U.S. Should Copy Estonia, Which Made Austerity Work

Another month of disappointing job numbers is a painful reminder that the U.S. economy is struggling after almost five years of fiscal and monetary stimulus.

Since 2008, Washington policymakers have been pacing around the doctor’s office too afraid to take the bitter but effective pill America needs: slash federal spending and end the U.S. Fed’s life support for zombie banks.

Economically stagnant Britain shows us where this continued procrastination leads. Instead of dashing after our tea-drinking transatlantic neighbors, American policymakers should look to Estonia, which took its austerity meds and quickly returned to prosperity.

First, let’s look at the UK. In the four quarters following the British government’s announcement of austerity in June 2010, general government spending increased by 4.3%, a rate of growth that has increased since then.

Some “austerity.”

Whitehall also has been squeezing more taxes out of British citizens, with revenues increasing by 7.8% the first year and the rate of growth shooting up into double digits the next two.

And the Bank of England’s balance sheet has grown 334% since September 2008, as it’s tried to prop up bad assets held at London banks.

The result: A still-unaddressed gap between wages and labor productivity that has sapped British competitiveness over the past decade, stagnant export growth (which was actually negative in 2012), and net negative economic growth since 2008.

Meanwhile, Britain’s phony “austerity” program, which will last through 2018, has only served to prolong the pain by covering up fundamental problems with taxpayer money and newly minted pound sterling.

It doesn’t have to be this way. For a better way forward, let’s look at Estonia, which took its medicine as soon as the global financial crisis broke. It cut government spending relatie to its pre-crisis level drastically — 2.8% in 2009 and 9.5% in 2010 — and is now one of Europe’s fastest growing economies.

Tax revenues fell, too. Moreover, Estonia’s central bank refused to prop up banks that shipwrecked on the rocks of a real estate bubble.

Today, the country’s number of non-performing loans is half what it was during 2009-2010. Export growth rebounded strongly during 2010-2011 and has since remained above its pre-crisis level.

Estonia’s economic recovery is impressive enough, with unemployment now below the Euro Area average and having made up its total economic losses by 2012.

But the most astounding element of this story is that in 2011 Estonian voters reelected the very politicians who implemented austerity — and in greater numbers than the previous election.

What can American politicians learn from this? Quite simply, not to be afraid of the short-term consequences of pro-growth policies.

Unfortunately, we seem to be following the Brits, echoing their denunciations of “savage austerity” with fear mongering about such futile budget measures such as the sequester, which doesn’t even cut spending but only its rate of growth.

Federal spending has averaged 29% above its pre-crisis level and is expected to keep going up. Revenues, which had been falling prior to 2012, increased last year and will shoot up by double-digit percentages by year’s end.

Meanwhile, the Federal Reserve has more than tripled its balance sheet since September 2008 and continues to be the backstop for an inefficient financial sector beset by non-performing loans even as it finances a heavily indebted federal government that spends 17% of its revenues on interest payments alone — roughly the same as Spain and Italy.

The Fed cannot keep interest rates at rock bottom forever. U.S. policy makers must stop pretending it can and begin paying down the almost $17 trillion national debt before interest payments bankrupt the federal government.

Washington needs to cut spending — now at its highest peacetime level ever — and rein in the ever-growing federal regulatory state, which restrains entrepreneurialism and job creation.

According to my colleague Wayne Crews, regulations will cost the U.S. economy a whopping $1.806 trillion in 2013 — that’s 13% of the economy. Add that to total spending and government’s burden is equal to nearly half the entire U.S. economy.

With 3,708 rules issued in calendar year 2012 — and 4,062 new regulations at various stages in this year’s federal pipeline — government’s economic footprint will grow even larger.

It’s no surprise that in a January 2013 Gallup poll, 56% of small business owners said they are not seeking to hire new employees because of future costs associated with new regulations.

America is sick. Government is fat and the economy is fatigued. Worse, politicians suffer under the continuing delusion that if only they had more taxpayer money, then they could solve the very problems created by spending too much taxpayer money.

They need to snap out of the same fantasy world they share with their counterparts in the U.K., where dieting means eating more, and take the austerity pill. It will make everyone feel better. Just ask the Estonians.