Beware the Myth of European Austerity
“France’s Austerity Drive Pushes Country into Recession.” “How Austerity Has Failed.” Thus proclaim two recent, typical headlines on how European governments are trying to tackle the economic crisis. But such claims rely on two myths based on faulty analysis.
The first myth about austerity is that it has been enacted throughout Europe. The second is that it has led to economic ruin. Americans ought to be wary of politicians and pundits who hold up the pains of Europe to argue against fiscal responsibility at home.
Several studies have attempted to show that European countries have made real cuts to their public sectors, using spending and revenue data. But cuts since when? Analyses to date have relied on selection of a base year – usually 2007 or 2008 – from which to measure changes in government spending and revenue.
The problem is that not every European country began implementing austerity at the same time. Therefore, analyzing all European countries from the same starting date captures budget changes in some countries that occurred before austerity programs began.
In a new Competitive Enterprise Institute report, “The True Story of European Austerity: Cutting Taxes and Spending Leads to Renewed Growth,” I address this common analytical flaw by measuring spending and revenue changes from the time each country began its austerity program. The results stand in stark contrast to the conventional wisdom.
Only four European countries – Bulgaria, Ireland, Latvia, and Lithuania – have actually decreased both spending and revenue as a share of GDP since announcing the implementation of their respective austerity programs. This is real austerity, as cutbacks are shared between the public and private sectors.
Meanwhile, nine countries pursued the exact opposite policy, increasing both spending and their tax burdens. This is no austerity in any reasonable sense of the term, as businesses and individuals already hemorrhaging from the recession face increased taxation from a government engorging itself at their expense.
The economic results of these two groups of countries are very different. The first group, which carried out real austerity, maintained an average annual GDP growth rate of 2.65 percent in the six years following budget consolidation, according to my calculations using Eurostat and International Monetary Fund data. The second group, the “austerians-in-name-only,” achieved an average growth rate of only 1.46 percent.
Moreover, various European countries enacted different combinations of spending and tax burden changes. The only group that achieved an average growth rate of more than 2 percent – the standard for healthy economic growth – is the aforementioned one whose members cut both taxes and expenditures.
The bottom line: Shrinking government’s economic footprint leaves businesses and entrepreneurs less encumbered to create wealth.
With U.S. federal expenditures and taxes set to increase over the next several years, according to the president’s budget, American policymakers should learn from Europe’s experience. The U.S. doesn’t have an unlimited amount of time to fix its economic problems, as the share of federal revenues taken up by interest payments on the federal debt now approximates those of Italy and Spain.
Washington continues to increase our debt load through increasing levels of federal outlays and encouraging private debt-fueled consumption with low interest rates. These debt-driving policies are the only ones to have had a net positive impact on GDP since 2007, according to my analysis of Bureau of Economic Analysis data.
By contrast, gross domestic investment has endured a total net loss of 11 percent from its 2007 level. As debt-financed consumption papers over our anemic economic situation, politicians claim that conditions are improving. It’s time for Washington to end this charade and make real cuts. Greater savings would then finance productive investment and government would be eating up fewer economic resources.
The howls of protest from both the left and right over the sequester – which cuts a mere 2 percent from a projected $2.54 trillion federal spending increase over the next decade, according to Veronique de Rugy of the Mercatus Center at George Mason University – only shows how far we still need to go.
In his 2013 State of the Union address, President Barack Obama declared, “We can’t just cut our way to prosperity.” Perhaps he should pay closer attention to the success of a handful of our European friends, as they shout back a familiar refrain: “Yes, we can!”