Tuesday, 15 May 2012

More on austerity

Note: This post was also published on the Adam Smith Institute blog on Thursday 24th May, titled "Austerity or bust". For all my other ASI writings see here.

The debate on austerity v stimulus is again the main focus of attention. Particularly due to the recent results of the Greek and French elections where opposition to European "redistributive austerity" is gaining strength. Even though they don't refer to it as redistributive austerity, but as "painful cuts that are hurting growth". Even in the very phrasing of the debate as 'austerity v growth', it is obvious that people don't really understand what austerity is, and even less what their governments are doing. 

The recent texts from the Mercatus Center, Cato institute, Tyler Cowen and many others shed some light on this and have pointed out to a controversial yet very true fact that there is no real austerity in Europe, at least not the type that could theoretically help the economies recover. In fact, just yesterday Tyler Cowen asks what is austerity, trying to come up with a precise definition in order to overcome the biases behind the term and its policy effects. Looking at Wikipedia and Investopedia he finds the following:
"In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided."
"A state of reduced spending and increased frugality in the financial sector. Austerity measures generally refer to the measures taken by governments to reduce expenditures in an attempt to shrink their growing budget deficits."
Defining the term is particularly important for the policy implications. As you can see there is no mention of tax increases in any of the two definitions. However, governments sometimes do tend to use tax hikes to lower the deficit. But essentially the very definition of austerity primarily implies cutting spending and cutting entitlements in order to create more scope for the private sector to grow on its own, i.e. to remove the dependency mentality from people and from businesses. 

Then comes the following graph from Veronique de Rugy of the Mercatus Center
Source: Mercatus Center, de Rugy: "Fiscal Austerity in Europe
Doesn't Mean Large Spending Cuts"
 (May 7th 2012)
Where is the austerity here? Where are the significant cuts in spending necessary to address public and private sector dependency on the government and to reform the labour market? Particularly interesting examples are UK and France, where no signs of decreasing spending can be seen. In the UK, public spending to GDP has reached its 50-year historical high point (46% of GDP, see figure). Some cuts have been made, but everything that was saved up was again used to steer the economy. And so Britain saw schemes that want to pick industry winners, guide investment projects, subsidize housing, subsidize young people, and even control the amount and prices of loans in the economy. How does any of these address systemic dependency and how does any of these fit in the aforementioned austerity definition?

In France, the painful burden of austerity was one of the causes of Sarkozy's electoral defeat. The French were apparently fed up with it. Even though I'm struggling to see the actual austerity in France. However, I don't live there, so maybe I'm wrong. Maybe what's bothering the people in France is the same thing bothering people in the UK - taxes are going up, people are left with less and less disposable income, nothing is done to address the endemic dependency of the people or businesses to the state - which means that private sector growth is highly unlikely to follow, banks are uncertain and they refuse to lend no matter what the ECB does (or the BoE in the UK case), and finally, as a result people resort to radicalism, which was evident on both French and Greek elections where ultra-right and ultra-left parties won seats in parliament and got a dangerously significant portion of the votes. 

The very idea of depicting the debate as austerity v growth is wrong. This implies that the solution is the opposite of austerity - a monetary or fiscal stimulus to close down the nominal GDP gap. Even if a short-term fiscal or monetary stimulus can temporarily boost growth, that isn't the way towards a proper restructuring of the economy. I know the logic behind these views - "let's just get the economy going and all will be better afterwards". The idea that it's much easier to do structural reforms after things are going well is a wrong approach, since no politician will have the power, strength or the courage to engage into painful but necessary reforms, especially after what the world economy is going through at the moment.

Austerity should be an unpopular policy. It's primary goal is to cut the dependency to the government. This does not come easily and will cost votes. But doing what the European politicians are doing currently, first of all has no chance of achieving growth any time soon, second it's constraining the population from spending (via tax hikes) and the businesses from investing (uncertainty, bad signals, no institutional support), and finally will result in a double loss - elections and the recovery. As Margaret Thatcher once said: "If you want to cut your own throat, don't come to me for a bandage". This precisely sums up what Europe's allegedly austere governments are doing - cutting their own throats and hoping they stay alive. Not likely. 

8 comments:

  1. if that's the definition of austerity, Britain has nothing of the sort. and even though both the government and the opposition are in favour of cuts (the pace is the only issue that separates them), I don't see any proposal from either that will make the move in the right direction. It's all political squabble without any idea what to do.
    So yes, good point there at the end - the politicians are shooting themselves in the foot all across Europe.

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  2. It would be much better to look at relative data for spending than absolute data. That would make the analysis on whether there is or isn’t austerity in Europe much more precise.

    Cause some sources always cite one type of information while others cite another. Only a relative size of spending, accompanied by real case examples can tell us precisely what the situation is.

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    1. Yes that was the initial idea, and I have applied it in the case of British austerity (see the first graph).
      But in this case both absolute and relative numbers show an increase in spending.

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  3. The people of France are concerned that additional austerity measures would endanger their lifestyle. It's more of a cultural question in France, which makes it very different in how the French cope with austerity and how for example the English do it.

    That's the reason why the French data in the graph show a constant increase in spending. The French welfare state must be preserved. The voters know and want this, and it's up to the politicians to deliver it. (That's why Sarkozy lost. He put Europe in front of France and the people didn't care too much for that.)

    I would compare the French welfare state culture to the one of Sweden or Denmark. It's the European way of life. Besides, France isn't in trouble because of high spending or large deficits, we always had those and we were doing just fine. So the answer to France's problems isn't in cutting spending.

    That's why in France people feel that austerity is hurting. They aren't used to having to cut down on their lifestyle. So consumer spending has fallen as a consequence. France is a victim of Europe's contagion, not among the causes.

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    1. I wouldn't go so far to call it a European way of life, and that the French voters are demanding this. Perhaps the reasoning goes the other way - welfare state policies have created a systemic dependency of the people towards the government which affected their incentives in the long run. At the same time this made the French less productive than, say the Germans, and is hurting them in the longer run. The remedy to this is necessarily painful. In fact I've read several opinions that say productivity problems are to blame for a slow recovery. And the only way to resolve productivity problems is to cut dependency.

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    2. You cannot continue this way forever, surely you can see that? You have very small families and an aging population, you have few small business and slow business start ups because only a large company can cut a crony deal it needs to exist in such an hostile atmosphere.
      You are out of money, almost out of credit, and soon you will be out of time.

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  4. this is the same graph Cowen used some time ago and my reaction was that this tells us nothing about the real cuts made. Looking at aggregates can reveal only so much, and can tell us nothing about the actual impact of cuts. If you look at consumption levels they will give you a much more accurate picture. Or household prices or any other indicator you can think of where personal, disposable income is affected and which is keeping aggregate demand low.

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  5. So you believe in aggregate demand but not in aggregate levels of spending? A bit puzzling but ok.

    Regarding the aggregates, if you look at this graph where you have spending adjusted for inflation, you get the same story:

    Also, the real levels of spending will result in the same situation (this graph one is for the UK).

    Besides, the point is that Europe is conducting a strange type of austerity based on constraining incentives to work, instead of encouraging them. The spending graphs simply tell the story of an unwillingness to engage into necessary reforms and that nothing is happening to address Europe's endemic dependency. That was, after all, the point of the text.

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