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Austerity Is Worth The Cost

In a January National Review article, I explained how Baltic countries such as Estonia that had undertaken short-lived but severe cuts to government spending and revenues -- what I termed “real austerity” -- had been outperforming West European countries that had been increasing both spending and taxes then speciously claimed “savage” cuts had taken place -- what I termed “phony austerity” -- for the past three years. But a relevant question for the economically troubled European countries and U.S. remained: Were such painful-but-temporary measures in the Baltics worth their economic cost? The answer is an emphatic “Yes!” By 2012, Estonia’s cumulative increase in GDP since 2008 (even after implementing austerity in 2009-2010) was greater than that of the Euro area average and of the frequent punching bag of the anti-austerity crowd: the U.K. By 2014, estimates indicate Estonia will have overtaken Germany in terms of GDP gained since 2008.

Estonia’s GDP gains are not only greater than the rest, but also the most economically sustainable. Breaking down cumulative GDP gains into consumption, government spending, investment and net exports reveals Estonia’s economic revival stems from a higher increasing level of investment and a much stronger boost to net exports than experienced in the “phony austerity” countries.

 

The supposedly strong performance of Germany throughout the Euro Crisis rests on a high level of consumption and government spending made possible by way of its productivity advantage. But Germany cannot sustain its economy like this forever; it will run out of money to spend on short-term private and public consumption if it does not undergo an increase in more productive, and thereby more sustainable, economic activities such as investment and exports.   The rest of Europe is in a much worse position than Germany. The Eurozone’s shrinking economies suffer from a severe lack of investment and export revenue. And unlike Germany, they cannot afford to continue spending to prop up their economies in the short and medium terms. Financial markets simply won’t lend them the money because their default risk is too high. Despite crying foul over so-called “austerity,” countries such as Greece, Spain, Italy, and France are all well behind Germany (and even further behind Estonia) in becoming more fiscally sustainable and in making pro-growth structural reforms, such as labor and product market liberalizations and welfare reform. Unfortunately, the prolonged pain inherent in “phony austerity” programs has led to populist frustration across Europe against austerity altogether. As I explained on Voice of Russia radio last week, the recent electoral success of the populist Five Star Movement in Italy is a direct rejection of technocrat Prime Minister Mario Monti’s austerity policies, of which the hardest hitting were tax increases. Italians are right to be frustrated with Monti’s faux-austerity, but they should demand real austerity -- meaning cuts to the bloated Italian budget and regulatory state -- instead of assuming that they can spend and regulate their way to prosperity. Italy and the rest of Europe should take a lesson from Estonia and its Baltic cohorts. U.S. policymakers would do well to pay attention too, instead of condemning a smaller federal budget as “recessionary” and tax cuts as “irresponsible.” Reducing the presence of government upon a hurting economy is the austerity that works.