The political shift in Europe has certainly rewritten the script on the debt crisis. Up until a few of weeks ago, the Germans seemed to have forged a consensus in favor of fiscal austerity.

But first the socialists overturned Slovakia's commitment to Germany's "austerity pact," and then in the Netherlands a vote of no confidence turned out the government that had agreed to it. Anti-austerity politicians have gained in Italian and even German provincial elections. Even before such election results, Italian Premier Mario Monti began questioning the single-minded commitment to austerity. European Central Bank (ECB) President Mario Draghi has done the same, though for different reasons.

Most recently, French elections unseated former President Nicholas Sarkozy and put in his place the very anti-austerity socialist Francois Hollande. Still, for all the upset, it is not necessarily sure that Europe will simply reject budget control. The anti-austerity camp is more nuanced than that.

In one sense, it is easy to see why German Chancellor Angela Merkel has so insisted on austerity. As Europe's largest and arguably healthiest economy, Germany knew from early on that it would have to carry the burden in any bailout. It is only reasonable then that its leadership would want to ensure that each assisted nation gives up its spendthrift ways. Even then, the German pact fell short of the "fiscal unity" of which some spoke and in which the Eurozone would have adopted a zone-wide approach to government budgeting, largely controlled by Berlin.

Still, the German pact is severe. It would insist on strict limits on the relative size of each member nation's budget deficits and debt outstanding, and would enforce such limits with fines on those nations that violate the rules.

On the other side of the question, the reaction against austerity makes good economic sense. The single-minded focus on austerity is actually dangerous. In fact, it runs the risk of putting Europe into a vicious downward spiral. Because austerity of this sort could easily create recessions in the nations on which it is imposed, it could actually create greater shortfalls in tax revenue and force greater spending on social services. Because the resulting deficit increases would, in the agreement, demand still more austerity, the approach would only then compound budget problems, leading to still more austerity that would only enlarge deficits more. Such a downward spiral would ensure that these nations could never reach solvency or even stability.

But if these impositions and dangers explain Europe's adverse reaction to the austerity pact, a simple desire to reject or reverse the German approach, such as planned by France's Francois Hollande, is no less dangerous. By ignoring deficits and continuing to spend, Hollande, and others like him, would simply extend the policies that have brought so many European nations to their present financial and economic impasses. Worse, plans to finance such spending by raising marginal tax rates—to 75%, according to the Hollande campaign, on those who make more than €1.0 million a year—would invite a flight of financial capital. And such financial capital is already in short supply in Europe, and could prompt a slowdown or downturn in economic activity. The situation would undermine the credit of these nations even faster and more surely than a vicious cycle imposed by austerity, hastening the insolvency of these governments and making the prospect of widespread default a probability. Especially since the Germans have rejected out-of-hand a renegotiation of the austerity pact or any use of debt to promote growth, Europe would seem to need a third way between these two dangerous extremes.

Fortunately, some who question austerity offer such an alternative. They would pursue overall deficit restraint. But, to avoid the risks of a single-minded focus, they would counterbalance budget restraint with a parallel "growth pact," to use the words of ECB President Draghi. This parallel pact would seek growth through what its proponents have referred to as "structural reforms." These might include a loosening of labor rules and other regulatory constraints on business, government asset sales and privatizations of some government services.

Such action would, they argue, increase the flexibility of European economies, encourage business formation and hiring, increase the dynamism of the economies, and so prompt growth, despite overall fiscal restraint. In this way, Europe could regain fiscal control, offset the dangers of a downward spiral that austerity alone risks, and relieve the strain of adjustment on their businesses and their working populations.

The frustrating thing about those promoting this alternative approach is that they have spoken in such maddeningly vague terms about something that desperately needs specificity. Monti, Draghi and LaGarde have talked about making Europe "more competitive," but beyond a few hints of the elements involved have remained less than forthcoming. The most specifics to emerge to date have come from Jörg Asmussen, the German member of the ECB's executive board. Drawing on Germany's 2010 reform, he has outlined a program for greater economic flexibility and growth that includes easing job dismissal protections, lowering bureaucratic hurdles for new business creation, setting higher retirement ages and revising regulations that heighten non-wage labor costs. Presumably, Asmussen speaks for Draghi in setting forth these points, but that is far from certain.

Meanwhile, Monti, by stressing the need for infrastructure spending, has added to the confusion by sometimes seeming to slide in the direction of those who would use debt to promote growth. In this, he could simply be arguing for a shift in spreading priorities and not an overall increase in spending, but he has failed to make that difference clear.

Since either austerity alone or a renewed turn to spending and debt run great risks, this situation desperately needs clarity and direction. If this electoral turn prompts such a response, it will, against all initial appearances, brighten prospects. Without such clarity, however, Europe will remain troubled, and a financial and economic danger to itself and the rest of the world as well.


Milton Ezrati is the senior economic strategist at Lord Abbett and
affiliate of the Center on Economic Growth in the Department of Economics
at The State University of New York at Buffalo