elections. The people excluded from taking part in the process of policy-making could not be politically silenced, and in election after election the incumbent governments carrying out the dictates of the financial superpowers have been deeply threatened and sometimes summarily removed. And voting rights without effective policy voices have also made it very difficult for practical solutions to emerge, with appropriate attention to well-reflected priorities and to acceptable compromises. 

Public reasoning is not only crucial for democratic legitimacy, it is essential for a better public epistemology that would allow the consideration of divergent perspectives. It is also required for more effective practical reasoning. It can bring out what particular demands and protests can be restrained in interactive public reasoning, in line with scrutinized priorities between a cluster of quite distinct demands. This involves a process of “give and take” which many political analysts, from Adam Smith and the Marquis de Condorcet in the eighteenth century to Frank Knight and James Buchanan in our time, have made us appreciate better.

AND WHAT ABOUT the soundness of Europe’s economic policy-making? There are two issues that arise immediately: the viability of the common European currency, the euro; and the policy of austerity—chosen by or imposed upon—European countries in financial difficulty. On the first question, most of the attention has tended to be concentrated on the shortrun survival of the euro, through providing liquidity to the troubled countries, by one means or another. Many alternative

rescue efforts are being considered right now, such as new bailout packages helped by the financially stronger countries, or the floating of guaranteed euro bonds, or the purchase of Greek, Spanish, and other high-interest bonds from troubled countries by Germany (thereby earning high interest, without much risk, so long as the euro survives in its present form). Many of these “rescue” proposals are certainly worth considering and may prove useful, but none of the proposals address—or are meant to address—the long-run viability problem arising from the inflexibility of the exchange rate through the shared euro, even as countries with relatively lower productivity growth (such as Greece and Spain and Italy) fall behind other countries in the euro zone in terms of competitiveness in trade. A country such as Greece may find that it has increasingly less it can sell abroad at the fixed exchange rate of the euro, unless what is not done by exchange rate adjustment is brought about by the brutal process of cutting wage rates—even in terms of the national currency—to an extent that would not be otherwise necessary. 

In the absence of exchange rate adjustments, competitiveness for the countries falling behind can indeed be recovered through sharp wage cuts and other ways of cutting earnings, thereby reducing living standards more drastically than would be otherwise necessary. This would yield much extra suffering and an understandable resistance. There would also be political resistance to the other “solution” through increased migration of the population—for example, from Greece to Germany. A unified currency in a politically united federal country (such as in the United States of America) survives through means (such as substantial population movements and significant transfers) that are not available to a politically disunited Europe. Sooner or later the difficult question of the longrun viability of the euro would have to be addressed, even if the rescue plans are completely successful in preventing a breakdown of the euro in the short run. 

HOW EFFECTIVE is austerity, or drastically cutting public expenditures, in steering the countries in difficulty out of their immediate problem of excessive deficits and huge debts? It is difficult to see austerity as a soundly reasoned economic solution to the European malaise today. And it may not even be a good way of reducing public deficits. 

The policy package demanded by the financial leadership of Europe has been, despite its rhetoric, severely anti-growth. The economic growth of the euro zone has been undermined dramatically, and the GDP there has been falling rather than growing—so much so that the recent report that there was zero growth in the euro zone in the first quarter of 2012 has been widely greeted as “good news.” If Germany is taken out of the total, the result would be continued bad news of falling output for the rest of the euro zone. Spain, Portugal, and Italy continued to decline in these months, and while Greece tempered its free fall from a previous negative 6 percent in 2011, the Greek economy has lost nearly a quarter of its production since 2008. While the economies and the people involved have suffered, the deficits have been quite resistant. The earning of public revenue is impeded by dampened—or negative—economic growth, and this directly cuts down the state’s ability to cut deficits.

There is plenty of evidence in the history of the world that indicates that the most effective way of cutting deficits is to resist recession and to combine deficit reduction with rapid economic growth. The huge deficits after World War II largely disappeared with fast economic growth in the postwar years. Something similar happened during the eight years of Bill Clinton’s presidency, when Clinton began with a huge deficit and ended with basically none. The much-praised reduction of the Swedish budget deficit between 1994 and 1998 occurred in a period of fairly rapid growth of GDP. The situation is very different today for many countries asked to cut deficits that are having zero or negative growth rates under an imposed discipline of austerity heaped on a recession. 

That austerity is a counterproductive economic policy in a situation of economic recession can be seen, rightly, as a “Keynesian critique.” Keynes did argue—and persuasively—that to cut public expenditure when an economy has unused productive capacity as well as unemployment owing to a deficiency of effective demand would tend to have the effect of slowing down the economy further and increasing—rather than decreasing—unemployment. Keynes certainly deserves much credit for making that rather basic point clear even to policymakers, irrespective of their politics, and he also provided what I would call a sketch of a theory of explaining how all this can be nicely captured within a general understanding of economic interdependences between different activities (emphasizing in particular the fact that someone’s expenditure is another person’s income). I am certainly supportive of this Keynesian argument, and also of Paul Krugman’s efforts in cogently developing and propagating this important perspective, and in questioning the policy of massive austerity in Europe. 

But I would also argue that the unsuitability of the policy of austerity is only partly due to Keynesian reasons. Where we have to go well beyond Keynes is in asking what public expenditure is for—other than for just strengthening effective demand, no matter what its content. As it happens, European resistance to savage cuts in public services and to indiscriminate austerity is not based only, or primarily, on Keynesian reasoning. The resistance is based also on a constructive point about the importance of public services—a perspective that is of great economic as well as political interest in Europe.

THERE IS A CENTRAL ISSUE of social justice involved here—that of reducing rather than enhancing injustice. The public services are valued for what they actually provide to people, especially to vulnerable people, and this is something for which Europe had fought. Savage cuts in these services undermine what had emerged as a social commitment in Europe at the end of World War II, which led to the birth of the welfare state and the national health services in a period of rapid social change in the continent, setting a great example of public responsibility from which the rest of the world—from East Asia to Latin America—would learn. 

In order to understand the inadequacy of Keynes as a guide to solving the European economic crisis, we have to ask: what kind of an economist was Keynes in terms of his vision of a good society? Keynes did say—famously, and accurately enough—that paying laborers to dig holes and then to fill them up can be a very good thing, because of its impact on increasing effective demand to combat a recession or a depression. This is fine as far as it goes, but Keynes had extremely little to say on what social commitments a state should have—what public expenditure should be for, other than for just strengthening market demand through state intervention. 

Keynes showed little concern about economic inequality, and was extraordinarily reticent on the horrors of poverty and deprivation. He had little interest in externalities and the environment, and neglected altogether the subject that his rival and adversary A. C. Pigou concentrated on, which was The Economics of Welfare, the title of Pigou’s most famous—and certainly most profound—book. It was the allegedly right-wing Pigou who initiated the measurement of economic inequality, spent time on analyzing the nature and causes of poverty, wrote extensively on externalities and on environmental degradation, and stressed the need for public economics to aim at remedying the allocational errors of the market economy. 

So the need to question current financial policies in Europe arises for economic reasons that go well beyond Keynes (while incorporating some important ideas of Keynes), in addition to the political and social reasons to which I have also tried to point. This skepticism does not in any way question the need to recognize the importance of reducing, on an appropriate timetable, the burden of public debt. But good economics is not only about what to aim at, but also about what can be effective, and how and when. 

If we add to this economic argument the long-term concern in Europe about some form of social justice and the more immediate political worry about the undermining of the European sense of solidarity, we can see what a disaster the recent European financial policies have been. The case for resisting the savage cuts in public services can hardly be ignored. This is not because the commitment to social justice must always be paramount, but surely it must be a serious concern that cannot simply be discarded by bankers and financial leaders. There is, of course, always a need for rational scrutiny and examination of what a country can afford and what it cannot—taking into account all the relevant factors, including the changing age distribution of the population. But this is not the same question as checking what a country can afford with inefficient economic and financial management, with fuzzy thinking on exchange rates and market demands and economic competitiveness. 

The guiding principle has to be, rather, what Adam Smith specified with clarity in The Wealth of Nations: how to work for a good functioning of the economy to be able to provide the public services that people agree are needed. Sound political economy, Smith argued, has to have “two distinct objects”: “first, to provide a plentiful revenue or subsistence for the people, or more properly to enable them to provide such a revenue or subsistence for themselves; and secondly, to supply the state or commonwealth with a revenue sufficient for the publick services.” Achieving the latter is just as much the goal of good economics as achieving the former. 

Finally, and very importantly, the cause of necessary economic reforms has not been served by confounding that necessity with the policy of austerity. Indeed, serious consideration of the kinds of reform that are needed has been hampered, rather than aided, by the loss of clarity about the distinction between reform of bad administrative arrangements (such as people evading taxes, government servants using favoritism, banks being exempt from necessary discipline, or—for that matter—preserving a nonviable system of early retiring ages), and austerity in the form of ruthless cuts in public services and basic social security. The requirements for alleged financial discipline have tended to amalgamate the two, even though any analysis of social justice would view policies for necessary reform in an altogether different way from drastic cuts in important public services. Even if that distinction may have been lost in rather crude financial thinking, opportunities for adequate public reasoning, in “government by discussion,” could have brought out its relevance clearly enough. 

Europe has been extraordinarily important for the world, which has learned so much from it. It can remain globally important by setting its own house in order—economically, politically, and socially. The first step is to understand properly, with some clarity, the policy challenges that Europe faces today. A failure to do so will reverberate far beyond Europe’s own borders.

Amartya Sen teaches economics and philosophy at Harvard University and received the Nobel Prize in Economics in 1998. He is the author, most recently, of The Idea of Justice (Harvard University Press). A version of this essay was given as a lecture at the Bank for International Settlements in June. 

This article appeared in the August 23, 2012 issue of the magazine.