Austerity? Not Really…

Many in the chattering class, especially the economists and politicians on the left, keep telling us "Austerity has failed!" No, austerity hasn't been tried.

I won't even bother with links to Paul Krugman's near-daily calls for stimulus — and inflation — in Europe, which would require a complete disregard for European experiences and German biases towards savings and low-inflation. Such economic arguments are beyond silly: convince Germans that an 11 percent savings rate is a bad idea? Really? Cause inflation in the hopes it will force Germans to spend money? Krugman and other economists can suggest these solutions because they know, they must know, that German citizens are not about to go on a spending binge and buy Greek, Spanish, or Italian goods.

Yes, Germans really do save more than 11.4 percent of their income. And for ten years, Germany employed true austerity and labor reforms. They loosened labor restrictions (compared to the rest of Europe), slowed spending growth, and managed a painful reunification. Germany is an amazing success story.

Why would any sane German leader listen to President Obama, Paul Krugman, or anyone else telling Germany to bailout the rest of Europe? Sorry, but Germany was the responsible, sober driver. Asking for "shared sacrifice" is idealistic and unrealistic.

Returning to the argument that austerity has failed, Veronique de Rugy discredits that argument nicely in a Los Angeles Times column. There has been no true austerity — only slower increases in spending and higher taxes. Sorry, but increasing taxes is not austerity. Raising taxes slows growth, and ironically often leads to lower tax collections.

In Europe, time for true austerity:
Half-hearted reforms won't work. European countries need to get serious about spending cuts.
By Veronique de Rugy
May 18, 2012

For several years now, European governments have tried versions of austerity — usually understood as an attempt to reduce the ratio of government debt to gross domestic product — in hopes of reviving the continent's flailing economies. But not only have their efforts failed, we're now told, they have actually made things far worse.

According to one naysayer, former Obama administration chief economic advisor Larry Summers, austerity efforts are "counterproductive" to growth. In a recent Bloomberg TV interview, Nobel laureate and economist Paul Krugman said, "I wish I'd been wrong for the sake of the world" about his prediction that "Austerians" pushing for fiscal retrenchment would destroy Europe. This sentiment is echoed in countries such as the Netherlands, among others, which have announced they will start spending again. And newly elected French President Francois Hollande's victory was pegged to his absolute rejection of austerity measures.

Austerity has not made things worse in Europe. However, trying to balance budgets on the backs of the "rich" and "capitalist corporations" has failed. Reducing debt ratios is not the only measure of austerity; it is a meaningless measure if this is accomplished via taxes alone. It is almost guaranteed to fail and fail badly.

There are two basic problems with this growing anti-austerity backlash. First, where spending was actually reduced, the cuts have been relatively small compared to the size of the problem and meaningful structural reforms were seldom implemented. Second, to the extent declining Europe countries pursued austerity, it has mainly been through large tax increases. If the economies of Spain, France, Britain and other European nations are suffering, it's not because of "savage" spending cuts. It's because small spending cuts are overwhelmed by tax increases.

Consider Britain, where supposed austerity measures represent a "stunning failure of policy," according to Krugman in his New York Times column. In 2009, British Prime Minister Gordon Brown promised he would reform social programs and dramatically cut spending and taxes. Instead, he increased the top marginal income tax rate shortly before he left office. When David Cameron replaced him in 2010, he promised to pursue the same austerity measures. However, in 2011-12, spending increased from $1.15 trillion to $1.2 trillion, and public pensions have yet to be reformed. Instead, the government increased the capital gains tax, national insurance tax and value-added tax along with other fees and duties.

I am reminded of the "severe cuts" proposed in various Republican budgets. Usually, these are reductions in the rate of increase, not actual cuts to anything at the federal level. Most people don't realize it, but the differences between the Obama and Ryan budgets are approximately 0.5 percent (yes, one-half of a percent) annually. Even Ezra Klein wrote, "You would never know from the rhetoric in President Obama's budget speech that there are broad swaths of government policy on which he and Paul Ryan mostly agree.) (see: Where Ryan and Obama Agree http://www.washingtonpost.com/blogs/ezra-klein/post/wonkbook-where-ryans-and-obamas-budgets-mostly-agree/2012/04/04/gIQA5SayuS_blog.html)

Only in politics is a reduction in the rate of spending a "severe" or "savage" spending cut. Growing a federal program 3 percent over a decade instead of 3.5 percent? Those vicious budget hawks! Of course, there are real differences, but as Klein and others now admit, "Neither man's budget makes any changes to Social Security. Both budgets are content to find their savings elsewhere." And therein is the same problem that is facing Europe: social programs need to be reformed, but that isn't going to happen.

Real austerity is politically unpalatable. No one wants to cut. The only difference between left and right in Europe or the U.S. (excluding Germany) is that the left is more willing to raise more taxes. Neither wants to adopt true cuts and austerity. In the end, our economies will suffer for this lack of discipline.

But, the left tells us, the French are proof austerity was rejected! What austerity, I ask again. Returning to the Rugy column:

Hollande wants to replace what he calls austerity with "pro-growth" policies. But there is nothing austere about France's spending, which rose by $33.4 billion between 2009 and 2010 and an additional $29.5 billion in 2011. French public spending already equals 56% of GDP. Hollande's own wishful projections show total tax receipts rising from 45% of the economy to 47% in five years thanks to his plan to impose a 75% top marginal income tax rate for those earning more than $1.3 million and an increase in the corporate income tax. If this is pro-growth, then garlic breath is pro-romance.

So more than $60 billion in new spending over two years under the "conservative" Sarkozy administration was somehow austere? Seriously? How can Krugman or any other economist (or White House adviser) argue that France was trying to reign in budgetary excess? No, the French "right" simply increased spending more slowly than the "left" might. Personally, I hope that the Socialists are in the odd position of being able to pass reforms simply because unions and other left groups might listen to Socialist politicians when they explain budget realities.
If the French are interested, and if Keynesians care at all about evidence instead of theory, Rugy offers the following evidence for real austerity:

In a 2009 paper, Harvard economists Alberto Alesina and Silvia Ardagna looked at 107 examples in developed countries over 30 years and found that successful austerity packages — defined by a reduction in debt to GDP greater than 4.5% after three years — resulted from making spending cuts without tax increases. They also found that this form of austerity accompanied by the "right policies" (easy monetary policy, liberalization of goods and labor markets, and other structural reforms) is more likely associated with economic expansions rather than with recessions. This makes intuitive sense: Austerity based on spending cuts signals that a country is serious about getting its fiscal house in order in a way that taxing and spending certainly does not.

On the other hand, they found that the so-called balanced approach — typically a mix of spending cuts and tax increases — is a recipe for failure. It fails to stabilize the debt, and it is more likely to cause recessionary economic contractions. And when it comes to plans such as Hollande's that would explicitly increase spending and taxes, they find little chance of either economic expansion or debt reduction.

Now, I have admittedly argued in favor of some increases in tax revenues within the United States. However, I have suggested lower rates and fewer deductions. Reducing complexity might increase revenues slightly. I would never suggest dramatic increases in tax collection as a way to balance the federal or state budgets in the U.S. or elsewhere.

"Balance" to our chattering class means striking a blow against the top earners, investors, and job creators. That's not balance. Nor is it "austerity" to slow rates of growth. Our budgets need to be trimmed; an extreme diet is necessary.

I'm also all for reallocating dollars. Move money from wasteful projects into infrastructure and education. But, I don't trust politicians to spend wisely, at least not in our current political climate. So, let's just cut and cut and cut some more.

Along with cuts, simplify taxes, simplify labor laws, and simplify the process to launch new businesses. Make it easy to create jobs, easy to employ people, and easier to pay taxes.

If the Italians actually want to revive their economy, they — and other Europeans — should hurry past the talking stage and abandon the so-called balanced approach to their situations. They must start actually cutting spending and reforming their bloated governments. They have nothing to lose but their debt.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

Sadly, I doubt reason will prevail. We all know our systems in Europe and U.S. need reform, but change seems to be impossible at the moment. There is going to be some sort of financial disaster and maybe then reform will finally be possible.