The Austerity Myth By Rick Kelo

The Austerity Myth

By Rick Kelo

We're Angry!

Yesterday the King of the Netherlands told the nation to waive good-bye to their collapsed welfare state and get ready for the "participation society."

This topic was greeted with hand wringing and mutters about "austerity."  You know austerity.... that intangible bugaboo that anything can be blamed on.  In 2009 it took the place of blaming things on "The Man."  However there has been no austerity in the Netherlands.  Government expenditures rose from $1.76B in 2008 to $1.87B in 2012, and as a percent of GDP government spending rose from 51.5% in 2008 to 59.4% in 2012.  So, since there have not been any cuts to speak of why is it so many want to saddle the blame of any reductions in government on "austerity" and what does that word even mean?

The term "austerity" has been adopted to mean cutting government spending and taxes during an economic contraction.  This is the populist view, which is opposed to the professional economic view on the topic.  Economic theory states that shrinking government, or lowering government's finances through tax reductions, leaves an economy less encumbered and raises economic output.  However, some groups involved in "austerity" debates believe in economic theory as much as fundamentalist Christians believe in evolution.  When you try to discuss it with them they're every bit as open-minded as well.  So, to spare you the spin and sabre-rattling we will conduct a fact-based review of this topic.

There are some myths about austerity and some truths, and nary the twain shall meet.
Common myths about austerity include:

1. It is in use across Europe
2. It produces bad, harmful results
3. Fiscal responsibility is economically bad
4. Fiscal irresponsibility produces economically good results

The truths about austerity include:

1. There are only 4 European nations who have cut spending and taxes since announcing what they called "austerity" policies.
2. There are only 4 European nations who have cut spending, but instead raised taxes, since announcing what they called "austerity" policies.
3. There are 9 European nations who have done the opposite of austerity: increased spending and increased taxes.

Has Europe, in fact, been savaged by brutal spending cuts?  Surely this must be the case, right?  Every day we read about protests in the streets.  Citizens of various countries in Europe are mad that the government benefits they never could afford now have to be reduced.  

Many of us have taken these protests at face value.  Very few of us have asked the question:

"Has government spending actually been cut?"

When we look at the truth we find that spending cuts have not, in and of themselves, harmed any nation in Europe.  That hasn't stopped the specter of government spending cuts from being fear-mongered to the unaware masses by those who see their empires of government bureaucracy on the chopping blocks.

This myth is more the arena of political pundits and internet authors than economists and politicians.  The European "austerity" debate has been more than anything dominated by one side seeking to maintain the government spending and another side that wants to raise taxes.  Usually neither side actually pushes for spending reductions, but spending cuts are the main thing you'll hear associated with this topic.

We will compare the 4 actual austerity nations against two other groups: the 9 nations who raised taxes and spending; and the 4 nations who raised taxes and cut spending.  Once we look at whether spending is the real issue you see that cutting government spending is nothing more than a Boogey Man used by pundits to scare people.

Of the nations we're about to look at only Ireland made any major cuts to government spending.  Below are the budgets for a few of the European nations where we see widespread protests.  As you will notice it is pretty tough to identify the "savage" spending cuts.

Countries w/ Most Austerity Protests.
Do you see any "Savage" spending cuts?
Source: World Bank's DataBank

Source: Dr. de Rugy; George Mason University

Ok, so we've looked over a few of the major measures and can see quite plainly that there is not an issue of widespread, massive spending cuts.  This is contrary to what the masses are being inflamed to believe by media pundits and by the agents of pro-big government groups like the various European socialist parties.

In reality, there has been more change in the increased taxation than in limiting spending.

Now what about the few countries who have cut their spending and have cut their overall tax burden?  That would be Ireland, Bulgaria and a couple of the Baltic countries: Latvia and Lithuania.  In the last 2 years those countries had an average 3.19% GDP growth rate (Source: International Monetary Fund, EuroStat, European Commission on Taxation & Customs).

Let's contrast that with the "non-austerity" countries in Europe.  The countries who have increased both their government spending and their overall tax burden include: the UK, France, Germany, Spain, Malta, The Czech Republic, Belgium and Slovakia.  In the last 2 years those countries had an average 0.98% GDP growth rate.

Lastly let's look at the countries who have lowered government spending, but increased their tax burden.  They are: Greece, Portugal, Hungary and Estonia.  These nations have, in the last 2 years, had an average -0.84% GDP growth rate.

These results aren't especially surprising given the economic impact of taxes.  Taxes redirect resources away from private property owners and into the hands of the state, which causes producer goods to not be fully economized.  Whatever the total tax burden of a country is, that's the percent of resource decisions that are in effect made by state officials.  Taxes interfere with the distribution of income from production.  Now the income earned by selling a good is partially disconnected from the resources committed to producing it, and this changes production decisions in a market.  The higher the tax, of course, the less production.  Lower the taxes (especially with the added juice of cutting government spending) and production increases... just like we see above.

So to close this topic, this is the misinformation that comes out of politicians and pundits:

"We can't just cut our way to prosperity."
~ President Obama, 2013 State Of The Union

"Slowly, with little fanfare, the whole notion that austerity might actually boost economies slunk off the public stage."
~ Paul Krugman, June 6, 2013

The next time you hear confident lies being spoken confidently remember that shrinking government, and lowering government's finances through tax reductions, unencumbered the 4 true austerity nations in Europe and raised their economic output.... just like the economic theory predicted.