Bad Austerity Analysis: Response to Veronique de Rugy

I am only allergic to two things: taxes and bad analysis. I can cope with my tax allergy because I live in a state with no income tax and no wealth tax; and I live in America where taxes overall are still relatively low.

I have a much harder time coping with my allergy to bad analysis. When the bad analysis comes from statists, it does not itch as bad; in fact, I make my living analyzing statism and producing research that explains the alternatives.

When the bad analysis comes from people who are on the side of economic freedom, I find it harder to deal with my allergy. The only remedy is an extensive analysis of where my fellow traveler has gone wrong. Today’s article, which belongs to this category, has its origin in a contribution to the debate over austerity from Veronique de Rugy, senior research fellow with the Mercatus Center at George Mason University.

In a recent piece on government spending and austerity in Europe, Ms. de Rugy tried to explain that: a) austerity has not caused any drop in government spending in Europe, and b) austerity is not all that bad. Superficially, de Rugy’s arguments seem to come full circle. However, a closer look gives the impression that her analysis has fallen victim to the twittered information fracturing that is so common these days.

Here is what de Rugy said a couple of weeks ago in her “analysis” of European government spending:

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 Economista 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? 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. These countries still spend more than pre-recession levels France and the U.K. did not cut spending.

There are lots of problems here. To begin with, de Rugy reports her data in a simple chart where government spending is going up in actual euros. But this is like studying global warming based on the temperature in Miami in July. Her data reporting opens more questions than it answers: How high was inflation? What about GDP growth? And the most important question of all: Was there any change in the composition of government spending?

But there is also a more important analytical problem with this piece, a problem that has to do with a deep misunderstanding of austerity in itself. I cannot stress this often enough: austerity does not mean “spending cuts” as de Rugy and many others on the East Coast libertarian consensus circuit seem to believe. Austerity is not a number – it is a policy strategy. This means that it has a purpose, a method and a set of effects and consequences:

  • The purpose of austerity is to reduce a budget deficit;
  • The method of austerity is a combination of tax increases and spending cuts;
  • The effects of austerity are reduced growth, higher unemployment and more people eligible for welfare;
  • The consequences of austerity are an eroded tax base and higher spending on welfare.

One of de Rugy’s problems, which she shares with others in the American austerity debate is that she seems to believe that austerity is a new invention in Europe. But the fact of the matter is that European countries such as (but not limited to) Denmark, Sweden, Ireland and Germany have used austerity policies on numerous occasions over the past three decades. The effects of those policies are visible all over national accounts data and socio-economic data, especially in the statistics over the heavy dependency on welfare and other entitlements in Europe. It is also visible in the disastrously high waiting lists in government-run health care, and in the combination of a low standard of living with high taxes.

Some would rightly point out that high taxes and low standard of living is a correlation that is general and not specific to austerity. But this only brings up another, all too common misunderstanding of austerity. People seem to believe that austerity policies somehow are aimed at reducing the size of government. They are not. Austerity aims to preserve government. It aims to preserve government by closing a budget deficit, without recognizing that the deficit is caused by the welfare state and aggravated by the taxes levied to pay for that same welfare state. The policies used to close the budget deficit are tax increases and spending cuts, which, obviously means a net expansion of government.

In other words, when de Rugy says that there is no austerity in Europe, she misstates the very meaning of the concept, as well as fails to analyze correctly the policies taking place there. What makes me concerned is that her fire-aim-ready approach comes with significant risks. Too many talking heads on the debate circuit stay alive not by virtue of their original contributions, but by regurgitating opinions and observations put forward by someone who got to the keyboard before they did.  When someone like de Rugy comes out and blasts off a salvo of “analysis”, others join in her debate shooting spree; drive-by debaters, to borrow a metaphor from Rush Limbaugh. In doing so, they unwittingly contribute to the establishment of truth by quantity, not quality. The more people repeat the same opinions and more  or less erroneous observations, the easier it is to create a prevailing paradigm. That paradigm, in turn, is based not on good analysis but on who fired first.

Let’s not forget the old memento that the establishment of the truth is a grueling, painstakingly methodoligcal process: If ten people people say that the sun revolves around Earth, and one person says Earth revolves around the sun, then who’s right?

This is a critical point, because with her latest salvo de Rugy made quite a splash in the economic policy debate. The latest example is a reference to her by Michael Barone in the Washington Examiner. That Barone fails to recognize her shoot-from-the-hip strategy is excusable; that de Rugy herself does not see it, is less so.

Austerity is not something that can be handled as casually as is currently the case here in America. For someone who has lived through the Swedish austerity of the 1990s, when government cut away nine percent of GDP in three years, and who has studied the dire consequences of the Danish austerity program of the late ’80s, it is ridiculous to suggest that austerity is palatable, perhaps even desirable.

By leaping over three decades of historic evidence of what austerity does to a country, de Rugy is also contributing to an emerging, and rather dangerous consensus among fiscal conservatives in America. This consensus favors a kind of spending cuts that have no other purpose than to balance the government budget. They do nothing to initiate structural reforms to the welfare state, which leaves the structural driving forces of government spending intact. As a result, their policies will backfire no later than in the next recession.

A major problem that de Rugy and others on the East Coast libertarian consensus circuit overlook is that Europe’s austerity policies have increased the demand for government spending. When taxes go up, government takes more from the private sector; when spending is cut, government gives even less back for the taxes they take. The result is less growth, fewer jobs, more people asking for a handout from government – and more government spending.

These obvious facts are right there for Veronique de Rugy to see, but instead she assumes that just because government spending has not fallen in nominal terms, there is no austerity:

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.

Exactly. The reason for this is theoretically well explained here, and empirically observable in Eurostat data over government spending on what Europeans call “social protection programs”. We call them entitlement programs. Detailed numbers are only available up to 2009, but we nevertheless see the trend that my theoretical paper explains:

  • For the EU as a whole (27 countries) entitlement spending grew from 25.7 percent of GDP in 2006 to 28.4 percent in 2009;
  • In Greece the increase was from 24.2 percent to 27.3 percent;
  • The Spanish increase is even more startling:  from 20 to 24.5 percent of GDP;
  • Italy: from 25.6 percent to 28.4.

These numbers indicate a correlation between austerity policies and entitlement spending: wherever austerity goes, entitlement spending increases as a result. The reason is not intention, but consequence: austerity drives people off self sufficiency and partly or entirely into dependency on government. This explains why de Rugy’s observation of no spending cuts and her wish…

…that we would stop assuming that gigantic “savage” cuts are the source of the EU’s problems…

…is entirely misguided. Austerity preserves government by purpose and expands government by method, effect and consequence. This perspective entirely escaped de Rugy. Her failure to recognize the nature of austerity is, sadly, symptomatic of a lot of the twitterized public policy debate we have to deal with these days.

By the way, it is worth noting that even the Baltic countries, which are often held up on the libertarian consensus circuit as examples of good governance, have significant problems with entitlement spending:

  • Estonia: entitlement spending grew from 12 percent of GDP in 2006 to 19 percent of GDP in 2009;
  • Latvia: from 12.4 percent to 16.6 percent;
  • Lithuania: from 12.9 percent fo 20.6 percent.

The shallowness of this debate also tends to blindfold friends of limited government in other areas of their research. A bizarre example is the growing consensus among East Coast libertarians that Sweden – with the world’s harhest, most austere welfare state – is somehow an example  of good, fiscally conservative governance. Ms. de Rugy joins in the appreciation choir lauding Sweden’s statist finance minister, Mr. Anders Borg. Here is what de Rugy says:

Sweden is another good example. The data show that after the recession, Sweden’s finance minister, Anders Borg, not only successfully implemented reduction in welfare spending but also pursued economic stimulus through a permanent reduction in the country’s taxes, including a 20-point reduction to the top marginal income tax rate. As a result, the country’s economy is now the fastest-growing in Europe, with real GDP growth of 5.6 percent. Unsurprisingly, the Financial Times recently declared Borg the most effective finance minister in Europe.

Returning to the Eurostat entitlement spending data reported above, we find that since Mr. Borg took office in 2006, the share of Sweden’s GDP that is spent on tax-paid entitlements has gone up from 29.8 to 31.5 percent. Other Eurostat data on total government spending shows that government gobbles up 52-53 percent of GDP on average, and does so even with Mr. Borg being in office since 2006.

Will someone please explain to me how spending one third of the economy on entitlements, and running more than half of GDP through government, is good libertarian policy?

Even more surprising is de Rugy’s suggestion that Mr. Borg has cut some kind of top income tax. If Ms. de Rugy won’t take my word for it, she can check for herself: there has been NO cut in the top marginal tax rate in Sweden. Contrary to what de Rugy is trying to tell us, Mr. Borg is adamantly defending Sweden’s high marginal income taxes, which for 2012 force the highest earning Swedes to surrender more than 60 percent of their last earned krona to the government. They have been there for the past two decades.

De Rugy completes her backward homerun with a suggestion that Sweden’s “fastest-growing” GDP is somehow related to some sort of policies for limited government. Nothing could be further from the truth, as national accounts data from Statistics Sweden reaveals. The latest growth spurt in the country’s GDP is entirely due to a rapid increase in exports:

  • Exports is the largest share of GDP in Sweden, bigger even than private consumption;
  • Sweden has a foreign trade surplus equal in size to government consumption!
  • The growth spurt in the Swedish economy over the past couple of years is driven entirely by a surge in exports. There is no domestically sourced growth, and no discernible spillover effects from exports to private consumption.

In short: Sweden is an industrialized banana republic, divided into two sectors: a thriving foreign-trade sector and a depressed domestic sector with a government-run health care monopoly with enormous waiting lists, the highest taxes in the world and, with the new earned income tax credit that Mr. Borg pushed through, marginal tax rates for low-income families are among the highest in the world.

I don’t like bashing fellow libertarians, but when someone puts forward bad analysis and incorrect facts, and when others run with those talking points as if they were tried, true and solid, there is suddenly a lot more at stake than friendship and collegial cordiality. Policies are made based on what is said in the public arena. The more people repeat purported facts and claimed conclusions, the more likely it is going to influence policy makers. Bad analysis leads to bad policy, and bad policy that is marketed as derived from alleged libertarian principles will come back to hurt those who actually try to advance libertarianism.

For this reason – and for the sake of the integrity of free-market think tank research – I have to put a foot down and point a finger at fellow travelers when they are wrong. I know that by doing this I infuriate some tenderfoot libertarians on the East Coast. But the goal for me is not to belong to the consensus circuit – it is to advance economic freedom in America.

2 comments

  1. Fake Herzog

    First of all, the wonderful Kurdish/Swedish economic blogger repeatedly talks about Sweden’s tax cuts since 2006 — given that he speaks the language and follows Swedish politics and public policy closely, I trust him a lot more than I trust you:

    http://super-economy.blogspot.com/2012/05/miracle-of-growth.html

    and here he even mentions his own taxes have gone down:

    http://super-economy.blogspot.com/2011/01/moderate-tax-sweden.html

    Secondly, with respect to the broader austerity debate and De Rugy’s blog posts, I think you ignore her many posts linking to the econometric studies that show it is spending cuts coupled with reforms that reduce debt levels over the long-run that produce economic growth, for example this one:

    http://www.nationalreview.com/corner/300051/ireland-and-austerity-fairy-veronique-de-rugy?vm=r#

    That post also links to the other post by her colleague at George Mason, which evaluates 21 econometric studies that all show spending cuts are what is needed to stimulate growth, specifically cuts that target entitlement spending. In other words, De Rugy is well-aware that we need to reduce the size and scope of the welfare state to promote economic growth — she is trying to also answer left-wingers who claim that austerity is bad and so sometimes I agree her message gets a bit muddled.

  2. S R Larson

    First of all, you need to read Tino’s blog again. He does not talk about tax cuts – he talks about taxes as share of GDP. These are two different statistics, and I am surprised the difference escapes you. Secondly, during the ’90s when I was politically active in Sweden and lectured on economic policy all over the country, including at the national parliament, there was an enormous austerity crisis that set back growth, employment and standard of living by terrifying numbers. The country has not recovered since then. if you want the story, read my book “Remaking America: Welcome to the Dark Side of the Welfare State”. Third, de Rugy’s blog post on Ireland adds nothing of substance. Fourth, the 21 studies only verify that less government spending can explain a higher standard of living. I published a paper on that years ago. Nothing new there. You are welcome to comment again, but do your homework first.