How Austerity Is Tearing Apart the G-20

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Peter Grimm / EPA

Journalists await the beginning of the G-8 and G-20 summit in Toronto

Convened in Washington, in November 2008, the first G-20 summit was a hasty attempt by top economies to forge common cause against a rapidly escalating financial crisis. That initial consensus risks unraveling at the G-20's fourth summit, in Toronto on June 26-27, with the U.S. and the European Union notably parting ways on how best to restore economic health.

The summit follows an extraordinary austerity drive by European economies as they attempt to redress their public finances. In the past few weeks, E.U. members have pledged some $240 billion in budget savings to deflate their bloated debts and deficits — as well as patching together a colossal $950 billion safety blanket for the euro. But the cost-cutting crusade has alarmed the U.S., with President Barack Obama warning that slashing too much and trimming too fast could stifle growth, provoking a 1930s-style depression.

The rumbling row threatens to hijack the entire Toronto agenda, as well as that of the G-8 summit, which takes place June 25-26 in nearby Huntsville. The leaders are set to debate a wide range of issues at the two summits, from bank levies and the Doha round of trade talks to climate change and development aid, but these are in danger of being skimmed over as the countries scramble to find common ground on economic-recovery strategies.

Until a few months ago, E.U. members were still committed to spending their way out of recovery with stimulus measures, reflecting the G-20 consensus from previous summits. But then came the Greek debt crisis and the market threats to the rest of the euro zone. It prompted an astonishing turnaround as fearful governments made swift and severe spending cuts in frantic efforts to restore confidence in their economies and defend themselves from further market attacks.

They have even pushed other G-20 nations to follow suit. French President Nicolas Sarkozy and German Chancellor Angela Merkel have written to summit host Canadian Prime Minister Stephen Harper, asking that G-20 countries pursue stricter fiscal policies. Harper, seeking concrete debt- and deficit-reduction targets from the meeting, broadly supports the move, as does Japan, whose chronic debt has held back its economy for over two decades.

But U.S. officials say Europeans are choking off the recovery before it has even started. Obama has sent his own letter to G-20 leaders, asking them to "learn from the consequential mistakes of the past" when stimulus packages were withdrawn too early, and warning that excessive spending cuts by governments could lead to "renewed hardships and recession."

Ironically, the euro area's overall fiscal situation looks healthier that that of the U.S. Considering the 16 euro-zone members as a whole, their budget deficit is expected to be about 6.5% of GDP and government debt 85% in 2010, but in the U.S., the deficit is at 10% of GDP while debt is at 116%. (The U.S. debt figure is the sum of federal, state and local government debt, which better corresponds to E.U. statistics.)

The conflicting approaches divide economists. Nobel Prize–winning economist Paul Krugman has been a trenchant critic of the sudden fiscal frugality, writing of the "utter folly" of "madmen in authority." UniCredit chief economist Marco Annunziata, however, says concerns over the austerity derailing the global recovery are vastly overrated, and that Europe should pursue more aggressive public-spending cuts. Meanwhile, 100 Italian economists put their names to a letter to business daily Il Sole 24 Ore warning that the austerity strategies risk tipping Europe into a self-feeding downward spiral, causing weaker countries to be catapulted out of the euro zone. Even within the E.U. there are differences, with Germany the most aggressive budget hawk, and the French bridling at Berlin's hectoring. "If we add austerity to austerity, we are going into recession," Sarkozy said earlier this month.

"At a time when this crisis has shown how global our economies have become, policymakers are making decisions through a purely national prism," says Thomas Klau, who heads the Paris office of the European Council on Foreign Relations. "We are very far from seeing an intelligent coordination and are slipping towards a free-for-all. But then, it was always misguided to hope that the G-20 could become a permanent steering committee of the world economy."

But what of the other G-20 members, whose emerging economies were the very reason that the wider summit format was created? In some ways, their silence is surprising. For example, China's main concern going into the summit seems to have been to deflect attention from its strict currency peg with the dollar. But Beijing's decision last weekend to allow the renminbi to appreciate — making imports cheaper — ensures it can continue to remain aloof from the transatlantic austerity arguments.

Nor have the other Toronto attendees — from Brazil and India to Mexico and Turkey — expressed much interest in the rest of the summit agenda, which includes reforming the International Monetary Fund, avoiding trade protectionism and a Canadian initiative for child and maternal health. Germany, France and the U.K. have joined forces to impose taxes or levies on their banking sectors, arguing that it will ensure that banks can contribute to future bank-rescue packages, while also giving banks an incentive to avoid unnecessary risk. The U.S. supports some version of a bank levy although its proposals are stuck in the Senate, while Canada, Japan and Australia are firmly against the idea.

Thus, having fashioned a big tent to contain the crisis in 2008, the G-20 appears to have lost its defining momentum, allowing the austerity row to overshadow its summit. But Kati Suominen, transatlantic fellow at the German Marshall Fund of the United States in Washington, says this simply reflects global political and economic dynamics. "It is the same five or six players that call the shots and have the real useful proposals," she says. "Even the Chinese are reluctant to step up to the plate, while emerging markets like Brazil see the G-20 as a tool of foreign policy and do not try to drive the process." Suominen says the E.U. and the U.S. may well paper over their differences on debt at Toronto, but even that might not be enough to maintain enthusiasm for future summits. "As the crisis dissipates, there will be more questions about whether the G-20 will just become a talking shop," she says.