Austerity is destroying Europe, we are told. In fact, this “anti-austerity” slogan was a big reason for the victory of newly elected socialist François Hollande to the presidency of France. Interviewed in The Economist a few weeks ago, Hollande’s campaign director said “We are not disciples of savage spending cuts.”
But then, I look at the data and I am asking: What “savage” spending cuts?
Look at this chart. It is based on Eurostat data which you can find here. Following years of large spending increases, Spain, the United Kingdom, France, and Greece — countries widely cited for adopting austerity measures — haven’t significantly reduced spending since 2008. As you can see on this chart:
- These countries still spend more than pre-recession levels
- France and the U.K. did not cut spending.
- In Greece, and Spain, when spending was actually reduced — between 2009–2011 — the cuts have been relatively small compared to what is needed. Also, meaningful structural reforms were seldom implemented.
- As for Italy, the country reduced spending between 2009 and 2010 but the data shows and uptick in spending 2011. The increase in spending represents more than the previous reduction.
The most important point to keep in mind is that whenever cuts took place, they were always overwhelmed by large counterproductive tax increases. Unfortunately, that point is often overlooked. This approach to austerity — some spending cuts with large tax increases — is what President Obama has called the “balanced approach.”
However, as I have mentioned previously, while this balanced approach may sound good and appeals to our sense of fairness and moderation, but it can be a recipe for disaster. That’s because it fails to stabilize the debt, and it is more likely to cause economic contractions.
We know what successful fiscal adjustment look like and it’s not what was implemented in Europe. Here is a reminder:
Now, a new book by the IMF called Chipping Away at Our Debt, edited by Paulo Mauro, looks at 66 instances of fiscal adjustments in Canada, France, the United States, Japan, Germany, and Italy. The key findings are in many ways consistent with the works highlighted above. For instance:
- Successful fiscal adjustments were grounded in structural reforms. Such reforms include welfare reforms as well as comprehensive expenditure review in the context of repositioning the role of the state (think Canada and Germany).
- Plans that avoided structural reforms failed to meet their targets.
- Successful plans were often grounded in real budget cuts.
- Expenditure cuts didn’t materialize to the extent initially envisioned.
- Revenue-based plans without well-specified tax-policy measures — a majority of the revenue-based cases — failed.
Other really interesting findings were:
- Ambitious plans tend to produce more adjustments than modest ones.
- Ambitious plans aren’t associated with more frequent changes in government (in other words, ambitious fiscal adjustment plans aren’t penalized by voters).
- In the case of successful adjustments, revenue often surpassed expectations Deviations of economic growth from initial expectations is key factor underlying a fiscal adjustment’s ability to meet its target.
- Public support is key to achieving successful fiscal adjustment.
Here is my hope: First, I wish we would stop being surprised by what’s happening in Europe right now. Second, I wish anti-austerity critics would start acknowledging that taxes have gone up too–in most cases more than the spending has been cut. third, I wish that we would stop assuming that gigantic “savage” cuts are the source of the EU’s problems. Some spending cuts have been implemented in a few countries. Also, if this data were adjusted for inflation (which I would prefer but the data isn’t available) it would possibly show a decrease and certainly a flatter line for all countries. However, the overwhelming take away from the European experience is that a majority of governments haven’t really implemented spending cuts, large or small, and some have even continued to grow.
Update: Will Wilkinson makes a good point about my chart and wishes:
I suspect the entire debate hinges on a difference in assumptions about the relevant spending baseline. If your theory prescribes significantly ramping up spending during recession, low or flat spending growth can look perversely “austere,” even if absolute spending as a % of GDP is very high
I agree with Will. However, note that when anti-austerity critics talk about it, they imply dramatic reductions in spending.
Obviously, I am sure that there is plenty more going on here. But it is misleading to say that “large” spending cuts are the sole source of EU troubles.
