Europe is trapped in a state of economic stagnation that is having tangible and serious consequences for Europeans in general. Compared to a growing economy like the American, the painful current economic stagnation in Europe means fewer jobs for the unemployed, fewer career opportunities for the fortunate who have jobs, and fewer profitable business venues for entrepreneurs and investors.
The stagnation has now eaten its way into Europe’s political institutions to the point where it is undermining the continent’s very political stability. Prime ministers can no longer count on sitting even one election cycle without being ousted. Over the past year, we have seen governments in Germany, the Netherlands, Belgium, and France fail to form—or even resign—partly or entirely as a consequence of the economic stagnation.
The link from a stagnant GDP to political instability is brutally simple: budget deficits. In many countries, a government’s ability to secure parliamentary support for its own continuation depends on its ability to deliver a budget. The budget, in turn, faces a litmus test in the form of a balance between revenue and spending.
Germany is a prime example of what this test can do to a government. So is France, where Prime Minister Bayrou has thrown his fiscal hat in the ring. Explains Euractiv, July 14th:
The €40 billion austerity plan for 2026 that French Prime Minister François Bayrou will unveil on Tuesday is expected to be rejected by all opposition parties. This could lead to the fall of the government when parliament votes on the proposal in autumn.
The plan is not a full-fledged government budget, but rather a layout for deficit-reducing fiscal policy changes. This is why Euractiv adds the term “austerity” in its description of the package. Fiscal austerity means that a government, when crafting its budget, uses tax increases or spending cuts, or a combination of both, explicitly to reduce its budget deficit.
As Euractiv reports, Prime Minister Bayrou wants to avoid “indiscriminate tax hikes” in the austerity package. The plan will therefore place the bulk, if not all, of the deficit-reducing burden on the spending side of the budget.
Regardless of what balance between tax hikes and spending cuts the austerity plan eventually strikes, it will have negative consequences for the French economy. Tax hikes would be disastrous: the French government already takes in 54% of the economy in taxes. Further levies on the private sector would send France tumbling into a deep and socially dangerous economic crisis.
While Prime Minister Bayrou realizes this, he has to know that spending cuts are nowhere near harmless to the economy either. When government spends almost 58% of the economy, any cuts of any significance will inevitably have a detrimental impact on large sectors of the economy:
In both these cases, less money will circulate in the economy, which will lead to higher unemployment. The effect will be the same even if the budget cuts are directed at regular government agencies, e.g., in health care, education, or law enforcement. Government employees will lose their jobs, but the general public will also be burdened with the consequences of deteriorating government services.
As an example, when hospitals have fewer employees, patients have to wait longer for health care—or go without treatment altogether. When the general public’s health declines, more people will have to take sick leave from work or quit the workforce. This, obviously, leads to higher demand for government benefits to replace lost income.
In a recession, which is where France is right now, all forms of government spending, one way or the other, lead to higher demand for government handouts, including but not limited to unemployment benefits.
The painful truth is that the budgeting process that the French government has just started is a lose-lose situation. No matter what deficit remedy Prime Minister Bayrou proposes, he will face strong political resistance, but even if he overcame that resistance, his fiscal policy would harm the French economy—at a time when that is the last thing the French economy needs.
As mentioned, France is not the only country in the EU that is trapped in this fiscal situation. In 2024, the total budget balance for all 20 euro zone member states was €-468 billion, equal to 3.1% of the zone’s GDP. If all the 15 countries that share in this deficit decided to systematically and persistently use austerity to end their deficits, the euro zone economy would be hurled into a catastrophe like the Greek macroeconomic meltdown in 2009-2014.
In other words, it would be wise for deficit-ridden governments in countries currently in a recession to avoid austerity altogether. Admittedly, this is easier said than done: many of them will hear the whispering voices of the EU’s fiscal rules in the background. Those rules recommend a cap on government debt at 60% of GDP and a cap on the budget deficit at 3% of GDP. The enforcement of these rules has become more tailored to the individual country’s situation, including their spending on defense, but the caps are nevertheless a reality that lawmakers cannot ignore.
While the threat of repercussions from Brussels is real, deficit-ridden governments also have to deal with the harsh realities of getting a budget passed by their parliaments. Beyond the legislature, their voters and taxpayers will not let them forget who bears the burden of deficit-fighting austerity policies.
With most of Europe in economic standstill and 15-20% of young workers unemployed in many countries, it is simply a terrible idea for governments to resort to more austerity policies. Contrary to what some pundits appear to believe, an economy in a recession actually benefits from a larger government deficit.
Since the German government has chosen to borrow more money, there is a chance that it can use fiscal stimulus to bring the economy out of its persistent standstill. A chance, but no guarantee. The outcome will depend entirely on how the borrowed money is spent; if it is used to simply thicken the layers of bureaucracy and pad pockets in the government procurement process, then the added public debt will have virtually no multiplier effects on the economy.
If, on the other hand, the money is spent in such a way that the cash increases consumer spending and boosts business confidence, the positive effects on the economy could be enough to set the economic wheels in motion again. The realm of choice is narrow, essentially stretching from direct, household-focused stimulus checks to an expansion of public investment projects. But it does exist, and it could be used—if politicians care to examine it before they go on a borrowing spree.
Many conservatives are opposed to active fiscal policies in recessions. They see this as a path to permanent growth in government spending. I agree with their criticism, which is why I emphasize the difference between productive debt-driven spending and unproductive alternatives.
However, what conservatives often refuse to accept—and I speak here from a wealth of experience with conservative policy analysts and policy makers on both sides of the Atlantic Ocean—is that austerity policies do not help an economy in a recession. Those who believe they do are invariably based in Austrian economic theory. This strain of economics brings a lot of useful theory to the table, but it also fails to recognize the dynamic macroeconomic forces that determine where, and how fast, an economy is going: the consumption multiplier and the investment accelerator.
I am not going to explain the intricacies of these terms; suffice it to say that they enhance whatever fiscal policy a government decides on. The contraction in economic activity that follows austerity measures is multiplied through household income and, as a consequence, consumer spending. Once consumer spending is reduced, businesses respond by scaling back investments and cutting payroll—hence, the accelerator effect.
By the same token, if the government stimulates the economy by increasing spending or—vastly preferable—cutting taxes, then the consumption multiplier will spread those positive effects throughout the economy. Businesses, picking up on the positive trend, will expand investments and create more jobs.
The bottom line for Europe’s conservative policy makers is that their specific brand of policies to reduce the size of government are best put to work when the economy has recovered from a recession. As a second-best option, conservatives can steer recession-fighting stimulus policies in the direction of lower taxes and deregulations, i.e., as far as possible, keep them away from increases in government spending.
