Why America Is Better and Europe Is Worse

"Better here, worse there." This is how Paul Krugman, the Princeton economist and blogger, recently summarised diverging transatlantic fates. Knowing that back in 2008, European politicians and commentators lambasted the United States for being at the origin of the financial turmoil and hailed the euro for protecting us from it, this is a shocking observation. 

Facts are unfortunately unambiguous. According to the European Commission, next year U.S. per capita GDP is expected to return to its 2007 level; in the euro area it is forecasted to be three per cent lower.  In 2009-2010 unemployment was about the same on both side of the Atlantic, but it is now almost four percentage points lower in the United States.

Capital expenditures are recovering more strongly in America, and exports are doing better. Even inflation this year is likely to be lower. The only field where Europe is posting better results is public finances: in 2012 the aggregate budgetary deficit in the euro area is expected to be slightly above 3 percent of GDP, against more than 8 percent in the United States. Europe, in fact, has already reduced the deficit enough to stabilise the debt ratio – at least it would be stabilised in normal growth and inflation conditions. 

There are two competing explanations for this state of affairs. One is that Europe is paying the price of misguided austerity. This is Krugman's conclusion. The old continent's defense is that the euro crisis demonstrates that there was no choice but to consolidate. Had it waited, things would have been worse. Furthermore, the day of

reckoning will come, even for the United States. The day it embarks on the inevitable consolidation, its growth will suffer. So the apparently stronger situation of the United States is illusory.  

There is truth in both views: Yes, austerity is having an impact on European growth and, yes, it will end up having some impact on U.S. growth. But both also overlook an important part of the story, which has to do with the balance between public and private repair efforts.

In the aftermath of the Great Recession, the United States and Europe (including, actually, Britain) adopted rather opposite strategies. The Obama administration and the Fed gave priority to healing the private sector. First, they expeditiously restored confidence in the banks by forcing them to undergo severe stress tests. Then, they gave households time to repair their balance sheets. 

The task assigned to economic policy was to substitute private demand until it would eventually catch up. In the meantime, fiscal consolidation was put on hold (although some actually took place because of the balanced-budget rules of most U.S. states) and monetary policy was geared towards flattening the yield curve. The United States'  private economy is undoubtedly in better shape now than in 2008. Household debt has declined, house prices are stabilising, banks function normally and companies are profitable. Public debt, however, is rising fast.