European Austerity in Perspective

April 26, 2012

by Chidem Kurdas

Attempts to rein in government spending necessarily have unpleasant side effects.  Thus the Dutch government collapsed amid budget talks to control the deficit.   And British national output appears to be shrinking.

Keynesians and advocates of the Obama administration’s colossal budget see this as vindication for unrestrained government spending. But in fact what we see in Europe is a very unfortunate consequence of past unrestrained spending.

Let’s look at it this way. Government largess acts as a short-term stimulant. Politicians and the groups they cater to become addicted to this quickie pick-me-up. Addicts, of course, tend to want more and more of the stuff that makes them feel oh so wonderful. Now, countries like the Netherlands and Britain are trying to kick the habit. Not surprising that the process is painful.

One can argue about the timing of the policies. In the middle of a debt crisis – largely brought on by government profligacy – may not have been the best time to revert to austerity. This is like a druggie who has broken his leg. He has to get free of his drug but he might wait a bit for the leg to mend before going cold turkey. Adding stress to an already stressful situation does not help the human body. The same goes for the economic body.

But the fact remains that there is a long-term underlying problem caused by politicians lavishly spending other people’s money and future generations’ credit to buy themselves power.

In 1977 James Buchanan and Richard Wagner pointed out that Keynes and the Keynesians removed the institutional and moral barriers to deficit spending. This freed politicians to spend without limit and rack up debt.  Yes, Keynes himself argued for deficit spending during recessions only, to be balanced by surpluses in good economic times. But in effect he destroyed the controls on spending and debt.

Governments at every level squandered immense resources and created mind-boggling liabilities, with the result that Europeans and no doubt eventually Americans face painful retrenchment.  It behooves Keynesians to recognize their handiwork in enabling a dreadful addiction. Instead, they interpret the pain they’ve caused as evidence of how right they are.

What is the long-term solution? Daniel Mitchell points out a Swiss law that limits central government spending, approved by a large majority of voters in 2001.  This law does not require the budget to be balanced every year but ties spending increases to growth in average revenue over a number of years. Government spending in Switzerland is at 34% of gross domestic product; in the US it is 41%.

Representative Kevin Brady of Texas has introduced legislation in Congress containing a  requirement similar to the one in Switzerland. One question is whether the bill can garner enough political support. Another, even more fundamental, question its whether it would really rein in government spending in the US.

Kicking a bad habit is notoriously hard. But not doing so makes for future misery. The sad spectacle of Europeans going cold turkey should be an incentive to keep government within bounds.

27 Responses to “European Austerity in Perspective”

  1. Roger McKinney Says:

    “Spending cuts? What spending cuts?”

    http://www.adamsmith.org/blog/economics/3051-words


  2. Great post.

    The other terrible effect of removing the limits on spending, is that the state became then an artifice for the promotion of consumption, rather than an institution that assisted in the coordination necessary for meaningful increases in production and invention.

    Industrial policy and welfare policy need their own houses of government.


  3. Good post and up to date with today’s op ed by Dan Mitchell. Buchanan/Wagner on Democracy in Deficit is still a seminal reading on the issues.

    As a WSJ editorial recently detailed, the Germans implemented an austerity program under Chancellor Schroeder and are now repeating the benefits. Maybe the Germans are made of stearner stuff.

  4. chidemkurdas Says:

    Roger McKinney–
    Interesting graphs. I see the data you have is central government, which may not fully reflect what’s going on. The debt graph does show some decline. In any case, I’d grant you that it is a mixed picture so far but they do appear to be making some cuts.

  5. chidemkurdas Says:

    Jerry O’Driscoll–
    The German case may be instructive. I wish there was more analysis of it.

  6. Allan Walstad Says:

    Addiction is an apt model. Reminded of a Steppenwolf song.

  7. chidemkurdas Says:

    “The pusher” I believe the song is titled.

  8. Lord Keynes Says:

    “Attempts to rein in government spending necessarily have unpleasant side effects. … And British national output appears to be shrinking.”

    Meaning that austerity leads to real output collapse? Causing unemployment, idle resources and loss of potential wealth?

    “in fact what we see in Europe is a very unfortunate consequence of past unrestrained spending.”

    And yet, to take just one example, Spain had budget surpluses in 2005, 2006 and 2007 and very small deficits as a percentage of GDP from 2003 onwards.

    This wasn’t “unrestrained spending” by any stretch of the imagination. This doesn’t fit your convenient morality tale of “unrestrained” Eurozone government spending evil.

  9. Bill Stepp Says:

    The press’s term “austerity” is absurd. Would that they use the term “profligacy” to describe the norm of ever increasing government spending and the resulting deficits.


  10. “Austerity” is ambiguous at best. Not a useful term. (See more below.)

    The sad fact is that many countries in EU have borrowed to finance consumption in excess of the income being generated. It doesn’t matter whether they were recording budget surpluses in the fat years. They were spending in excess of what could be sustained.

    (I believe the Spanish have also discovered the regions had bigger deficits than had been officially recorded. Similar to the Greek story.)

    The people of these countries now are finding they are poorer than they had thought they were. Why is it surprising they are spending less? The resources to sustain their spending are not there. This problem must be analyzed in real terms.

    The cure is not demand-side “stimulus” (another useless term), but supply-side reforms. In general, the governments have been unable to implement these or not to the degree needed (Italy).

    Much of the “austerity” has been in the form of higher taxes, not reduced spending. Italy is again a good example. Meanwhile, the Germans have police roaming trains that cross the Swiss border in search of currency fleeing the country. I got to winess this first hand recently.

    You cannot book a table in a good Zurich restaurant, so I think financial transactions are occurring despite attempts to prevent them. Corporations wire money out. Anectodal evidence suggests they have been doing so systematically since the crisis began: from the banks of weak countries to to those of strong ones. The latter is a shorter list each day.

  11. Olivier Braun Says:

    Prof. O’Driscoll,
    Your comment is right to the point. The word “austerity” is so badly employed as to give it a (very) bad name. As prof. Bagus wrote, in a new chapter of his “the Tragedy of the Euro” (for the Brazillian edition) :
    ” ‘Austerity’ is a clear misnomer. Higher taxes mean that the government tries to suck more resources into the public sector. The public sector is gaining weight and depressing the space for the private sector. Austerity for the public sector means growth for the private sector and vice versa. Tax increases does not mean austerity of the government.”
    Governments should indeed reduce deficits but should concentrate on reducing spendings, as you say whan you wrote about countries findind they are poorer as they thought. That is not what they are doing in Europe, at least not in my coutry, France, where all our presidential candidates want to increase taxes and invent new ones.

  12. Allan Walstad Says:

    Sobering up is painful. The Keynesian “solution” is: keep drinking! It is the political economy of puerility.

  13. Lord Keynes Says:

    “The sad fact is that many countries in EU have borrowed to finance consumption in excess of the income being generated. It doesn’t matter whether they were recording budget surpluses in the fat years. They were spending in excess of what could be sustained.”

    You mean they were privately borrowing money? That isn’t a public debt problem, but a severe problem of the private sector. And precisely what you get when you deregulate the financial sector, as in America’s epidemic of liars loans and NINJA loans.

    “The resources to sustain their spending are not there. This problem must be analyzed in real terms.”

    In real terms, the problem is idle resources: idle capital goods, unused capacity, idle workers.

    “Meanwhile, the Germans have police roaming trains that cross the Swiss border in search of currency fleeing the country. I got to winess this first hand recently”

    That sounds frankly bizarre, not least of all because the Germans must be the recipients of a good deal of capital inflow from other EU nations, since most people think the place to have your Euros is in a German bank.

    I’ll bet you the net effect of any such inflows and outflows will be capital inflow into Germany.

  14. chidemkurdas Says:

    Re term “austerity”
    This is not an accurate term but unfortunately it has become so widely used that it’s hard to avoid.

  15. chidemkurdas Says:

    Lord Keynes–
    Reducing government extravagance will require re-adjustment in the economy. That is certainly the case. If that’s what you’re objecting to, well, had the extravagance never happened the re-adjustment would not be necessary but now there is no alternative.

    However, as I mentioned in the post, the exact timing is arguable.


  16. @Lord Keynes,

    Why do you obfuscate the issues? I wrote about budget surpluses, which you somehow interpreted as a statement about private borrowing. Why do you do that?

    Are you seriously denying that the public-sector debt is unsustainable in many EU countries? Perhaps you should aacquaint yourself with the facts. Here is a link to a Eurostat table showing the trend by country since 1995 (through 2011); for the EU as a whole and for just the Eurozone. Eurostat is the official source of statistics for the EU.
    http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=en&pcode=tsieb090

    The fact that you find what the Germans are doing is “frankly bizarre” indicates to me that you really do not understand what is going on in the EU. The Germans are worried about tax evasion. The Italian Financial Police are doing much the same thing. (Yes, the Italian state has a separate police force to collect taxes.) The Spanish government has put on capital controls.

    Again, the so-called “austerity” in these countries has largely taken the form of higher taxes. No wonder consumption is collapsing.

    The “idle resources” are a consequence of debt crises involving the banking sector and the public sector. Rogoff and Reinhart detail this effect in their work.


  17. A follow up with an on the ground report on the craziness still going in Spain. The construction industry remains in denial, and is building new housing as vacancies soar.

    http://www.bloomberg.com/news/2012-05-01/madness-in-spain-lingers-as-ireland-chases-recovery-mortgages.html

    One might ask why the banks keep financing this. My surmise is that it’s a go for broke strategy made possible because the government is unwilling to shutter zombie banks.

    I witnessed the same thing in Las Vegas at the bginning of the housing bust. Vacant homes were being auctioned off on one side of the road while new ones were being constructed on the other side of the road.

  18. chidemkurdas Says:

    THat’s an interesting observation. Liquidity provided by central banks may be channeled this way.


  19. Chidem,

    It reminds me of the S&L crisis and the later Texas banking crisis. Insolvent banks are kept open and offical lending finances them. It was a combination of FSLIC and FDIC support with the Fed as backstop.

  20. Bill Stepp Says:

    Johan Norberg has a good article about this, “Financial Crisis II,” in the May issue of Reason, which is adapted from the pb issue of his book Financial Fiasco.


  21. Voices of reason, Constantin Gurdgiev and Morgan Kelly 2012 and 2007 respectively, on Ireland
    http://awakenlongford.wordpress.com/2012/05/03/323/

  22. Roger McKinney Says:

    “The chart above comes from Veronique de Rugy of the Mercatus Centre. It tells a different story to the popular narrative that European voters have tried and rejected austerity. In fact, they have hardly tried it at all, returning generally to 2008 levels of government spending. France has not cut at all, yet it has just elected the patron saint of mediocrity, Francois Hollande.” from http://www.adamsmith.org/blog/international/europes-nightmare-has-just-begun

  23. videolar Says:

    Are you seriously denying that the public-sector debt is unsustainable in many EU countries? Perhaps you should aacquaint yourself with the facts. Here is a link to a Eurostat table showing the trend by country since 1995 (through 2011); for the EU as a whole and for just the Eurozone. Eurostat is the official source of statistics for the….

  24. video Says:

    And yet, to take just one example, Spain had budget surpluses in 2005, 2006 and 2007 and very small deficits as a percentage of GDP from 2003 onwards.

  25. Derek Johnson Says:

    The question is how do you get everyone on board, because every article I read its about how no one is approving of this method of deficit cutting. These governments, like Britain for example forecasted that they will be back on track in 2013. 30,000 jobs will be cut by then and yes your no longer in a recession as a country but this didn’t work unless you can replace those jobs with equal or better jobs. Thats how we have define will work. Here is how I think about it, say I have a car and spend a certain amount of money on gas with the income I earn, but the government pays my toll to cross a bridge. Well with austerity I still have a car to cross the bridge but I have no job for the gas and now I have to pay a toll at the bridge.  That’s how I see it when they cut spending and raise taxes. So will this work? It all depends on the growth that comes out of it.


  26. [...] Krugman quotes Keynes: “The boom, not the slump, is the time for austerity.”  Now, I have to admit that I was somewhat in sympathy with the notion that it may be premature to reduce federal spending. Government largess acts as a quickie pick-me-up, to which economies have become addicted. I thought a debt crisis – though largely brought on by government profligacy – may not be the best time to go cold turkey. [...]


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