Skip to comments.Paul Krugman and the European Austerity Myth
Posted on 05/09/2012 6:56:17 AM PDT by Kaslin
With both France and Greece deciding to jump out of the left-wing frying pan into the even-more-left-wing fire, European fiscal policy has become quite a controversial topic.
But I find this debate and discussion rather tedious and unrewarding, largely because it pits advocates of Keynesian spending (the so-called growth camp) against supporters of higher taxes (the austerity camp).
Since Im a big fan of nations lowering taxes and reducing the burden of government spending, I would like to see the pro-tax hike and the pro-spending sides both lose (wasnt that Kissingers attitude about the Iran-Iraq war?). Indeed, this is why I put together this matrix, to show that there is an alternative approach.
One of my many frustrations with this debate (Veronique de Rugy is similarly irritated) is that many observers make the absurd claim that Europe has implemented spending cuts and that this approach hasnt worked.
Here is what Prof. Krugman just wrote about France.
The French are revolting. Mr. Hollandes victory means the end of Merkozy, the Franco-German axis that has enforced the austerity regime of the past two years. This would be a dangerous development if that strategy were working, or even had a reasonable chance of working. But it isnt and doesnt; its time to move on. Whats wrong with the prescription of spending cuts as the remedy for Europes ills? One answer is that the confidence fairy doesnt exist that is, claims that slashing government spending would somehow encourage consumers and businesses to spend more have been overwhelmingly refuted by the experience of the past two years. So spending cuts in a depressed economy just make the depression deeper.
And hes made similar assertions about the United Kingdom, complaining that, the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the governments pullback.
So lets take a look at the actual data and see how much slashing has been implemented in France and the United Kingdom. Heres a chart with the latest data from the European Union.
Im not sure how Krugman defines austerity, but it certainly doesnt look like theres been a lot of slashing in these two nations.
To be fair, government spending in the United Kingdom has grown a bit slower than inflation in the past couple of years, so one could say that theres been a very modest bit of trimming.
Theres been no fiscal restraint in France, however, even if one uses that more relaxed definition of a cut. The only accurate claim that can be made about France is that the burden of government spending hasnt been growing quite as fast since the crisis began as it was growing in the preceding years.
This doesnt mean there havent been any spending cuts in Europe. The Greek and Spanish governments actually cut spending in 2010 and 2011, and Portugal reduced outlays in 2011.
But you can see from this chart, which looks at all the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), that the spending cuts have been very modest, and only came after years of profligacy. Indeed, Greece is the only nation to actually cut spending over the 3-year period since the crisis began.
Krugman would argue, of course, that the PIIGS are suffering because of the spending cuts. And since there actually have been spending cuts in the last year or two in these nations, does that justify his claims?
Yes and no. I dont agree with the Keynesian theory, but that doesnt mean it is easy or painless to shrink the burden of government. As I wrote earlier this year, the economy does hit a short-run speed bump when the public sector is pruned. Simply stated, there will be transitional costs when the burden of public spending is reduced. Only in economics textbooks is it possible to seamlessly and immediately reallocate resources.
What I would argue, though, is that these nations have no choice but to bite the bullet and reduce the burden of government. The only other alternative is to somehow convince taxpayers in other nations to make the debt bubble even bigger with more bailouts and transfers. But that just makes the eventual day of reckoning that much more painful.
Additionally, I think much of the economic pain in these nations is the result of the large tax increases that have been imposed, including higher income tax rates, higher value-added taxes, and various other levies that reduce the incentive to engage in productive behavior.
So whats the best path going forward? The best approach is to implement deep and meaningful spending cuts, and I think the Baltic nations of Estonia, Lithuania, and Latvia are positive role models in this regard. Lets look at what theyve done in recent years.
As you can see from the chart, the burden of government spending was rising at a reckless rate before the crisis. But once the crisis hit, the Baltic nations hit the brakes and imposed genuine spending cuts.
The Baltic nations went through a rough patch when this happened, particularly since they also had their versions of a real estate bubble. But, as Ive already argued, I think the cold turkey or take the band-aid off quickly approach has paid dividends.
The key question is whether nations can maintain spending restraint, particularly when (if?) the economy begins to grow again.
Even a basket case like Greece can put itself on a good path if it follows Mitchells Golden Rule and simply makes sure that government spending, in the long run, grows slower than the private economy.
The way to make that happen is to implement something similar to the Swiss Debt Brake, which effectively acts as an annual cap on the growth of government.
In the long run, of course, the goal should be to shrink the overall burden of government to its growth-maximizing level.
Mitchell’s Golden Rule has a flaw.
The government should not be allowed to grow, unless it can be proven that, that growth is necessary and not arbitrary. Arbitrary would be growth that is meant to grow social programs, and government should not be in the business of doing for people what they should do themselves. Government spending should be done on the necessary functions of government, such as infrastructure and defense and courts/judiciary and police departments, and perhaps some portions of education. Other than the necessary functions which only government could carry out, no spending should be allowed to increase.
In my opinion, the austerity issues add an interesting look into the arguments of the Keynesians and the Austrians on understanding economic problems.
John Maynard Keynes theory says that when the economy enters a recession, particularly when facing a liquidity trap problem, the government should step in and increase spending to boost the economy. To do this in Keynes’s theory the government has to dis-save (run a deficit). During good economic times the government is supposed to save and run a surplus. As is readily apparent, no politician in the world is going to follow this strategy. even during good economic times government's spend more than they bring in taxes. Especially since no one wants to spoil a ‘recovery’ or economic boom by backing off government spending.
F. A. Hayek’s focus was investment. What causes economic problems is bad investment. Mal-investment causes changes in the capital structure of the economy that must be corrected during recessions. Government spending to stimulate the economy makes purchases and drives investment that would not be undertaken by the market. Once the government stops spending these investment's are exposed as mal-investment and the economy has to readjust. That appears to be where Europe is at right now. Hooked on government spending just the way Hayek’s theory would predict.
Of course like a drug addict the answer is to quit spending and suffer withdrawal. The other option is to keep increasing the dosage until you go bankrupt.
If your family gets used to a lifestyle such that you are running up more debt per month than your entire paycheck then what is the solution? Run up more? If you try to cut spending significantly back to realistic levels you will probably have divorce and maybe child support on your hands and face bankruptcy any way. In this case you get another wave election.
Krugman can claim he is right only because there was NO good options for those countries and so he makes up a straw man for Republicans that cutting spending suddenly stimulates the economy and things immediately start getting better, some here seemed to believe this too a while back believe it or not.
Anyone who owns a business knows that government spending, like we’re seeing now, means your taxes are going to the moon. The ‘Progressives’ claim that Obama hasn’t raised taxes but the evidence proves otherwise.
I have no confidence in the people voting for these fools in office.
he makes up a straw man for Republicans that cutting spending suddenly stimulates the economy and things immediately start getting better, some here seemed to believe this too a while back believe it or not
take a meataxe to the *budgets* at every level and let the market/economy find its own level...if it [we] survives the transition, great...if not, well then i guess we'll check ole darwins theory and at least have less statism in general...
Except it would never stand in a Democratic system. In fact modern China's leaders wouldn't even try that for fear of being hanged. Stalin or Mao could get away with it by using sheer terror and mind control.
well maybe *chinas* leaders need to learn to fear the pitchforks in the hands of the producers, rather than just the parasites ???
The grasshoppers always outnumber the ants in real life. That is why they pay no federal general revenue taxes while sjb loses his shirt yet the grasshoppers think he is not paying his 'fair share'.
Time to raise sjb’s taxes to pay for those child tax credits for illegals with the kids in Mexico. Dems call that ‘fairness’.