Europe’s austerity disaster is not just a matter of reckless policy decisions by arrogant leaders in the EU, although that is ultimately where the buck stops. Many others have been involved in explicitly or implicitly, directly or indirectly, keeping the crisis going. Among them are assorted economists in various positions whose forecasts have reinforced the desires among political leaders: while the politicians want austerity to work, economists have predicted that it would work.
There is just one problem. Austerity does not work. While it has taken economists quite a while to begin to realize this, others have raised questions for some time now. Among them are business leaders: two years ago British corporate executives began expressing concern about the soundness of continuing EU-imposed austerity policies. The seeds of that doubt have grown, so much in fact that a few days ago Britain’s Chancellor of the Exchequer found it necessary to make a plea to business leaders to stay on board with Britain’s own austerity program. The Guardian reports:
George Osborne has asked business leaders to hold their nerve and continue backing the government’s austerity measures after the Bank of England gave the first signal since the financial crash of a sustained economic recovery. The chancellor told the CBI annual dinner on Wednesday night that the business community should ignore critics of his economic policy who advocate a stimulus package to spur growth and reduce unemployment. … His speech followed a series of forecasts from Threadneedle Street showing the UK recovery strengthening and inflation falling over the next three years. Sir Mervyn King said the outlook had improved, with growth likely to reach 0.5% in the second quarter of 2013, after the 0.3% registered in the first three months.
This is a good example of how the desires of politicians conspire with unrefined forecasts by economists. Anyone who reads a “strengthening recovery” into a 0.2 percent of GDP uptick in growth, from 0.3 to 0.5 percent, is either sloppy or desperate. Since the difference between 0.3 and 0.5 percent is little more than a margin-of-error change to GDP growth, I am inclined to conclude that at least some of the involved economists are sloppy.
One reason for this is that there have been forecasts of an improvement at the time of the announcement of every new austerity package in Europe over the past few years. I am planning a larger research paper to expose these errors; in the meantime, it is important to ask why economists think that the current austerity policies will have any other effect than the others that have been implemented since 2009.
More on that in a moment. It is important that we do not let the political leaders off the hook. I am firmly convinced that they are desperately looking for any sign that austerity is working – and that their desperation has reached such levels that they are inviting to a conspiracy of the desperate and the willing. It is interesting, namely, to see all the optimistic forecasts that are surfacing now. Politicians who should know better than most of us that austerity does not work, give a surprising amount of attention to those forecasts.
Their desperation is cynical yet understandable. Almost every political leader in Europe has invested his entire political career in supporting austerity. Now he is witnessing more and more critics lining up with The Liberty Bullhorn, pinning the unfolding social disaster on austerity advocates.
The obvious reaction should be to question austerity. After all, I cannot be the only one to ask how much farther the EU is willing to push its member states. For example, how much more can Greece take before the country explodes?
Europe’s leaders are no doubt aware of how close some parts of the continent are to social unrest. So long as austerity-minded politicians cannot provide people with an economic recovery, they know they are accountable for whatever happens.
As an alternative, they use forecasts of willing economists to convince people that the recovery is just about to happen, no matter how microscopic it might be. The Guardian again:
The modest improvement in output over recent months comes against a backdrop of rising unemployment, the lowest wage rises on record … According to the Office for National Statistics unemployment rose by 15,000 to 2.52m in the three months to the end of March. Wages were 0.8% higher in March than a year ago and only 0.4% better if bonuses are taken into consideration, which is the lowest rise in incomes since records began in 2001.
Again, calling this a “strengthening recovery” is clear signs of desperation. There were times when any growth under two percent set off alarm bells, among economists as well as politicians. Now, numbers a fraction as high are raised to the skies as signs of a “strengthening” recovery. From the Sydney Morning Herald:
The dogged recession across the eurozone has snared key economy France, with the latest EU figures released Wednesday [May 15] showing a full year-and-a-half of contraction as tens of millions languish in unemployment. In Brussels, French President Francois Hollande tipped ‘zero’ growth on the national level, blaming an EU-wide, German-led austerity trap — and hitting out at banks for holding back on lending as he and fellow leaders battle to unlock taxable assets hidden in offshore bank vaults or breathe life into training programmes for Europe’s disillusioned youth.
And his recipe is to take it all out in the form of higher taxes instead. Yep. That will really make things better… The fact of the matter is that France desperately needs a complete reversal of its economic policy, with long-term credibility to go with it. The same holds for the entire euro zone, which according to the Sydney Morning Herald is in deep trouble:
official figures showed a 0.2 per cent contraction between January and March, in the longest recession since the single currency bloc was established in 1999. EU data agency Eurostat said output across the 17 states that share the euro — which are home to 340 million people — fell by 1.0 per cent drop compared to the same quarter last year. France notably slid into recession with a 0.2 per cent quarter-on-quarter contraction, with unemployment already running at a 16-year high.
French president Hollande blamed the bad economic news…
on “the accumulation of austerity politics” and a “lack of liquidity” within the banking sector leading to a euro-wide loss of confidence. Fresh from winning France a two-year period of grace from the Commission to bring its public finances back within previously-understood EU targets, Hollande argued that nascent plans to divert state and private investment towards projects intended to get Europe’s youth working would make a difference.
In other words, more government programs on top of government programs that don’t work. If government was the answer, there would not be a crisis in Europe today.
Instead, as the Sydney Morning Herald reports, Europe is heading for yet more of the same, though some economists seem stubbornly unwilling to accept the permanent nature of the crisis:
Following a string of disappointing survey results in recent weeks, Ben May of London-based Capital Economics warned: “We doubt that the region is about to embark on a sustained recovery any time soon.” The latest official European Commission forecast for 2013 published earlier this month tipped a 0.4-per cent contraction, but May said that was way off course with “something closer to a two-per cent decline” likely. His firm’s pessimism was backed by Howard Archer of fellow London-based specialist analysts, IHS Global Insight. “We expect the eurozone to suffer gross domestic product (GDP) contraction of 0.7 per cent in 2013 with very gradual recovery only starting in the latter months of the year,” said Archer.
What reason does he have for expecting a recovery? This is the standard mistake that mainstream economists and econometricians make: they rely heavily on models that are inherently prone to draw the economy toward long-term full employment equilibrium. When they “inject” a change to economic activity, such as an austerity package, their model automatically makes the assumption that this sudden and uncharacteristic change – called a “shock” – will be absorbed and the economy will move on.
Every new austerity package is treated the same way, both by the econometricians who design the models and by the economists who provide the analytical framework. Their take on the European crisis is therefore a series of individual shocks, not a systemic re-shaping of the entire economy. As a result, they always predict a recovery and return to some long-term stable growth path.
To the best of my knowledge there is not a single macroeconomic model out there that has yet incorporated the systemic effects of austerity. Therefore, the economics profession will continue to make systemic forecasting mistakes – and advise politicians based on those mistakes.
Don’t get me wrong. I am not blaming economists for the errors that politicians end up making. But our profession must begin to recognize its almost chronic inability to deal with economic crises. Our forecasting methods can handle regular recessions but are frustratingly inept at dealing with situations that become inherently unstable, such as the current European disaster.
In fairness, I am not the only economist with an unequivocal criticism of austerity. On March 5, Joseph Stiglitz explained in Economywatch.com:
While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. Indeed, it will now take a decade or more to recover from the losses incurred by misguided austerity policies – a process that may eventually force Europe to let the euro die in order to save itself.
Strange conclusion. The euro is not the cause of the crisis. But Stiglitz is probably letting his ideological preferences get in the way of good economic judgment. Otherwise he would do the same analysis has I have and conclude that the crisis is caused by the welfare state.
That said, Stiglitz is eloquent in his criticism of austerity:
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60 percent, and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy. The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease.
Well said. But what alternative is Stiglitz proposing? Certainly not that the welfare state must go:
The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
I don’t know where Stiglitz gets his data but here are the debt/GDP ratios for Ireland and Spain in 2003-2008:
In terms of actual euros, the general government debt in Ireland shot up by almost 84 percent from 2003 to 2008. In other words, it was only thanks to strong growth in current-price GDP that the Irish did not see their debt ratio grow faster than it did. They were expanding their government as fast as they could, and certainly more than was healthy for the economy: in 2010 the debt-to-GDP ratio had reached 87 percent, i.e., close to double what it was two short years earlier.
The Spanish situation followed a similar pattern, though with less dramatic numbers than the Irish. The lesson to be learned from this is not that these economies could afford their big governments, but that their big governments survived only because there was enough current-price GDP growth to pay for them. As soon as GDP slacked off, the cost of the welfare state quickly became completely unbearable.
Stiglitz refuses to see this. He goes on to advocate even more government, without a hint of explanation of how the world’s already highest-taxed nations would be able to pay for that:
Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the United States; but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates). … There will also have to be Eurobonds, or an equivalent instrument.
More welfare state spending, more government, more debt, more of the same that brought about the crisis in the first place.
Instead of wanting more of the same and providing politicians with rosy outlooks, practitioners of economics should re-examine the results of their own contributions over the past few years. The ability of hundreds of millions of people to maintain their current standard of living, even support their families, depends on it.
It has been said that those who cannot remember the past are condemned to repeat it. It has also been said that someone who repeats the same action over and over, expecting different results, is an idiot.
If so, the EU Commission is a bunch of condemned idiots.
Sorry for the colorful opening, but just when the Commission has started talking about backing off austerity, they are forcing Greece to put to work perhaps the most devastating austerity package to date. Without even a hint of remorse over the past, blaming instead the negative results of previous packages on “mistakes” by the Greek government, the Commission charges ahead with demands that Greece cut away 6.5 percent of its GDP in the next austerity round.
I am not even going to attempt to predict the social, economic and political fallout of this complete fiscal madness, though it might be a good idea to remember that in last year’s Greek election the Nazis returned to the European political scene. I will say this, though: the Germans tried a decade of austerity during the Weimar Republic. Greece is now six years down the same path.
Before we get to the report on more Greek austerity, let us first note a new report from Pew Research Center. It presents some seemingly bizarre data, showing that a majority of Europeans still support austerity:
The countries still backing cuts over spending included Italy and Spain, which are both in the grip of prolonged recessions made worse by their efforts to bring down government borrowing. On average, 59% backed further austerity in the survey, against 29% in favor of more spending to stimulate the economy.
You would expect the victims of austerity to demand something better. But in order to do so the Europeans would have to know of an alternative – and it does not exist in their world view. For a good decade now, the public policy debate in Europe has been almost entirely lopsided in favor of austerity. Everyone from leading economists to political leaders to business leaders have been telling the public for years that the alternative to austerity is Hell on Earth.
When people see no alternatives, then after a while they tend to believe that there are indeed no alternatives.
Besides, the very issue of austerity is technical in nature and not likely to stimulate the average Joe to go off looking for alternative views on his own.
One would think that the hardships suffered in, e.g., Greece and Spain would be enough to make the general public back off from austerity. After all, the benefits they have been promised from austerity never seem to materialize. This is a valid point, but at the same time, history is full of examples of man’s ability to accept and endure hardships in the name of some abstract goal. It will probably take an entire generation before Europeans start questioning the changes for the worse that they are now living through.
With this in mind, it is easier to understand why Greece – ground zero of European austerity – is entering yet another cycle of fiscal torture. From Fox Business:
Greece is on track to meet its budget targets this year and next but may have to make further cuts in 2015 and 2016, the European Commission said in a report that will provide the basis for a decision Monday on whether to release more bailout loans for the country. The report sums up the findings of the three institutions overseeing Greece’s bailout–the Commission, the International Monetary Fund and the European Central Bank–which sent a team of auditors to Athens earlier this spring to review the country’s finances.
As I explain in Austerity: Causes, Consequences and Remedies, a country will always see a reduction of its government deficit the year after an austerity package is implemented. Then, as the negative multiplier effects of austerity kick in, the budget improvement is reversed. That is why the European Commission is forecasting more austerity in 2015 and 2016. However, you only need to take a quick look at macroeconomic data from Eurostat to realize that the notion of no budget cuts in 2014 is optimistic.
And now, Fox News delivers the big number:
It is the first time in Greece’s three-year-old aid program that the country is deemed to have met its goals. In past years, a deeper-than-expected recession and government missteps led Greece to miss its targets. The draft notes that the Greek government has followed through on most of the austerity measures it promised for 2013 and 2014–also in sharp contrast with previous assessments of Athens’ efforts to ease its crushing debt load. ”The very large and highly front-loaded package of fiscal consolidation measures for 2013 and 2014–totalling over 6.5% of gross domestic product–agreed in the previous review has been largely implemented,” the report says.
Six and a half percent of GDP.
Let’s leave the technospeak behind for a moment. An austerity package of 6.5 percent of GDP means that government is going to increase what it takes from the private sector by 6.50 euros for every 100 euros that people earn. Not for every 100 euros it currently takes in – it is 6.50 euros for every 100 euros of GDP.
The 6.5 percent number is a net tax increase on the Greek economy. It does not matter what the combination is of spending cuts and tax increases: the Greek government is telling its taxpayers that it is going to raise the price of whatever it provides them by 6.5 percent of all the money that all taxpayers earn.
If all of the austerity comes in the form of spending cuts, and taxes do not go up, then government is saying “we are going to sell you a 2011 car at 2013 prices”; if all of the austerity comes in the form of tax hikes, and spending is not cut, then government is saying “we are going to sell you a 2013 car at 2015 prices”.
Either way, government will increase its net drainage from the economy by 6.5 percent of GDP, and front load the plan so most of it shows up in one year. All this in a country that has already lost 25 percent of its GDP in five short years, all due to austerity.
I would not want to set my foot in Greece over the next year.
Apparently, the EU Commission has an eerie feeling that something bad might come out of this. According to Fox Business they are quick to add fine print to their optimism:
Beyond 2014, the outlook is uncertain and depends “on the strength of the recovery and improvement in taxpayer capability to service their tax obligations,” the commission says. It estimates the country’s budget gap at around 1.8% and 2.2% of GDP in 2015 and 2016 respectively.
This is B.S., Barbara Streisand. They have made similar predictions in the past, all of which have turned out to be outlandishly optimistic. So long as they believe that austerity somehow will improve the performance for the Greek economy, they will continue to believe that the first-year effect of an austerity program will become permanent.
I would not want to be a Greek politician saddled with implementing this chainsaw massacre of an austerity program. Perhaps some of the elected officials in Athens are on the same page, or why else would they according to Fox Business be so eager to promise that “there will be no more belt-tightening”?
Fox Business does not elaborate on this. Instead they conclude their report with a couple of notable factoids:
The country is in its sixth year of a deep recession made worse by waves of austerity. Unemployment, already over 27%, is expected to continue rising.
So if they acknowledge that the waves of austerity have made the recession worse, then why doesn’t Fox Business ask the EU Commission why this particular austerity package would do the trick?
In case anyone is still in doubt what this new austerity package will do to the Greek economy and to Greek society, please re-read the statement above about unemployment.
The Greek government is sitting on one side of an open powder keg. On the other side the EU Commissioners are sitting, smoking big fat cigars. The Greek government is holding out an ashtray where the Commissioners are supposed to kill their cigars. It’s dark, so it’s hard to see the ashtray.
There’s the future of Greece for you.
Recently I have reported on the changing tone among Europe’s political leaders when it comes to austerity. The change came after the French government basically declared that it would not be able to unite around the same kind of job-destroying policies that the EU so viciously had forced upon France’s southern neighbors. But rather than admitting that their austerity policies have been a disaster for Europe, the Eurocrats simply shifted foot, declaring plainly that austerity had done its job.
Given the death of jobs and destruction of prosperity from the Aegean Sea to the Iberian peninsula, this is more than a little arrogant. It is political elitism coupled with a disdain for the lives of regular citizens.
It is, in one word, Eurotarianism.
If the EU Commission really cared about the citizens whose taxes are paying for their lavish lifestyle, they would pay a lot more attention to mundane things like, oh, the GDP growth rate of the euro zone. As technical and yawn-inspiring as that figure might be, it is still one of the best indicators of whether or not austerity is working. (Let’s not forget that Greece, Italy, Spain and Portugal are still enforcing austerity policies, despite the new words hot-airing out of the mouth of some Eurocrats.)
A good place for them to start learning about reality would be a recent article in Euractiv about the sluggish – to say the least – European economy:
The eurozone economy shows little sign of recovering before the year-end despite an easing of financial market conditions, European Central Bank Mario Draghi said … after interest rates were left at a record low. The ECB held its main rate at 0.75%, deferring any cut in borrowing costs … .
The common belief among parishioners of the Austrian school of economics is that so long as a government balances its budget a so called natural interest rate will emerge that will encourage entrepreneurs to invest and expand their production capacity. Regardless of the budgets of EU’s member states, if it was true that a low interest rate encourages investments, then a rate of 0.75 percent should have entrepreneurs all over Europe flocking to the banks.
Do you see that happening?
Neither does Euractiv, which reports that the ECB is also ready to keep interest rates down through its bond buying program:
The central bank has said it is ready to buy bonds of debt-strained governments such as Spain and Italy once they sign up to a European bailout programme with strict conditions, under a programme dubbed Outright Monetary Transactions (OMTs). So far no request has been made, but the announcement alone has calmed markets.
And is thereby keeping interest rates down. How surprising. The ECB has explicitly said that “we will use our money printers to churn out whatever trillions of euros it takes to buy every single treasury bond from Spain, Italy, Greece and Whateveristan, from now until Sweden freezes over”. When owners of even the junkiest of euro-denominated treasury bonds know that they can always get their money back, no matter how bad things get, then of course they will rest easier.
The problem is of course that at some point they will have had to print so much euros that owners of bonds outside the euro zone will want to secure the exchange rate of the currency. That becomes increasingly difficult if the ECB is going to flood the world with euros just to save its member states from the financial junk yard.
No one can say for sure when that point will come. Doomsday preachers have cast a spell on the U.S. dollar for years, yet it still stands relatively strong. That does not mean the doomsdayers are wrong – all it means is that we simply do not have enough examples of collapsing currencies to predict where either the Federal Reserve or the ECB will have printed too much money for their own good.
But long before we find that out, we will find out that the low interest rates the come with excessive money supply are not going to get the wheels turning in the economy. There is a very simple reason for that, which we will get to in a second. First, back to Euractiv:
Gloomy data this week indicated the eurozone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates. Recent survey evidence gave no sign of improvement towards the end of the year and the risks surrounding the euro area remain on the downside, Draghi said. He signalled the ECB would downgrade its GDP forecasts next month, describing “a picture of weaker economies”, and said inflation would remain above the ECB’s target for the rest of the year, before falling below two percent during in 2013.
It is interesting that inflation is above two percent in an economy – the euro zone – that is at a complete standstill when it comes to GDP. While we will have to wait for the micro data behind the inflation number to know exactly where it comes from, my bet is that it is caused by tax increases and terminated government subsidies in austerity-ridden countries. The private sector is always quick to pass on such explicit and implicit tax hikes, even in tough economic times.
Pricing in modern economies is typically done on a mark-up basis where producers and seller review prices about two times per year. (If your microeconomics professor told you anything else, then I’m sorry for the rude awakening…) This means that if we have austerity measures being put into place this spring with a direct effect on consumer prices, we will see repercussions in inflation data for the rest of the year.
That said, inflation above two percent and interest rates at rock-bottom levels is actually – according to standard economic theory – a good recipe for investments. You see consumer prices on a slow upbound trajectory, which tells you that if you lock in your costs today you have good reasons to expect profit margins in the future. At the same time, with very low interest rates you have good reasons to believe that you will lock in those low costs.
So why aren’t they investing?? Patience, my young padawan. Uncle Keynes will give you the answer in just a moment.
Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the eurozone, a mechanism that has been broken by the bloc’s debt crisis. The new bond purchase plan is the ECB’s designated tool but it can only be activated once a eurozone government requests help from the bloc’s rescue fund and accepts policy conditions and strict international supervision.
Which is technospeak for “more austerity”. Despite the hot air from Barroso, nothing has changed in the conditions that the ECB attaches to its bail-out program for debt-mired member states. Governments in already-suffering countries know that if they try to push more tax hikes and spending cuts on their citizens they will have an armed revolution on their hands – or be booted out of office in the next election and replaced by Nazis or “Bolivarian” communists. They obviously don’t want this to happen.
The problem for the ECB is that their bond-buying pledge has now calmed the markets, but the member states have not accepted the terms of the program. This means that in effect, the program is worthless. In order to avoid losing credibility the ECB is going to have to relax the conditions attached to the program, not now but in a year or two. The reason is that the countries in Europe’s dungeon of debt will not recover from their current crisis.
Why won’t they recover? Because their fiscal policies are still geared entirely toward balancing the budget in the midst of zero or negative growth and very high unemployment. With too few taxpayers and too many entitlement consumers indebted governments continue to run deficits – and therefore continue to try to close those gaps with the same policies that brought about the depression in the first place.
In order for those economies to start growing again the hopelessly indebted governments must give the private sector room to spend money. So long as consumers are pushed to the end of their finances by high taxes and unemployment they won’t spend. If they don’t spend there won’t be any demand for consumer products, services, houses, cars, food, clothes, haircuts, vacation travel services, books, plumbers, painters, carpenters, restaurants, recreational services like spas and gyms…
Which brings us back to why entrepreneurs are not taking advantage of virtually free money. They have no reason to believe that they will get their money back in the form of sales revenue.
People have cut their spending today, which according to the pastors of the Church of Mises and Menger means that they will increase spending by the exact same amount at 1:20PM on Monday. Keynes, however, had a more sober analysis. Here is how he opened Chapter 16 of his General Theory of Employment, Interest and Money:
An act of individual saving means — so to speak — a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand,— it is a net diminution of such demand. Moreover, the expectation of future consumption is so largely based on current experience of present consumption that a reduction in the latter is likely to depress the former, with the result that the act of saving will not merely depress the price of consumption-goods and leave the marginal efficiency of existing capital unaffected, but may actually tend to depress the latter also. In this event it may reduce present investment-demand as well as present consumption-demand.
Only Keynes can save Europe. It would take an enormous load of work, though, to allow his theory of effective demand to actually go to work in the European economy. While economically possible, I seriously doubt that there is enough political will power to allow that to happen. It would mean that those who have gained enormous political power both in the Eurocracy in general and among the austerity merchants, will have to take more than a few steps back.
I frankly don’t think this is politically possible. I am fairly certain that Europe has gone so far down the path of austerity and big government that it won’t ever come back again. But this message from Uncle Keynes could serve as an excellent reminder for American lawmakers to get their own house in order – the right way.
The Keynesian way.
First you send your tanks in and pound away at schools, hospitals and private businesses. When people are laid off and flock to unemployment offices you direct your bombardment at those instead. When the unemployed and homeless former middle-class citizens go scavenging for food in dumpsters behind McDonald’s, you hammer away at them with yet another round of big-caliber fiscal ammunition. Then you tell everyone that this invasion may be a bit hard on them right now, but at some point, somewhere in the long run, their lives will get better.
When people still defy your fiscal army you keep fighting them until they have lost a quarter of their income and their jobs and their entire country has been transformed from a relatively prosperous European nation to an economic wasteland.
You keep going until your austerity storm troopers have wreaked havoc and destruction on country after country and reached the outskirts of Paris. Then, but only then, do you pause and try to brush off the image of a fiscal imperialist. From the EU Observer:
European Commission chief Jose Manuel Barroso on Monday (22 April) indicated that the EU’s budget-slashing response to the economic crisis has run its course. Speaking in Brussels at a meeting of European think tanks, Barroso commented that “while I think this policy [austerity] is fundamentally right, I think it has reached its limits.”
Of course. When austerity robbed the Greeks of 25 percent of their GDP, they got what they deserved. When Spain is risking regional secession and political and economic disintegration, and when Portugal is simmering at the point of civil unrest, that is all right and good in Barroso’s playbook.
In reality, what really concerns Barroso is the presence of public opinion in the way of his fiscal tanks. The EU Observer again:
In a reference to rising public discontent at the severity of spending cuts and tax rises, he noted that “a policy to be successful not only has to be properly designed, it has to have a minimum of political and social support.” ”We have to have tailor-made solutions for each country, we cannot apply a one size fits all programme to the European countries,” he added.
What exactly does this mean? Different combinations of tax hikes and spending cuts depending on what country you are in? More tax hikes in Portugal and more spending cuts in France? Do note that Barroso still believes in austerity – his only reason for not charging ahead to conquer France is that the French prime minister’s cabinet is not united in the desire to greet the invading austerity army at the border.
In the words of the EU Observer:
Barroso’s remarks are a further sign that Brussels is ready to give the likes of France, Spain and Italy more time to force through unpopular economic reforms to reduce their budget deficits. For his part, speaking at the same event, EU Council President Herman Van Rompuy conceded the economic crisis is “lasting too long. He added that “patience is understandably wearing thin and a renewed sense of urgency is setting in.” He underlined the need to “move faster on the reforms with the biggest immediate growth impact.”
The problem with Barroso and van Rompuy is that they have absolutely no idea of what really gets an economy going, nor do they have an interest in learning about it. Their only goal is in expanding their own power, and they have discovered that austerity is a formidable tool that can conveniently be applied to further that goal. Right now they are hesitant because France is a big chunk of real estate to bite off, and French politicians are a bit less inclined to bow their heads to the new fiscal masters than they were in Athens, Rome, Madrid and Lisbon.
As the EU Observer notes, the critics of the EU’s fiscal invaders have just been given more ammunition to use in the defense of their national fiscal sovereignty, as the EU Commission’s own economic forecasts…
make grim reading, especially for countries on the Mediterranean rim, which have been among the worst hit by the eurozone’s economic crisis. … Portugal and Spain saw their deficits swell to 6.4 percent and 10.6 percent of GDP, respectively, while Greece’ deficit rose to 10 percent. The ongoing recession also forced up average EU government debt levels to 90.6 percent, well above the 60 percent threshold set out in the EU’s Stability and Growth Pact.
In other words, the countries that have been subjected to austerity the longest, are the ones with the biggest deficit and GDP growth problems. Austerity is sold as a recipe for smaller deficits and stronger economic growth, yet the outcome is the exact opposite.
I have only one thing to say to my many European readers: don’t let yourselves be fooled by what Barroso says about austerity reaching its limits. He has stopped his barrage for now because you are paying attention. Once you let your guard down and look the other way, his fiscal stukas will be taking aim at your country again before you know what hit you.
If you want to know why Europe is becoming an economic wasteland with nothing but a life in industrial poverty to promise its youth, you need look no further than at the report on so called macroeconomic imbalances that the European Commission released on Wednesday (April 10).
The Commission, which is the de facto executive office of the EU, is the main culprit in destroying the economies of several euro-zone countries – what with wiping out one quarter of the Greek GDP – and its members are as ignorant about macroeconomics as the Soviet communists were about consumer choice.
Yet despite this the Commission has authored a report about the “prevention and correction of macroeconomic imbalances” that is full of pretense and completely void of substance. The gap between the two is called the degree of perbertility (the phrase coined from the name, Per Bertil, of the hands-down most incompetent college professor I ever had) and illustrates two things:
- The arrogance of the speaker – the more you think you know, relative to your actual knowledge, the more arrogant you are; and
- The potential harm that the speaker can do.
A college professor does harm in that he pretends to teach students things he does not know. But his negative influence usually stops at the doorstep of the classroom. A group of powerful politicians, on the other hand, can do enormous harm by exhibiting a high degree of perbertility.
The EU Commission hits a perbertile home run with its report on “macroeconomic imbalances”. Let’s listen to what these clowns have to say:
The on-going economic and financial crisis has prompted a profound restructuring of our economies.
I just love it when people use the term “restructuring of our economies”. It shows that they have absolutely no understanding of what the term “structure” means. It gets even better when the EU Commission is referring to some kind of restructuring that did allegedly take place as a result of a recession.
The structure of an economy is the relative size and significance of its components over time. If, e.g., 75 percent of all output in an economy is from the agrarian industry, then the economy has an agricultural structure. If most of the output is industrial, either in the form of manufacturing or in the form of high-end services (engineering, consulting, high-quality health care, banking and legal services), then obviously the economy has an industrial structure.
There is also a structural aspect to the role of government. A big government plays a different structural role than a small govenment. That role does not change over a recession – it changes over a period of time that is longer than at least two business cycles.
Now back to the clownocrats:
This [non-existent restructuring] needs to be accompanied by a new kind of economic governance in the EU that recognises the interdependence between our economies and which builds the foundations for future growth and competitiveness that will be smart, sustainable and inclusive. Correcting the problems of the past and putting the EU on a more sustainable development path for the future is a shared responsibility of the Member States and the EU Institutions, as our economies are closely intertwined.
From the perspective of the EU Commission this “shared responsibility” is like a marriage where the normal give-and-take between loving and respectful spouses has been replaced with one party’s “You give, I take” attitude. For the better part of the Great Recession the EU has been dictating to member states that they need to subject their economies and their citizens to ever tougher, ever more destructive austerity policies. When people have expressed their disagreement with the policies, the EU has doubled down and even forced democratically elected officials to step aside for appointed bureaucrats.
That’s the EU Commission’s definition of “shared responsibility”.
The perbertility fest continues:
In the decade leading up to the outbreak of the crisis, not enough attention was paid at the EU level to developments in the economies of individual Member States. This was due in part to an insufficient recognition of the spillover effects of economic policies pursued in one Member State on the economies of other Member States – spillover effects that were particularly acute in the euro area, due to the close economic interdependence of countries sharing a currency.
So now the Commission is trying to say that they had no idea that countries that share a currency union would be closely tied together! The currency union has existed for a decade and more, and the volume of research that preceded its inauguration was so big it could fill the entire cargo bed of a Ford F-150. (I know – I had all of it stored in my office for some time.) The three main points of that research was: economic integration, economic integration and economic integration.
And this research was not published now… ten years after the currency union went into effect. It was published in the 1990s.
Are we to believe that the EU Commission was totally ignorant of that research when the Great Recession opened up? If so, we can only draw one conclusion: they are all a bunch of fools whose feet are far too small for the shoes they are wearing.
Had enough? If not, here’s more:
But it was also in part due to the lack of tools at the disposal of the EU to help detect, prevent and where necessary correct such imbalances. As a result, imbalances were allowed to develop unchecked, with negative consequences both for the economies of several Member States and for the proper functioning of the Economic and Monetary Union. Drawing on the lessons of the past and determined to avoid repeating similar situations in the future, the EU has put in place a new system of economic governance.
This is how the Commission explains why it is treating its member states like French geese, force-feeding them a debilitating dose of austerity and using loans from the ECB as the “enticer”. If the member states are good and compliant and do as they are told by the Commission, there is a nice little check from the ECB on the way to them in the mail.
When the Commission says it has now “put in place a new system of economic governance”, this is exactly what they are referring to. To paraphrase The Godfather of Chicago, the EU Commission turned the economic crisis into an opportunity to expand its own power even more.
Cleverly, the Commission disguises its new power grab in some technical terms that shield its true content from probably 90 percent of all the people who even bother to read their report on “macroeconomic imbalances”:
As part of this new way of working, on a proposal of the Commission, the legislator set up a Macroeconomic Imbalances Procedure (MIP) to help detect, prevent and correct problems at an earlier stage. The MIP – together with the reinforced Stability and Growth Pact, with its focus on sustainable public finances – is at the heart of the EU’s strengthened economic governance.
So from now on the EU Commission has institutionalized its austerity measures in the “Macroeconomic Imbalances Procedure”. It is now de facto the law of the land, primarily in the euro zone but secondarily across the entire EU. The austerity measures that destroyed the lives of some 30 percent of all people in Greece, that has ravaged Spain to the brink of provincial secession, that nearly destroyed parliamentary democracy in Italy and is now tearing apart Portugal; these austerity measures, which the IMF have found to be essentially ineffective, have now become part of European law.
No elected legislator has had the chance to vote on, let alone review the law. Nowhere in Europe have people had the chance to cast an up-or-down vote on whether they would like to give such enormous power over their livelihood – their lives – to such a small group of people.
This is as far from democracy as you can get without putting marching boots on the streets. This is Eurotarianism on full display.
I could go on from here. I could comment on the absolutely ridiculous statements in this report about how “structural rigidities” are to be blamed for the persistent recession in some EU countries – when in reality it is the EU’s own war of austerity on prosperity that is turning the continent into an economic wasteland.
But I’ve said enough about the report already. Anyone who feels that they need more of the Commission’s perbertile nonsense can of course download a copy of the report and see for themselves. Just remember to continue to come back here, to The Liberty Bullhorn, for a healthy, daily dose of clarity, common sense and crisp economic analysis!
Europe’s austerity battle continues. The latest skirmish took place in Portugal’s Supreme Court, which, according to Reuters…
on Friday rejected four out of nine contested austerity measures in this year’s budget in a ruling that deals a blow to government finances but is unlikely to derail reforms two years after the country’s bailout. The measures rejected by the court should deprive the country of at least 900 million euros ($1.17 billion) in net revenues and savings, according to preliminary estimates by economists.
Obviously, “net revenues” means tax increases and “savings” means spending cuts. The curious part of this is how a supreme court of a country can find it within its jurisdiction to pass judgment on individual spending items in a government budget, as well as individual taxes. That, however, is a topic for a separate story. This one from Reuters is primarily concentrated on the policy battle over austerity, and the amazing thing about this story is that it is completely void of context. Greek context, that is:
Debt-ridden Portugal agreed to a 78 billion euro bailout in 2011 from the European Union and International Monetary Fund. The entire package of austerity measures introduced by the 2013 budget is worth about 5 billion euros and includes the largest tax hikes in living memory, which were mostly upheld.
Back in January I explained the draconian nature of those tax hikes. What is unfolding now in Portugal is essentially the sequel to Greece.
However, as Reuters reports, not everyone seems to understand this:
“It’s a lesser evil. … Putting it into perspective, a good manager and leader should not have difficulty finding room in a budget to accommodate this cut,” said Joao Cantiga Esteves, economist at the Lisbon Technical University. “We are talking about an impact of only 1.2 to 1.3 percent of Portugal’s total spending,” he added.
That’s what they said in Greece, too. But 1.3 percent three years in a row accumulates to more than four percent of GDP, with compound interest in the form of negative multiplier effects. Apparently, Mr. Esteves has not kept up to speed with either the events in Greece or the IMF’s new research on the accelerated negative effects of austerity (he might also want to read my paper on austerity to get the rationale behind the IMF’s findings). Government spending cuts cause a faster multiplier reaction than government spending increases. This is a major piece of the puzzle in explaining why austerity has been such a nightmare for Europe’s debt-ridden economies.
It is notable how this perspective is entirely absent in the reporting on Portugal. Reuters is no exception:
The government … has to cut the budget deficit to 5.5 percent of GDP this year from 6.4 percent in 2012, when it missed the goal but was still lauded by its EU and IMF lenders for its austerity efforts. Analysts consider the outcome manageable and say the government should be able to cover the shortfall with additional spending cuts it has been working on at the request of lenders. Analysts say the lenders could also give Portugal more leeway in terms of budget targets. Earlier in the day, Bank of America Merrill Lynch analysts wrote in a research note that even a negative ruling was likely to be “in line with our muddling through outlook,” expecting Lisbon to resume negotiations with its lenders as a result.
The analysts at Merrill Lynch, the university professors interviewed, and the journalists reporting, all take an attitude of business as usual. It is as though the Greek disaster, with one quarter of GDP being wiped out in four short years, has nothing to do with austerity.
Perhaps the parties involved are turning a blind eye to Greece because they don’t want to see the repercussions for the cost of the government debt. Zerohedge notes this:
…the government warning that the court’s decision would put into question the country’s ability to fulfill its €78 billion international bailout program … would send bondholders of Portuguese sovereign debt scrambling for the exits as suddenly the country may find itself in the ECB’s “dunce” corner, with Draghi preparing to pull a “Berlusconi” on a government which can’t even whip its judicial branch in line.
Then comes this comment:
However, of more immediate concern is how will the government now plug a hole of up to €1.3 billion in its €5.3 billion 2013 budget. A solution has, luckily, presented itself: bypass the unconstitutional provisions by paying government workers not in cash, but in government bills!
This is a startling statement, but Zerohedge has a source, namely none other than the Wall Street Journal (subscription required):
The Portuguese government is considering a plan to pay public workers and pensioners one month of their salary in treasury bills rather than cash after a high court ruled out wage cuts, a person familiar with the situation said Sunday. “This is one of the ideas being considered,” the person said. By paying one month of salary in T-bills to public workers and pensioners, the government would save an estimated €1.1 billion in expenses, narrowing the budget gap significantly.
In all honesty, is this really what the defense of the welfare state has come down to – paying employees in IOUs? Is the Portuguese government so desperate that it is ready to resort to this kind of accounting trickeries??
The California state government has from time to time resorted to “paying” some bills with IOUs, which has caused little more than grumbling among those whom the state owed money. I doubt that the same would be the case in Portugal – especially if they are going to pay their government employees with promises instead of cash. This could contribute to a further destabilization of the country’s economy and, even more so, political landscape.
All, again, caused by austerity in an attempt to defend an indefensible welfare state.
UKIP leader Nigel Farage comments on the British budget. Take note of his very brief but right-to-the-point recipe for what to do about the British economy:
Mr. Farage understands that a roll-back of government spending works best when combined with spending cuts. For a systematic combination of these two instruments, check out my book Ending the Welfare State: A Path to Limited Government That Won’t Leave the Poor Behind.
Discussing austerity policies with an Austrian economist is a little bit like discussing free-market capitalism vs. socialism with a leftist. Both compare an abstract ideal of their favorite theory to a poorly managed, diluted and distorted example of their opponent’s theory. There is a reason for this common character trait: both Austrian economics and socialism are exclusively theories with only inferential contact with the real world.
Unfortunately, a Keynesian economist cannot afford himself that privilege. He has to stand with both feet on the ground and begin his reasoning right there. The same goes for the free-market capitalist who is trying to propose policies that will let private citizens – be they consumers, investors or entrepreneurs – go about their business unfettered by government.
Some would object right there and say that there are no more fervent advocates for free-market capitalism than Austrian economists. Rhetorically, that may be true, but as soon as we get down to the policies that Austrians suggest, a divide opens up between them and the free-market capitalist whose cause they claim to be advancing.
This gap between Austrian theory and the real life is particularly obvious in today’s Europe, where Austrian economists have had lauded the current destruction of GDP and have had only one complaint: it’s not enough. The former point is made by economics professor Phillip Bagus and the latter comes from think-tank economist Veronique de Rugy.
As I have explained at length, both Bagus and de Rugy are wrong, morally as well as analytically. And perhaps the Austrian community is beginning to realize that they have ended up on the wrong side of the European crisis. Today a good friend sent a link to the latest issue of The Free Market, a monthly publication of the Mises Institute. There, Mark Thornton makes a case for what he calls “real” austerity, joining his fellow Austrians Bagus and de Rugy in a passionate plea for tough budget cuts all across Europe.
However, unlike his two comrades Bagus and de Rugy, Thornton actually takes time to try to elaborate his case. Therefore, it is my pleasure to counter his analysis with free-market Keynesianism.
First, a quick reminder of where I stand with reference to big government: the welfare state must go, permanently and forever – but it must do so in a way that does not cause undue harm to the most vulnerable of our fellow citizens.
With that in mind, let’s give microphone and spotlight to Mark Thornton:
Austerity has been hotly debated as either an elixir or a poison for tough economic times. But what is austerity? Real austerity means that the government and its employees have less money at their disposal. For the economists at the International Monetary Fund, “austerity” may mean spending cuts, but it also means increasing taxes on the beleaguered public in order to, at all costs, repay the government’s corrupt creditors. Keynesian economists reject all forms of austerity. They promote the “borrow and spend” approach that is supposedly scientific and is gentle on the people: paycheck insurance for the unemployed, bailouts for failing businesses, and stimulus packages for everyone else.
1. “Real austerity means that the government and its employees have less money at their disposal.” Well, that is exactly what has happened in Greece, and is currently happening in Spain and, to a lesser degree, in Italy. Thornton better provide a more concise definition of Austrian-based austerity, or else we will have to assume that Phillip “Less GDP is good” Bagus has the final say on that matter.
2. The austerity policies that are currently being forced upon crisis-ridden countries in Europe has nothing to do with repaying “the government’s corrupt creditors”. I would not consider the regular middle-class family corrupt because it buys treasury bonds. Nor would I consider retirement funds, investing the same middle-class family’s long-term savings, to be corrupt because it buys treasury bonds.
The real reason why Greece, Spain, Portugal and Italy are raising taxes and cutting spending is that they are trying to close a budget gap. This budget gap, in turn, is the work of an overloaded, over-bloated welfare state.
3. Bailouts for failing businesses has nothing to do with Keynesianism. I challenge Thornton to provide one logically consistent example from the vast academic Keynesian literature that prescribes corporate welfare. This is a good example of how Austrian theorists bastardize Keynesianism to lower the analytical bar for themselves.
Austrian School economists reject both the Keynesian stimulus approach and the IMF-style high-tax, pro-bankster “Austerian” approach. Although “Austrians” are often lumped in with “Austerians,” Austrian School economists support real austerity. This involves cutting government budgets, salaries, employee benefits, retirement benefits, and taxes. It also involves selling government assets and even repudiating government debt. Despite all the hoopla in countries like Greece, there is no real austerity except in the countries of eastern Europe.
Mark Thornton might want to talk to his fellow Austrian economist Phillip Bagus about this. In December, Bagus said:
One would think that a person is austere when she saves, i.e., if she spends less than she earns. Well, there exists not one country in the eurozone that is austere. They all spend more than they receive in revenues. In fact, government deficits are extremely high
Bagus then goes on to argue that so long as there is a deficit, governments are by definition not austere. When governments close their deficits, they are austere, he concludes. This definition is quite different from the one Thornton is putting forward, which couples tax cuts with spending cuts. The question, then, is: what role does the deficit play in Thornton’s definition of austerity?
I realize that any theory, be it Austrian, Keynesian, Rational Expectations or Marxism, is full of internal disagreements. Being only one of two libertarian Keynesians in the world (there is another one in Australia…) I know very well what it is like to clash with people who share your overall theoretical viewpoint. That said, the disagreement between Bagus and Thornton has nothing to do with fundamental theory or methodological principles. It is entirely on the application side, where things are conditioned by solid theory and methodology. Therefore, the question is: how deeply does this disagreement cut into Austrian theory?
Back to Thornton:
For example, Latvia is Europe’s most austere country and also has its fastest growing economy. Estonia implemented an austerity policy that depended largely on cuts in government salaries. There simply is no austerity in most of western Europe or the U.S. … The Keynesians’ magical multipliers have once again failed to materialize. Given that most of these economies have not achieved growth from stimulus, they should give the idea of true austerity a fresh look.
Let’s start with Thornton’s claim about Latvia. Here are the latest numbers from Eurostat on real GDP growth in Latvia:
Needless to say, the numbers for 2013 and 2014 are forecasts, and as we know from the past few years any GDP growth forecast in Europe should be taken with a big grain of salt. Therefore, the only numbers worth looking at are the ones from 2006 to 2011; the 2012 figure is still an estimate, as it takes about one quarter of a year to process all data for last year’s GDP. But let’s be generous to Thornton and assume that the 4.3-percent growth number is accurate.
If you started out with $100 in 2006, and that money grew on par with GDP, you’d have $105.70 in 2012. That is less than one percent growth per year.
The same experiment on the U.S. economy, using the same database from Eurostat, allows the $100 to grow to $107.52. By Thornton’s own reasoning, this means that the U.S. policies of out-of-control debt spending, bank bailouts and completely irresponsible and wasteful stimulus packages is in fact a better strategy than what he defines as “real austerity”.
As for Estonia, here is my exchange with Michael Tanner where I refute the idea that Estonia has implemented some sort of “real” austerity.
There is one point, though, where I will give Thornton a thumbs up. He is absolutely correct about the multiplier and its failure to work in Europe. There are two reasons why it has failed (and neither is that the multiplier does not exist, which it does). First, there is a confidence component embedded in the multiplier, which econometricians – who do forecasting on suggested fiscal policy measures – consistently fail to recognize. A consumer will respond to an income increase with more spending if, and only if, he is confident that: a) the income increase is of a lasting nature, or: b) he won’t need the money in the bank for contingency purposes.
If a consumer is uncertain about the future, he will refrain from spending a dollar extra he has earned so that he can have money in the bank in case tomorrow turns out to be worse than today. The same goes for entrepreneurs, whose responses to certainty exhibit themselves in their investment and hiring decisions. A temporary increase in orders will not make a construction contractor hire more people on permanent payroll. A temporary rise in the demand for a certain car model will not be enough to motivate the manufacturer to invest in a new assembly plant.
Confidence, or its flip side which we know as uncertainty, is hard to quantify. The consumption functions that form the base for traditional multipliers do not come with specific confidence components. Mainstream economics still resists the very notion of distinguishing between risk and uncertainty, but in some heterodox circles, primarily Post Keynesian economics, there is a reasonably good body of literature on this. My own doctoral thesis is one of them.
There are ways to quantify the confidence component and embed it in the multiplier. However, those applications have not been absorbed by the mainstream economics literature, and are therefore – understandably yet regrettably – still not used in econometrics.
The second reason why the multiplier has failed in Europe has to do with a recently recognized asymmetry in the multiplier. The traditional view is that the multiplier mechanically works the same way for expansions and contractions in economic activity. This is still true under regular business-cycle circumstances, and when it comes to private-sector economic activity. When these two conditions do not apply, however, the multiplier starts acting up, throwing economists out of their comfort zone.
The IMF recognized this in a good, highly recommendable paper by Olivier Blanchard and Daniel Leigh. Concerned over the consistent errors that the IMF made in forecasting the effects of austerity policies in Europe, they set out to find the bug in their models. It turned out that the multiplier is stronger for contractions in economic activity than for expansions. While not explicitly spelled out by Blanchard and Leigh, their results indicate that the stronger reaction to a contraction has to do with the fact that the contraction is caused by government spending. The explanation could be that the reductions in spending hit low-income families more than others, whose economic margins are small or non-existent. As a result, they contract their spending more than higher-income families would.
Uncertainty and asymmetric response together explain why the multiplier has not kicked the European economy into higher gear. There is, however, a third one. Thornton seems to believe that just because there are persistent deficits in Europe, no spending cuts have taken place. This is a regrettable exercise of armchair theorizing; there is plenty of evidence to the contrary. Thornton might want to start with this piece.
Then, finally, we get to some specifics as to what Thornton himself wants to do about a nation in economic crisis:
Austerity applied … simply means that the government has to live within its means. If government were to adopt a thoroughgoing “Libertarian Monk” lifestyle, then government would be cut back to only national defense (withoutstanding armies and nuclear weapons), with Mayberry’s Andy and Barney protecting the peace.
A philosophical view I definitely share – I am strong supporter of Robert Nozick’s minimal state. But pointing to a star in the sky is one thing. Building the space ship that will get us there is an entirely different matter, one that Austrian theorists do their best to avoid discussing. They touch upon it in the passing, like Thornton:
The national debt would be wholly repudiated. This would involve certain short-run hardships, although much greater long-run prosperity.
Thornton is more than welcome to explain exactly what he means by “repudiating” the national debt. I was under the impression that Austrians considered contractual enforcement a cornerstone of a functioning, civilized economy.
As for the reference to “long-run prosperity”, I am curious: how long is that run? The only concerted effort at estimating that long run, based on Say’s law, that I can remember ever seeing actually places the end of the long run at 100 years. The proof offered (by Swedish economist Assar Lindbeck) is that there is no trend in unemployment over that period of time. This would echo Keynes’s famous comeback that “in the long run we’re all dead”.
Another question is what the “short-term hardships” actually involve. Does Thornton recommend immediate turn-off of the welfare faucet? An immediate shut-down of tax-funded, government-run hospitals?
I like the challenge that Austrian theory presents, partly because it is often of high analytical quality. But so long as its advocates won’t even waste a single breath on specific policy recommendations, their theory amounts to little more than fiscal sophistry. Unfortunately, Mark Thornton confirms this impression.
But more than that, the steady stream of calls for even more spending cuts, even harder reductions in entitlement spending, and a faster execution of them, puts Austrians in rather ugly moral company. They come across as little more than sophisticated Ayn Randians, their policy ambitions darkened by the shadow of overt egoism and disrespect of the poor and weak.
Mark Thornton and his Austrian fellows should also keep in mind that their dismissive attitude toward the suffering that tens of millions of European families are now enduring does – in some people’s eyes (not mine) – qualify him for even more ominous friendships.
In contrast to Austrian armchair theorizing, I offer a facts-based, empirically workable, Keynesian route to limited government. It is built on reality, solid analysis, recognition of human nature and a steadfast moral commitment to not let the poorest and weakest among us pay the price for the damage that big government has done to our economy.
Watching Europe trying to get out of its recession is like watching a man trying to ride a bike in zero gravity. No matter how hard they try to pedal forward, they are completely and utterly stuck in one and the same spot. That GDP growth spurt that was going to jolt the European economy back to life is turning into little more than a fairy tale. In fact, reality is going in the exact opposite direction. From the EU Observer:
The eurozone economy will shrink by a further 0.3 percent in 2013, the European Commission said Friday (22 February), revising down a more optimistic previous estimate that had predicted 0.1 percent growth for this year. The data also indicates that average government debt rose by 5 percent in 2012 to 93.1 percent as a proportion of GDP. The average debt level is expected to peak at 95.2 percent in 2014, well above the 60 percent threshold set out in the bloc’s Stability and Growth Pact.
Please note that the growth rate is adjusted down by 0.4 percentage points, a relatively large adjustment for such a short period of time. The reason is probably not faulty economic models, as the EC gets its data from their own statistics bureau, Eurostat. It is more likely that the reason has to do with political meddling with the non-formal forecasting process – or, to be blunt: politicians and bureaucrats have written in their own delusional beliefs in the virtues of austerity into a forecast that otherwise would show the naked truth about said austerity.
As for the 60 percent debt level, it is entirely artificial without the slightest scientific foundation. It was imposed on the EU by a group of politicians and bureaucrats who designed the Stability and Growth Pact and wanted to look fiscally conservative. The 60-percent level was one of two arbitrary features of the Pact, the other being the requirement that EU member states cap their deficits to three percent of GDP. This latter feature is, by the way, the main culprit behind the panic-driven austerity assaults on the budgets in, e.g., Greece, Spain, Italy and Portugal. Needless to say, that has made it even harder for the member states to meet the goals of the Stability and Growth Pact.
Back to the EU Observer:
News on government budgetary positions was more positive. The average deficit in the eurozone had fallen by 1.5 percent to 3.5 percent, with the commission expecting a further 0.75 percent improvement to bring the eurozone average under the 3 percent threshold. Announcing the figures, Economic Affairs Commissioner Olli Rehn admitted that “the hard data is still very disappointing” adding that the progress made by national governments to cut budget deficits was “not yet feeding into the real economy.”
Yes they are. They are just not feeding in like Mr. Rehn thinks they should. Instead of making the economy grow, which is Mr. Rehn’s delusional belief, his spending cuts and tax increases are perpetuating and even aggravating the recession.
As for the improvement on the budget deficit front, it is an expected, temporary effect resulting from last year’s spending cuts and tax increases. Things will turn for the worse again once the latest austerity round proliferates through the economy.
To get the full story of what it is Mr. Rehn does not get, download this paper and check out Figure 3 on page 15. Given how obvious these macroeconomic mechanisms are, it is very surprising that Eurocrats like Mr. Rehn are still getting away with their austerity fantasies.
Or maybe they are not. Perhaps things have gotten so bad in so many countries now that people are prepared to throw out the balanced-budget requirements in order to allow for prosperity to start growing again. The Italian election will give us a big hint, explains another story from the EU Observer:
Italian voters are heading to the polls on Sunday and Monday (24-25 February) in a closely-watched race that could bring the country back to the brink of a bailout. Outgoing Prime Minister Mario Monti, a respected former EU commissioner and economics professor, may be the favourite among EU leaders watching from the side lines, but at home, he appears to have failed to convince voters that his reforms and sober politics are what the country needs today.
It is hardly a sign of sobriety when someone recommends higher taxes and spending cuts in the midst of a recession.
In a significant catch-up effort – thanks to his media empire and promises to pay back taxes introduced by Monti – former leader Silvio Berlusconi was just five percent behind [center-left candidate] Bersani in the 8 February survey. … For its part, Italy’s leading investment bank, Mediobanca, has predicted that if Berlusconi wins, the country would face an immediate backlash on financial markets and could be forced to ask for financial assistance from the European Central Bank.
For what reason? Berlusconi would in all likelihood abandon the austerity policies, and if he follows through on its promises to not only reverse the tax cuts but do it retroactively, he will in fact inject a stimulus into the economy of a kind that could get the Italian economy growing again. That in turn would ease the budget pressure and increase confidence among investors in, e.g., Italian treasury bonds.
If, on the other hand, Bersani wins he might form an alliance with Monti to please the Eurocrats. That in turn would increase the likelihood of more austerity hammering down on the Italian economy. Given its size, that will have clearly negative effects on the economy of the euro zone.
As will the continuing commitment to austerity in France, where the socialist government has been forced to adjust its budget deficit forecast. From the increasingly influential pan-European news site The Local:
The figure for this year, when France was due to get back within the EU’s ceiling of 3.0 percent of output, is worse than the 3.5 percent previously tipped, and leaves Socialist President Francois Hollande looking for special leeway from Brussels. European Union Economy and Euro Commissioner Olli Rehn told a press conference that France could be given more time to meet its commitments, much as Spain and others have been over the three years of the debt crisis. “If the expected negative economic headwinds bring significant, unfavourable consequences for public finances, the (EU’s) Stability and Growth Pact allows for the deadline (for France) to be pushed back to 2014,” he said.
This is not very surprising, given that the French government has been forced to acknowledge that the nation’s economy will not grow as fast as they had suggested it would. This concession is hardly surprising, given the harsh fiscal measures that President Hollande and his fellow socialists in the National Assembly have imposed on the French economy.
In fact, the situation is beginning to look a bit panicky in Paris. Another story from The Local:
France needs an extra €6 billion in revenues next year, the budget minister said on Monday, and the European Central Bank said it had to act fast to cut spending and retain credibility after slashing the 2013 growth forecast. … Budget Minister Jerome Cahuzac … did not specify how this would be achieved saying taxes “are already very high in France.”
Really…? Does that mean that even socialists acknowledge that a 75-percent hate tax on high incomes is a bad idea? Or is 76 percent the “very high” limit?
Regardless of whether the French want to have stupidly high taxes or very stupidly high taxes, the pressure is on them to keep the austerity pressure on the economy. The Local again:
French ministries have been informed how much to cut spending in order for the government to generate €2 billion in savings this year. “Economies in public spending are inevitable,” Cahuzac said. “We have started to do it, we will continue to do it,” he added. Benoît Coeure, a Frenchman who sits on the managing board of the European Central Bank, said on Monday that Paris had to take strong action to convince its European Union partners that it was serious about keeping to the EU’s deficit norms.
Surprisingly, in the midst of all this, President Hollande does not want more austerity…
arguing they would only slow growth and further aggravate the country’s finances.
But a 75-percent hate tax on the “rich” does not slow growth, right? Regardless, it seems like the French government is now forced to walk a thin rope. On the one hand, budget minister Coeure says that:
“As for credibility on the short-term, France must absolutely respect its commitment to cut the structural deficit,” … “In the medium-term, it has to take quick and concrete decisions to achieve spending cuts, so that France reassures its European partners,” he said.
On the other hand we have president Hollande’s realization that austerity might not be such a good idea after all. What to do? Well, the Eurocracy is going to maintain its pressure on Hollande and the French government, especially now that Mr. Rehn has made clear that he believes the crisis is basically over and Europe has austerity to thank for it. He is not going to let go of his story that easily, which means he will keep Hollande in check and force him to “pet the horse” as the Danes say, i.e., do as he is told.
If at the same time the Eurocrats’ favorites form the next administration in Italy, the forces of austerity will continue to prevail. Under their boot, Europe will solidly establish itself as an economic wasteland, mired in industrial poverty. The balanced budgets will shine their glory over rusting steel mills, crumbling hospitals and the masses of the unemployed.
One of the main flaws with Austrian economics is that it pays absolutely no attention to the actual working of an economy. From its founder, Carl Menger, and on leading Austrian theoreticians have worked hard to thoroughly isolate their theory from reality. As a result of this effort to keep the world at bay, they have become exceptionally useless as policy advisors; the Russian disaster decade, from the fall of the Soviet Union to the turn of the millennium, followed a strict implementation of Austrian theory as brought to the Russian leaders by two Swedish economists.
I recently reported on another example of how Austrian theory falls to the ground when confronted with reality. Phillip Bagus, professor of economics at the King Juan Carlos University in Madrid, Spain, claimed that a shrinking GDP is actually desirable. This notion that things get better in the long run when everyone is made poorer today (and tomorrow, and the next day) is widespread among Austrian theoreticians. Conveniently escaping the question “when” the “long run” comes about, they jump through economic hyperspace and make ridiculous arguments about how austerity is good and Europe needs more of it.
Austrian theoreticians rely heavily on the so called Say’s Law. Put simply, this law dictates that any new investment in production capacity will automatically generate demand for whatever that capacity can produce. This is why they believe that austerity, which destroys economic activity today, will benefit everyone in the long run (though to get the full theoretical chain worked out one has to add their surreal theory of the interest rate).
The problem for the Austrians is that whenever their theory has been practiced, it has failed utterly. The aforementioned Russian decade of destruction is a great example – it took ten years before the Russian economy was producing on par with what the poorly managed, inefficient Soviet economy was able to crank out at the end of its life. Countries that did not take the destructive Austrian route from Communism to economic freedom did much better: East Germany, Czekoslovakia (later split into two nations) and Hungary are the best examples.
The Chinese economic success rests in part on the choice to actively and patiently transition from one system to another.
But it is not just in the realm of active destruction that Austrian theory can do harm. It has played a role in the definition and execution of austerity in several European countries over the past few years. Aforementioned economist Phillip Bagus from Spain raves about his country’s austerity.
When reality checks in, with tens of millions of people being hurled into poverty, misery, financial despair, hunger and hopelessness, the Austrianites are nowhere to be found. They have gone both scholarly and morally AWOL, which should be a wake-up call for anyone and everyone interested in economics and economic policy. An economist who is not willing to take moral responsibility for the effects of his policy advice should go look for another career.
As a contrast, I want to once again express my respect for Olivier Blanchard, chief economist at the IMF, for his courageous mea culpa after the IMF got it so wrong on the effects of austerity in Europe.
While the Austrian theoreticians vanish from reality, others step in and paint a picture of the waste and destruction that follows in the footsteps of austerity. The latest contribution is from Caritas, the charitable arm of the Catholic Church. A new report from Caritas Europa conveys the image of an economic wasteland:
The prioritisation by the EU and its Member States of economic policies at the expense of social policies during the current crisis is having a devastating impact on people – especially in the five countries worst affected – according to a new study published today by Caritas Europa. The report finds that the failure of the EU and its Member States to provide concrete support on the scale required to assist those experiencing difficulties, to protect essential public services and create employment is likely to prolong the crisis.
What Caritas is saying here is precisely the same thing as I have been pointing to ever since I published my book Remaking America three years ago, namely that in times of crisis, governments that take to austerity will always default on promises to those who depend on government. This is really not very difficult to understand, but politicians from all over the industrialized world fail utterly to understand this.
Some are motivated by Austrian theory to turn a blind eye to the effects of austerity. Others do it because they are under the false impression that a balanced budget is more important than to keep government promises.
They all have one thing in common, though: they believe in short-term, immediate solutions to long-term, complex problems. More on that in a moment. Right now, let’s go back to Caritas:
The report “The Impact of the European Crisis“ is the first to provide an in-depth examination of the impact that current policies are having on people in the five EU countries worst affected by the economic crisis. It presents a picture of a Europe in which social risks are increasing, social systems are being tested and individuals and families are under stress. The report strongly challenges current official attempts to suggest that the worst of the economic crisis is over. It highlights the extremely negative impact of austerity policies on the lives of vulnerable people, and reveals that many others are being driven into poverty for the first time.
This is the truly troubling, two-pronged effect of austerity: first, it leaves the most vulnerable people out in the cold – the very citizens for whom the welfare state was constructed in the first place; then it devalues the standard of living of a large portion of middle-class working families. Unlike the poor, who are left to basically fend for themselves at the mercy of whoever passes their street corner, the middle class still has resources to prioritize from. They also pay taxes. When they see that they get less or nothing from government when they really needed it, and when they see that their taxes are as high as before – or even higher – they drastically change their economic behavior. They refrain from long-term spending commitments, such as a new house, a new car, appliances for their home, etc. Private spending is depressed, causing more job losses and solidifying the crisis.
The devaluation of the middle class is one of the most important features of Europe’s transformation from post-industrial prosperity to industrial poverty. It is refreshing to find well-done research on this in the Caritas report (get the full 68-page version here).
The report’s conclusions are based on the unique grass-roots perspective of Caritas organisations working with people experiencing poverty. Its principal conclusion is that the policy of prioritising austerity is not working and that an alternative approach should be adopted. It points out that the authorities have choices that they can make in deciding what policy approaches to use, and how various measures are targeted. It calls for a fair solution to the debt crisis to be found.
This is where Caritas goes wrong. Their policy recommendations are essentially focused on reinforcing, not to say reinvigorating, the welfare state:
Economic and social policies must be integrated at EU level to a much greater extent
Stronger leadership is required at EU level for groups at risk of poverty, focusing on child poverty and youth unemployment
Social Monitoring should be put in place for countries in EU/IMF Programmes
EU Funds must play a bigger role in addressing poverty
The EU must increase the involvement of Civil Society Organisations in Governance
The answer to Europe’s crisis is not more government. It is less government. However, rolling back government is almost an art in itself. Done wrong – as in austerity – it causes more problems than it solves, without any prospect of any kind of recovery on the horizon. While an Austrian economist would tell the deteriorating European middle class that their private finances are going to improve “in the long run”, a Keynesian economist would insist that the Austrian present even a shred of evidence for his claim.
The cold, hard truth is that Austrian theory relies critically on the notion that a dollar less spent today is a dollar more spent tomorrow. The reallocation over time is governed, they say, by the natural interest rate. However, they have no method for defining the “natural” interest rate that will also allow them to prove that this intertemporal reallocation actually takes place.
In practical terms: the Austrian theorist who lends credibility to austerity policies has no way of explaining to a middle-class family, whose livelihood is in jeopardy due to that very same austerity policy, when and how they will be able to turn a corner. Granted, the free market is a spontaneous institution, but spontaneity is not the same as lack of evidence, foresight or structure.
Furthermore, history offers many credible examples of how an orderly transition from big government to economic freedom can actually work. The European section of the former Soviet sphere offers, again, plenty of examples of how that orderly transition can take place. It applies, obviously, to the transition from a Communist command-structure economy to a traditional European welfare state. But it also applies to the transition from that welfare state to full economic freedom: the key is always to provide a predictable pathway, where economic institutions change in a way that does not cause uncertainty but instead encourages private citizens to become consumers and entrepreneurs.
In my book Ending the Welfare State I explain what policy models can help us make this transition into economic freedom. I make a big point out of designing the transition so that the poor and needy:
a) do not suffer immediate financial hardship as government terminates its programs; and
b) are given a good chance to provide for themselves, on their own terms, in the new system.
The choice between reckless Austrian-based austerity and a sound, Keynesian path to economic freedom is not just one for Europe to make. The European crisis can tell us a lot about what we should and should not do here in America. Even though our economic outlook right now is notably better than it is in Europe, that does not mean our fiscal crisis is over. The federal budget deficit is still staring us in the eyes every morning, with irresponsible spending cuts and tax hikes on the horizon.
We need to make a different choice than Europe. We need to create a credible, sustainable path to limited government – and then stay the course.