Best of the Week
Most Popular
1.Are UK Savings Interest Rates Finally Starting to Rise? Best Cash ISA 2017 - Nadeem_Walayat
2.Inflation Tsunami - Supermarkets, Retail Sector Crisis 2017, EU Suicide and Burning Stocks - Nadeem_Walayat
3.Big Moves in the World Stock Markets - Big Bases - Rambus_Chartology
4.The Next Financial Implosion Is Not Going To Be About The Banks! - Gordon_T_Long
5.Why EU BrExit Single Market Access Hard line is European Union Committing Suicide - Nadeem_Walayat
6.Trump Ramps Up US Military Debt Spending In Preparations for China War - Nadeem_Walayat
7.Watch What Happens When Silver Price Hits $26...  - MoneyMetals
8.Stock Market Fake Risk, Fake Return? Market Crash? - 2nd Mar 17 - Axel_Merk
9.Global Inflation Surges, Central Banks Losing Control and Triggered the Wage Price Spiral? - Nadeem_Walayat
10.Why Gold Will Boom In 2017 - James Burgess
Last 7 days
Bitcoin Price Rises Higher Than Gold… But Its Value Is a Different Story - 30th Mar 17
Critical Fibonacci Extensions May Mark End Of Trump Stock Market Rally - 29th Mar 17
Ending Syria’s Nightmare will Take Pressure From Below - 29th Mar 17
Charts That Reveal US Real Employment Status and It’s Not Good - 29th Mar 17
SNP Controlled Scottish Parliament Demands Right for Scotland to Commit Suicide - Indyref2 - 29th Mar 17
USD Gold Myriad of Signs - 28th Mar 17
Ominous Social Trends That Will Shape Our Future - 28th Mar 17
Foundation And Empire: Is Donald Trump The Mule? - 28th Mar 17
Top Ten US Dollar Risks - 27th Mar 17
The Popularity of Gambling and Investing Amongst Students - 27th Mar 17
Is Political Betting on the Rise? - 27th Mar 17
US Stock Market Consolidation Time - 27th Mar 17
Russia Crisis - Maps That Signal Growing Instability and Unrest - 27th Mar 17
Goldman Sachs Backing A Copper Boom In 2017 - 27th Mar 17
Foundation – Fall Of The American Galactic Empire - 27th Mar 17
Stock Market More Correction Ahead - 27th Mar 17
US Dollar Inflection Point - 27th Mar 17
Political Week Presurres US Stock Market - 25th Mar 17
London Terror Attack Red Herring, Real Issue is Age of Reason vs Religion - 25th Mar 17
Will Washington Risk WW3 to Block an Emerging EU-Russia Superstate - 25th Mar 17
Unaccountable Military Industrial Complex Is Destroying America and the Rest Of The World Too - 25th Mar 17
Silver Mining Stock Fundamentals - 24th Mar 17
A Walk Down the Dark Road of Bad Government - 24th Mar 17
Is Stock Market Flash Crash Postponed Until Monday? - 24th Mar 17
Stock Market Bubble and Gold - 24th Mar 17
Maps Of Past Empires That Can Tell Us About The Future - 24th Mar 17
SNP Independent Scotland's Destiny With Economic Catastrophe, the English Subsidy - IndyRef2 - 24th Mar 17
Stock Market VIX Cycles Set To Explode March/April 2017 – Part II - 23rd Mar 17
Is Now a Good Time to Invest in the US Housing Market? - 23rd Mar 17
The Stock Market Is a Present-Day Version of Pavlov’s Dog - 23rd Mar 17
US Budget - There’s Almost Nothing Left To Cut - 23rd Mar 17
Stock Market Upward Reversal Or Just Quick Rebound Before Another Leg Down? - 23rd Mar 17
Trends to Look Out For as a Modern-day Landlord - 23rd Mar 17
Here’s Why Interstate Health Insurance Won’t Fix Obamacare / Trumpcare - 23rd Mar 17
China’s Biggest Limitations Determine the Future of East Asia - 23rd Mar 17
This is About So Much More Than Trump and Brexit - 23rd Mar 17
Trump Stock Market Rally Over? 20% Bear Drop By Mid Summer? - 22nd Mar 17
Trump Added $3 Trillion in Wealth to Stock Market Participants - 22nd Mar 17
What's Next for the US Dollar, Gold and Stocks? - 22nd Mar 17
MSM Bond Market Full Nonsense Mode as ‘Trump Trades’ Unwind on Schedule - 22nd Mar 17
Peak Gold – Biggest Gold Story Not Being Reported - 22nd Mar 17
Return of Sovereign France, Europe’s Changing Landscape - 22nd Mar 17
Trump Stocks Bull Market Rolling Over? You Were Warned! - 22nd Mar 17
Stock Market Charts That Scream “This Is It” - Here’s What to Do - 22nd Mar 17
Raising the Minimum Wage Is a Jobs Killing Move - 22nd Mar 17
Potential Bottoming Patterns in Gold and Silver Precious Metals Stocks Complex... - 22nd Mar 17
UK Stagflation, Soaring Inflation CPI 2.3%, RPI 3.2%, Real 4.4% - 21st Mar 17
The Demise of the Gold and Silver Bull Run is Greatly Exaggerated - 21st Mar 17
USD Decline Continues, Pull SPX Down as well? - 21st Mar 17
Trump Watershed Budget - 21st Mar 17
How do Client Acquisition Offers Affect Businesses? - 21st Mar 17

Market Oracle FREE Newsletter

Elliott Wave Trading

Is Economic Austerity Responsible for the Crisis in Europe?

Economics / Economic Austerity Jun 12, 2013 - 05:15 AM GMT

By: MISES

Economics

Martin Masse writes: Most European economies have been in recession, or close to it, since the beginning of 2012. Unemployment rates are reaching record highs. Meanwhile, a debate has been raging about the deleterious effects of “austerity” measures. Various heads of government, finance ministers, and European Union officials have declared that austerity has gone too far and is preventing a recovery.

Keynesian economists like Paul Krugman are seeing this as unassailable proof that stimulus policies adopted when the financial crisis started in 2008-09 should never have been reversed and replaced by austerity measures, notwithstanding the explosion of public debt that they entailed.


In the Keynesian view, when idle resources are left unused by the private sector, governments should put them to work. They should stop worrying about budget deficits and start spending again.

Whereas Keynesians and the rest of the economics profession see downturns as unexpected and disastrous events to be prevented, Austrian School economists explain them as the inevitable result of an earlier unsustainable boom provoked by excessive credit expansion and interventionist government policies.

For Austrians, the recession is actually a cure to get rid of distortions that have accumulated during the boom. Resources being wasted in unproductive uses have to be freed and moved to sectors where there is real and sustainable demand. Unfortunately, this takes time, and some resources will have to remain idle until entrepreneurs have found the best way to use them. This means temporarily higher unemployment, plants used at half capacity or closed until they are retooled, and financial resources parked in short-term assets instead of invested in long-term projects.

Governments should not try to prevent this reallocation process. Keynesian-style stimulus programs and bailouts simply prolong the unsustainable economic processes of the boom and delay the recovery. They also create a climate of uncertainty regarding debt burdens and taxes, deterring private investment. In short, unlike Keynesians, who believe government should intervene and spend more in times of crisis, Austrians advocate a withdrawal of government and a reduction in spending and taxation.

Given this theoretical background, how should we view the situation in Europe? Is austerity responsible for the crisis, as Keynesians believe? Or is it part of a necessary cure, as Austrians think? As we shall see, these alternatives do not accurately capture what is happening in Europe because of the ambiguous meaning of the word “austerity.”

The Meaning of Austerity

The debate on austerity in Europe has focused exclusively on government budget deficits and public debt as a percentage of GDP. The Maastricht Treaty requires that countries joining the European Union should have budget deficits no higher than 3 percent of GDP and debt levels no higher than 60 percent. These are also goalposts for member countries. Most of them (with the exception of Germany, among the larger countries) fail to meet these criteria. One facet of the current debate is whether some countries should obtain additional time to meet these goals, as France has just succeeded in doing.

In all these discussions, the only numbers presented as evidence that austerity measures have been implemented consist of statistics indicating that deficits have gone down. Indeed, they have, as the most recent Eurostat numbers show (Figure 1).[1] The average level of deficit as a percentage of GDP in EU countries in 2012 is much lower (4 percent) than it was in 2009 (6.9 percent).

Figure 1
General government deficit as a percentage of GDP

Source: Eurostat, Government deficit/surplus, debt and associated data.

It should be obvious that there is no direct relationship between reducing the size of the deficit and reducing the size of government, the latter being a key factor to consider if we want to compare Keynesian and Austrian solutions to the crisis. A budget deficit can be reduced either by cutting spending or by increasing revenue. It can also be reduced if spending is cut a lot but taxes are cut only a little. It can be reduced even as spending increases if revenues increase even faster.

In practice, “austerity” can thus cover all kinds of situations with differing economic impacts. The term can apply just as well to growth as to reduction in the size of government. It seems to be universally taken for granted in this debate that austerity measures adopted in Europe have meant drastic spending cuts, coupled with some tax increases, the net effect being a downsizing of government. But is this really the case?

Governments Keep Growing

As Figure 2 shows, there has only been a slight decrease of 1.7 percentage points in government spending as a proportion of GDP in the Union as a whole over the past three years. Moreover, the proportion is still 4 percentage points higher in 2012 than before the crisis started, 49.4 percent compared to 45.6 percent in 2007. Among the major countries included in this figure, only in Poland have expenditures gone back to where they were in 2007.

Figure 2
Total general government expenditure as a percentage of GDP

Source: Eurostat, Government revenue, expenditure and main aggregates.

However, there is reason to wonder if these numbers have been distorted by the periods of negative economic growth that have hit the continent. Expenditures may have come down in absolute terms, but they would still be higher as a proportion of GDP if the economy had contracted even more. So, let’s look at expenditures in nominal terms.

Figure 3
Total general government revenue and expenditure in billions of euros — European Union (27 countries)

Source: Eurostat, Government revenue, expenditure and main aggregates.

Figure 4
Total general government expenditure in billions of euros

Source: Eurostat, Government revenue, expenditure and main aggregates.

As we can see, government spending has never stopped rising in the Union as a whole since the beginning of the financial crisis, except in 2011 when it remained constant (Figure 3). Spending grew by 6.3 percent in the last three years, in other words during the period when “austerity” policies were supposed to have been applied.

Thus, whenever finance ministers announced budget cuts, they were actually referring not to absolute reductions in total spending but simply to spending increases that were lower than what was previously planned or to cuts that were offset by more spending elsewhere.

There are only a handful of countries where nominal expenditures really fell between 2009 and 2012, including Greece and Portugal (Figure 4)[2]. It should be noted, however, that both in nominal terms and in proportion to GDP, the governments of these two countries spent more in 2012 than in 2007.

With no net decrease in spending, the deficit reductions observed in most countries must have occurred because tax revenues went up faster than spending. And that is precisely what the Eurostat data show, with revenues up 12.9 percent from 2009 to 2012, double the pace of increase in public spending (Figure 3).

Governments have not been borrowing as much—although they still borrow heavily, and public debt keeps increasing. Instead, they tax their citizens more to fund their growing expenditures (Figures 5). And this is the case even in countries such as France where “austerity” has been most strongly criticized. France leads the pack both among countries where spending has risen the most and among those where taxes have climbed most sharply.

Figure 5
Total general government revenue in billions of euros

Source: Eurostat, Government revenue, expenditure and main aggregates.

Conclusion

Governments in almost all European Union countries are therefore as large as they were when the crisis started in 2007 or even larger today.

If we define austerity as the measures taken to reduce budget deficits, then in that sense austerity is indeed responsible for the crisis. If, however, we define it more properly as policies bringing about a reduction in the size of government, then these policies cannot be held responsible for the crisis in Europe because they were never applied.

Unfortunately, confusion over the meaning of austerity impedes a better understanding of the situation and precludes a more relevant debate over the causes of the crisis.

Keynesians will, of course, regret that there haven’t been even larger spending increases, greater borrowing and expanded deficits in the past few years to stimulate the economy. But, from an Austrian perspective, bloated governments, and higher taxes certainly help explain why European economies are still in the doldrums, several years after the financial crisis.

What Europe needs is smaller governments, not just in terms of public spending but also as regards deregulation of the job market and other structural reforms to encourage entrepreneurship, private investment, and job creation. There will be sustained growth in Europe only when governments, and not citizens or businesses, finally bear the brunt of austerity.

Comment on this article.

Martin Masse is an associate researcher at the Institut économique Molinari in Paris (www.institutmolinari.org) and publisher of the libertarian webzine Le Québécois Libre (www.quebecoislibre.org). See Martin Masse's article archives.

You can subscribe to future articles by Martin Masse via this RSS feed.

© 2013 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife