Higher wages - not austerity - is the cure for eurozone crisis, say economists

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Higher wages - not austerity - is the cure for eurozone crisis, say economists

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As unemployment in the eurozone nears 12%, expert voices are joining protesters in criticising the spread of austerity measures in the area.

On January 8, the Macroeconomic Policy Institute (IMK), a leading German economics think tank, released a report that advocated wage increases rather than austerity cuts. These “excessive savings programs” are actually counter-effective and are leading to more debt in affected countries like Greece and Spain, the report says. It also confirmed the tepid 0.8% GDP growth forecast for 2013 in Germany, blaming bleak Europe-wide demand.

“For reasons of European and German stability, the next couple of years should really see wage hikes in Germany of four percent or even slightly more,” IMK Director Gustav Horn explained.

Higher wages would whip up Germany’s growth by increasing domestic demand and positively affect Germany’s main trade partners, most of them being European countries.

In an earlier report published last October, IMK researchers wrote that “continued fiscal austerity and disregard of current account imbalances is likely to lead to further deteriorating data that fail to live up to current growth forecasts.” In layman term’s, this understatement warned of the dramatic effect of continued austerity measures on growth in affected countries. Germany might actually join these countries soon; Spiegel Online revealed last December that Finance minister Wolfgang Schäuble’s team of experts is preparing austerity measures to be implemented after parliamentary elections this autumn, no matter which side wins. The plan combines tax hikes, welfare cuts, and pension reforms in what the Spiegel Online dubbed “nothing less than the most comprehensive austerity program in postwar German history.”

More elements are fuelling the anti-austerity debate. On January 3, IMF chief economist Olivier Blanchard and his economist colleague David Leigh admitted in a research paper to have miscalculated the fiscal multipliers, determining the effects of austerity reforms on European economies.

“Blanchard and Leigh deduced that IMF forecasters have been using a uniform multiplier of 0.5, when in fact the circumstances of the European economy made the multiplier as much as 1.5, meaning that a $1 government spending cut would cost $1.50 in lost output,” the Washington Post explains.

The paper’s authors wrote that “forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation.”

The paper comes with the warning that it “should not be reported as representing the views of the IMF,” and its authors declared that they did not think the results meant that austerity was necessarily a bad thing. However, as the Washington Post notes, “coming from the agency’s top economist, it is bound to change how the agency generates forecasts.”