After Greece: Spain on the Austerity Downhill

After Greece, austerity is now crippling Spain. Back in June, the EU decided to open the bailout floodgates to save the Spanish government, provided of course that Spain did its part. That part is now going into effect: in a desperate effort to save the welfare state the Spaniards are implementing higher taxes and spending cuts. And just like in Greece, political turmoil is just around the corner. Yahoo News relays a report from AFP:

Spanish police fired rubber bullets and charged protestors in central Madrid early Friday at the end of a huge demonstration against economic crisis measures. The protest was one of over 80 demonstrations called by unions across the county against civil servant pay cuts and tax hikes which drew tens of thousands of people, including police and firefighters wearing their helmets. “Hands up, this is a robbery!” protesters bellowed as they marched through the streets of the Spanish capital. At the end of the peaceful protest dozens of protestors lingered at the Puerta del Sol, a large square in the heart of Madrid where the demonstration wound up late on Thursday.

Compare this to the Tea Party protests here in America, where middle class families joined together in a protest over too much government. In Spain, just like in Greece, the protests are over too little government. This shows a very sharp economic and cultural divide, a divide that we here in America would like to keep.

The protests held Thursday were the latest and biggest in an almost daily series of demonstrations that erupted last week when Prime Minister Mariano Rajoy announced measures to save 65 billion euros ($80 billion) and slash the public deficit. Among the steps is a cut to the Christmas bonus paid to civil servants, equivalent to a seven-percent reduction in annual pay. This came on top of a pay cut in 2010, which was followed by a salary freeze.

And just like in Greece, these cuts have made no dent in the real problem behind the deficit. In fact, they are designed to reduce the cost of the welfare state so that government can preserve it. The purpose of the spending cuts is to shrink the welfare state so it fits in the tax revenues that taxpayers can produce. This is not going to work – on the contrary, it is only going to make matters worse.

Back to the Yahoo News story:

“There’s nothing we can do but take to the street. We have lost between 10 and 15 percent of our pay in the past four years,” said Sara Alvera, 51, a worker in the justice sector, demonstrating in Madrid. “These measures won’t help end the crisis.” Spain is struggling with its second recession in four years and an unemployment rate of more than 24 percent. Under pressure from the European Union to stabilise Spain’s public finances, the conservative government also cut unemployment benefits and increased sales tax, with the upper limit rising from 18 to 21 percent.

And the reason is that the spending cuts remove money from the economy while the tax increases that accompany the spending cuts remove even more money from the economy. Two months ago I explained this paradox of thrift at work in this article about Greece.

Critics say the government’s new austerity measures will worsen economic conditions for ordinary people. Cristina Blesa, a 55-year-old teacher, said she and her husband would struggle to pay their son’s university tuition fees because of the cuts and tax hikes. “We’re earning less and less and at the same time the price of everything is going up,” she said at the Madrid protest. “Now with the rise in VAT everything is going to be even more expensive. It’s more and more difficult at the end of the month.”

The parallels to Greece are downright scary, yet obviously predictable against the background of what kind of policies they are putting to work. The Spanish austerity programs are going to have the exact same effects as they had in Greece, with the same real consequences for ordinary people. We will be able to witness the same lack of sustainable improvement in the government budget.

Hopefully the Spanish example will make it easier for some of my libertarian peers to understand the true nature of austerity. At any rate, the global investors who seek a safe haven for their money have already seen the writing on the Spanish wall:

Spain had to offer investors sharply higher interest rates in a bond sale on Thursday, suggesting investors remain worried over the country’s ability to repay its debts. Protestors complained that they were being made to pay for the financial crisis while banks and the rich were let off. “We have to all come out into the street, firefighters, street-sweepers, nurses, to say: enough,” said Manuel Amaro, a 38-year-old fireman in Madrid holding his black helmet by his side. “If we don’t, I don’t know where this is going to end.”

If the austerity spending cuts would work they would now be flocking to Spanish treasury bonds. Interest rates would be going down, not up.

The macroeconomic mechanics at work in Spain are really not that hard to understand. Yet it seems like in every corner of Europe there is a new bunch of politicians who are willing to try to preserve the welfare state by means of the very same socially and economically dangerous measures. Or how about this one from France, reported in another story from Yahoo News-AFP:

French lawmakers Thursday backed a series of measures abolishing tax breaks and taxing the wealthy as the new Socialist government pursued efforts to kickstart the economy with a tax-and-spend programme. The measures were part of the first budget bill presented by President Francois Hollande’s government since he unseated right-wing Nicolas Sarkozy in May with pledges to focus on growth instead of austerity.

For anyone who has studied the austerity policies in Europe at any reasonable detail, this tax-and-spend scheme is frankly very similar to what has come out of Greece and now Spain. While the Greek government tried to cut spending, the effect of its austerity policies was instead a rise in demand for tax-funded entitlements. This increased government spending: while the government went in to austerity with higher taxes and lower spending, it exited with higher taxes and higher spending. (See this paper for a detailed explanation of the mechanisms at work.)

If a government skips the spending cuts and combines higher taxes with higher spending, the net effect is not likely to be much different than what we saw in Greece: a sustained deficit, less private-sector jobs and more people living off government. Some economists would say that it matters a great deal what you spend money on – building roads is better than paying entitlements – but there is not a lot of evidence to prove that. For one, consider the non-existent multiplier effects from the Obama stimulus bill.

The only way to put an economy back to work is to let the private sector go about its business without taxes and regulations getting in their way.

Back to France:

The lower house National Assembly approved the first measure in the early hours of Thursday, ending a Sarkozy policy dubbed the “work more, earn more” rule of exempting overtime hours from payroll charges and income tax. Lawmakers later voted to back an emergency rise in the ISF wealth tax applying to taxpayers with a net worth of more than 1.3 million euros ($1.6 million) and which is expected to bring in an extra 2.3 billion euros in revenues this year. They also approved a tightening of the inheritance tax to reduce the exemption ceiling from 159,000 euros per child to 100,000 euros, the creation of a three percent surtax on cash dividends and the doubling of a tax rate on financial transactions to 0.2 percent.

No wonder high-earning French entrepreneurs and professionals are flooding to real estate agents in London. And the more of them leave, the less tax revenues the French government will get for all its new spending programs. As revenues from the new taxes dry up, the deficit that these new measures were designed to close, will increase. When the deficit increases, the EU and the ECB will get even more nervous. Eventually, France could find itself on the receiving end of the same conditioned bailout program that has gone into effect in Greece, Spain and to some degree Italy.

All in the name of preserving the unsustainable welfare state.

There is only one way out of this. End the welfare state. End it now and end it forever.