The lessons of austerity

The hot topic in Europe is “austerity,” and the reluctance of various populations to embrace it.  The term is generally understood to mean savage budget cuts, necessitated by the bankruptcy of the benevolent State.  Popular anger against austerity is not difficult to muster, especially since opponents are never required to submit their own reasonable plan for avoiding budgetary disaster.  Vague assurances that tax increases on faceless, evil rich people can satisfy budget shortfalls are good enough. 

Until the situation degenerates to Greek levels of impending collapse, anti-austerity candidates can also assure the public that huge deficits are not harmful… or, in accordance with mangled Keynesian economics, they’re actually helpful.  Only when government spends far more than it takes in can the economy function properly!

We’ve heard versions of all these arguments in the United States, as we confront our own debt crisis.  They can all be refuted by studying events in both America and Europe.

For one thing, European “austerity” rarely has anything to do with “savage spending cuts.”  In fact, as Veronique de Rugy recently noted in the Washington Examiner, France never actually got around to “cutting” anything, but a socialist President still swept into power by running against “austerity.”  France had spending cuts only in the sense Washington has been using the term for decades: reductions in the rate of growth for government programs.

Even worse is the version of austerity peddled to U.S. voters, under the brand name of “a balanced approach”: spending cuts alongside huge tax increases.  This is always treated as if it were a bold new idea, but it actually has an impressive pedigree of failure in both the United States and Europe.  In the U.S., we always get the tax increases, but the spending cuts never materialize.  In the Old World, De Rugy says it has “unfortunately proven a recipe for disaster.”

In a 2009 paper, Harvard University’s Alberto Alesina and Silvia Ardagna looked at 107 attempts to reduce the ratio of debt to gross domestic product over 30 years in countries in the Organisation for Economic Co-operation and Development. They found fiscal adjustments consisting of both tax increases and spending cuts generally failed to stabilize the debt and were also more likely to cause economic contractions.

On the other hand, successful austerity packages resulted from making spending cuts without tax increases. They also found this form of austerity is more likely associated with economic expansion rather than with recession.

(Emphases mine.)  Examples of successful spending cuts without tax increases include the Baltic states, Germany, and Sweden.  The latter nations brought their budgets under control with spending cuts, while also maintaining much stronger GDP growth than the United States has managed, despite a trillion dollars’ worth of Obama “stimulus.” 

Writing at the Wall Street Journal, Robert Barro sees this as a repudiation of Keynesian stimulus theory, or at least the modern understanding of it:

For the U.S., my view is that the large fiscal deficits had a moderately positive effect on GDP growth in 2009, but this effect faded quickly and most likely became negative for 2011 and 2012. Yet many Keynesian economists look at the weak U.S. recovery and conclude that the problem was that the government lacked sufficient commitment to fiscal expansion; it should have been even larger and pursued over an extended period.

This viewpoint is dangerously unstable. Every time heightened fiscal deficits fail to produce desirable outcomes, the policy advice is to choose still larger deficits. If, as I believe to be true, fiscal deficits have only a short-run expansionary impact on growth and then become negative, the results from following this policy advice are persistently low economic growth and an exploding ratio of public debt to GDP.

The last conclusion is not just academic, because it fits with the behavior of Japan over the past two decades. Once a comparatively low public-debt nation, Japan apparently bought the Keynesian message many years ago. The consequence for today is a ratio of government debt to GDP around 210%—the largest in the world.

This vast fiscal expansion didn’t avoid two decades of sluggish GDP growth, which averaged less than 1% per year from 1991 to 2011. No doubt, a committed Keynesian would say that Japanese growth would have been even lower without the extraordinary fiscal stimulus—but a little evidence would be nice.

It’s not necessary to look across the Atlantic or Pacific oceans to see the failure of big government spending, and desperate attempts to balance the budget on the backs of taxpayers.  Just look at California, where capital flight (most famously Facebook co-founder Eduardo Saverin renouncing his U.S. citizenship and heading for Singapore) has caused income tax revenues to crater, even as the out-of-control government vows to crank rates even higher.  At this point, only a madman would relocate a business into California.

The illusion of robust growth in the shadow of massive spending is shattered by a review of the most successful states in America, undertaken in the Wall Street Journal by Senator Jim DeMint (R-SC) and Rep. Kevin Brady (R-TX):

Compared with the 10 U.S. states with the lowest rates of economic growth since 1990, the states with the highest rates of growth had smaller unfunded pension ratios (by 26%); lower debt ratios (by 18%); less tax revenue collected (by 22%); and lower welfare benefits (by 31%). Our report also shows that over the last decade, states with no income tax have much higher rates of job growth and population growth than states with the highest income taxes.

To their credit, many state policy makers have recognized the unsustainability of high-tax, high-regulation, welfare-state economics. But just as in Europe, many of the states in the deepest trouble seem the least interested in reform—either out of incompetence, ideological blindness, or a cynical expectation that when a crisis hits, someone else will bail them out.

The machinery of Big Government creates these “austerity” crises by accumulating massive liabilities, such as entitlements and public-sector pensions.  Of course, the looming menace of future austerity is never discussed when these commitments are made.  No one ever wants to discuss what will happen when the money runs out. 

By the time fiscal collapse begins, the pressure from dependents to maintain these systems has become politically irresistible.  President Obama, who has piled over $5 trillion onto the American national debt, was actively seeking to harvest dependency votes by exploiting an “austerity” crisis based on student loans.  Imagine what pensioners will say, when America’s $200 trillion liability bomb detonates! 

Well, you don’t really have to imagine it.  You can see it playing out on the streets of Athens.  The trick is to avoid that fate while it’s still possible, before a hopelessly dependent population becomes incapable of hearing anything except sweet nothings whispered into their ears by socialists.  There is no reason to tolerate further hollow promises from Big Government theorists when the evidence is all around us: Keynesian stimulus doesn’t work, debt is deadly, and no government ever seems capable of balancing a budget through a mixture of tax hikes and spending cuts. 

Making intellectual concessions to these bankrupt ideas only leads to a longer stroll down a dead-end road, and brings us closer to the political death spiral of austerity.  Grant the necessity of tax increases as part of a “balanced” approach, and you can rest assured you will never stop hearing excuses that the tax increases weren’t big enough.  Grant the government power to manage the economy with “stimulus” spending, and you will always be assured the last failed stimulus was too small.  It’s a mistake to allow escape valves that bleed off the pressure for politicians to do what they should have been doing all along: make a tight budget that drains the minimum amount of vitality from the private sector, and stick to it.