Europe's Crisis

A Roadmap From the Past

Hayek and Röpke saw it all coming

By Peter B. Doran & P. Bracy Bersnak

These are rough days for the European Union (EU). What began as a sovereign debt crisis has now metastasized into a political debacle for the leaders left holding the bag. Nicolas Sarkozy's electoral defeat in France, the ouster of an austerity-minded government in Greece; and last month's collapse of the governing coalition in the Netherlands are all symptoms of a deeper problem for Europe: bloated governments are hard to tame, even when there is no money left to pay for them.

This is bad news for Europe. But the political tumult on the continent is also a stunning vindication of the post-War thinkers who anticipated this outcome. These individuals, men like Friedrich von Hayek and Wilhelm Röpke, would become founding intellectual fathers behind the modern conservative movement in Europe and the United States. Even today, their foresight provides a defining roadmap for navigating away from Europe's current crisis and offers a chilling warning to the United States about repeating the same mistakes.

Much like the debt crisis of our own time, the dimensions of Europe's post-War reconstruction were staggering. Only instead of ruined factories and decimated cities, today's contemporary European leaders must contend with bombed out credit ratings and the herculean task of reordering the continent's dysfunctional economies. Then, as now, the basic policy debate centered on the state's role as guarantor of public prosperity and welfare; and perhaps more importantly, how to finance it.

Wading into this dispute, Hayek, Röpke and other post-War conservatives did not deny the need for basic social insurance schemes. But they foresaw that the promises of an ever-expanding welfare state would be maintained at heavy costs: both in taxation and freedom. With stunning prescience, they warned that unless state services were limited to basic forms of social insurance, the financial basis for Europe's economic order would become structurally unsound and dangerously unmanageable. Government largesse would invariably grow and require increased revenue from taxes or heavy borrowing against future economic growth. As citizens relied on the state to protect them from the uncertainties of life, they would become dependent on it; but woe to politicians who would try to wean voters off of the state.

This is an uncannily close portrait of Europe as it exists today. From angry street protests in Greece and Romania, to plaintive calls for a return to government stimulus spending by France's president-elect François Holland and Italian Prime Minister Mario Monti, resistance to budget austerity is as predictable as it is strident. While this opposition does not alter the EU's underlying financial problems, it could affect the political outcomes of the crisis. Going forward, the EU faces four potential scenarios, some of which could occur in combination:

Voluntary Austerity: Europe's over-burdened governments could fully commit to the rationale and rigors of sustainable budgets. Already, the EU's Baltic economies (Estonia, Latvia and Lithuania) have demonstrated that deep cuts to state spending are possible. Such an approach, however, requires strong leadership and an understanding of what's at stake by the voting public. In this case, Baltic memories of economic chaos during the late 1980s and early 1990s helped to catalyze decisive action.

Imposed Austerity: External actors (e.g., Germany or the EU) could alter national spending habits by leveraging treaty or market forces. As recently as January, trading houses savaged Hungary's currency and imposed crushing interest rates on government debt until officials agreed to a credible reform agenda. By enacting its new Fiscal Treaty, the EU hopes to avoid a similar pummeling of Euro-zone economies. But in binding its members to budgetary prudence, the EU has triggered virulent push back in France, Greece, Spain, Italy, Ireland and the Netherlands.

Repudiation: Individual states could repudiate their treaty and debt obligations but incur economic isolation and impoverishment. Significantly, this approach would accelerate the emergence of a "two tiered" Europe as the gap between healthy and unhealthy Euro-zone economies widens. EU decision-making would be concentrated into the hands of solvent countries, while weaker economies could invite aggressive speculative pressure against the Euro. Faced with this scenario, the common currency is unlikely to survive in its current form.

Repugnant Replacements: Paralyzed by inaction, Europe's current governments could be replaced by new leaders who are antagonistic to trans-Atlantic norms and fiscal necessity. In recent months, non-mainstream parties in Austria (Freedom Party), France (National Front), Greece (Golden Dawn), Hungary (Jobbik), and the Netherlands (Freedom Party) have reaped an alarming windfall of voter support. And even if these parties are unable to translate a burst of popularity into majority rule, their role as political kingmakers in wobbly parliamentary coalitions could inflict lasting damage on fundamental values like open borders, free trade, free markets, and inclusive societies.

As the EU gropes for a way out of its financial malaise, continental leaders would benefit by heeding the advice of thinkers like Hayek and Röpke. Faced with Europe's current economic prospects, both men would be skeptical of centralized or collectivist approaches to spurring growth, preferring instead to stimulate entrepreneurialism through tax incentives and greater economic freedom. While Hayek might argue against applying a Keynesian balm for Europe's ills, Röpke was more willing to prescribe public sector spending during a crisis. Even so, he warned that such a policy should be deployed only with great caution and for brief periods.

Given the current levels of European indebtedness, it is difficult to imagine either Hayek or Röpke endorsing the rising counter-argument in France and Greece that public debt got us into this and even more debt will get us out. This would reinforce the rationale behind "voluntary austerity" and encourage national governments to fearlessly prune decades of overgrowth in public sector spending. For the United States, the insight of Hayek and Röpke highlights the need for cutting our own runaway deficits. Viewing Europe's troubles, we can glimpse how our own story is likely to end if Congress cannot bridle federal spending. In this event, the cost of inaction would be counted not only in dollars and cents but in the unwanted decline of America's capacity for global leadership.