Best of the Week
Most Popular
1.London House Prices Bubble, Debt Slavery, Crimea 2.0 - Russia Ukraine Annexation - Nadeem_Walayat
2. Gold And Silver – 2014 Coud Be A Yawner; Be Prepared For A Surprise - Michael_Noonan
3.Sheffield, Rotherham Roma Benefits Plague, Ch5 Documentary Gypsies on Benefits & Proud - Nadeem_Walayat
4.Glaring Q.E. Failure Spotted - Money Velocity Is Falling Rapidly - Jim_Willie_CB
5.Don't Miss the Boat on Big Biotech Catalysts: Keith Markey - Keith Markey
6.Gold Prices 2014: Do What Goldman Does, Not What It Says - David Zeiler
7.Bitcoin Price Strong Appreciation to Be Followed by Declines? - Mike_McAra
8.Gold Preparing to Launch as U.S. Dollar Drops to Key Support - Jason_Hamlin
9.Doctor Doom on the Fiat Money Empire Coming Financial Crisis - Andrew_McKillop
10.The Real Purpose Of QE - It’s Not Employment - Darryl_R_Schoon
Last 72 Hrs
What Will December 31, 2014 Financial Headlines Look Like? - 23rd Apr 14
Why Gasoline Prices are Surging Again - 22nd Apr 14
Cold War 2.0 - 22nd Apr 14
The JIS – Junk Ideology Syndrome - 22nd Apr 14
How to Avoid Losing All Your Money - 22nd Apr 14
Silver Up, Stocks S&P Down - 22nd Apr 14
U.S. Mainstream Media Propaganda Setting the Stage for War With Pakistan - 22nd Apr 14
U.S. Interest Rates are NOT Rising! - 22nd Apr 14
A Crisis vs. the REAL Crisis: Keep Your Eye on the Debt Ball - 22nd Apr 14
Bitcoin Implications of Lack of Price Action - 22nd Apr 14
Japan - The Twilight Of The Rising Sun - 22nd Apr 14
Is This What a Credit Bubble Looks Like? - 22nd Apr 14
The Dark Side Of The Silver Mining Industry - 21st Apr 14
Strong U.S. Dollar Rally Could Pull Rug From Under Gold and Silver - 21st Apr 14
Silver Feeble Rally Fails to Hold Breakout, Falling Back Towards Support - 21st Apr 14
Stock Market Smart Money – All Out or More to Go? - 21st Apr 14
Fast Rising Pump Prices Counterattack - 21st Apr 14
Extreme Climate Change And Life On This Planet - 21st Apr 14
Gold and Silver Stocks Sitting Tight - 21st Apr 14
Stock Market Minor Correction Imminent - 21st Apr 14
Gold and Silver - Counting Blessings and Tender Mercies - 20th Apr 14 - Jesse
The CIA Through The Looking-Glass - 20th Apr 14 - Stephen_Merrill
Gold And Silver - Gann, Cardinal Grand Cross, A Mousetrap, And Wrong Expectations - 20th Apr 14 - Michael Noonan
Nikkei Stock Market - Sell Japan - 20th Apr 14 - WavePatternTraders

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Three Types of Economic Austerity

Economics / Economic Austerity Sep 04, 2013 - 06:09 AM GMT

By: MISES

Economics

Frank Hollenbeck writes: Reading the financial press, one gets the impression there are only two sides to the austerity debate: pro-austerity and anti-austerity. In reality, we have three forms of austerity. There is the Keynesian-Krugman-Robert Reich form which promotes more government spending and higher taxes. There is the Angela Merkel form of less government spending and higher taxes, and there is the Austrian form of less spending and lower taxes. Of the three forms of austerity, only the third increases the size of the private sector relative to the public sector, frees up resources for private investment, and has actual evidence of success in boosting growth.


Let’s take a closer look at the Merkel form of austerity being implemented in Europe in which governments “plan” to cut their spending and raise tax revenues. Of course, “planned” cuts are not actual cuts. Four years after the crash of 2008, the UK government had only implemented 6 percent of planned cuts in spending and only 12 percent of planned cuts in benefits. In almost all European countries, government spending is higher today than it was in 2008. A new study by Constantin Gurdgiev of Trinity College in Dublin examined government spending as a percentage of GDP in 2012 compared with the average level of pre-recession spending (2003–2007). Only Germany, Malta, and Sweden had actually cut spending.

Although several governments have raised tax rates, tax revenues have collapsed in response. The large and growing black markets in Greece, Italy, Spain, and even France are a testament to wrongheaded European tax policies. Current commitments to reign in tax fraud are a joke when tax rates are already at nosebleed levels.

Notably, the Merkel form of austerity has led to an increase, not a decrease, in the relative size of the public sector. For example, the Greek public sector, while getting smaller, has nonetheless been contracting at a slower rate than the private sector. Since the first bailout, Greece lost at least 500,000 private sector jobs but shed far fewer public sector jobs. For years, the Greek government has been pledging to cut 500,000 public sector jobs, and in recent months, the Greek government has finally pledged to begin laying off public sector workers over the next two years. A total of 12,500 civil servants, including teachers and police, face reassignment or the axe by the end of the year, with a further 15,000 facing the same options next year. Not only is this too little, too late, but it is also only a pledge.

The Keynesian form of austerity is no better. According to these economists, we need even more government spending to boost demand to obtain growth. For the Keynesians, the lavish amounts of money already spent was apparently too little and not spent in the right places, yet the last five years are a testament to the failure of this type of austerity. We are now left with a massive debt overhang and little growth to show for it. Government spending has simply “crowded out” private spending.

Ignored is the fact that we don’t need government to boost demand because there is never a deficiency of demand. Governments instead should be more concerned with the ability of the private sector to produce the right supply.

Growth will come from the private sector, and the austerity we need is one that makes the private sector larger than the public sector and one similar to that implemented in 1920 in the United States. In what Thomas Woods calls “The Forgotten Depression of 1920,” the U.S. government cut spending 50 percent and sharply reduced taxes. The public debt was reduced by a third, while monetary policy was kept on hold. The economy recovered quickly (in 18 months) and by 1923 the unemployment rate had fallen below 3 percent.

A more recent example of similar tactics is Latvia which followed a similar strategy in 2009-2010. It cut government spending from 44 percent of GDP to 36 percent. It fired 30 percent of the civil servants, closed half the state agencies, and reduced the average public salary by 26 percent in one year. Government ministers took personal wage cuts of 35 percent, although pensions and social benefits were barely reduced and the flat tax on personal income was left untouched at 25 percent.

The Latvian economy dropped 24 percent in two years, but rebounded sharply in 2011 and 2012 with yearly real growth of over 5 percent. Unemployment hit 20.7 percent in 2010, but has steadily declined to a little over 12 percent today. Because the cuts prompted deregulation, Latvia enjoyed a boom in the creation of new enterprises in 2011. It was able to transition from a bloated construction sector to a vibrant economy of many small- and medium-sized enterprises.

Latvia borrowed heavily from the IMF, and was criticized in 2009 for its overly aggressive economic strategy. Latvia recently repaid its loan to the IMF three years early, indirectly silencing its critics.

Austerity worked because it was the right form of austerity: one which gave people hope and one with a light at the end of the tunnel. Today, Europe has austerity fatigue. It missed the opportunity to implement the right type of policies.

Since it now seems impossible to implement the right form of austerity, what should Europe do? To get back on the path to growth, Europe needs to dump policies to spur aggregate demand, and focus on policies which bring the right products at the right prices. As J.B. Say said:

The encouragement of mere consumption is no benefit to commerce, for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of Good Government to stimulate production, of bad Government to encourage consumption.

Without growth, Europe is heading for a train wreck since it will shortly be unable to finance its debt. It must refocus its strategy toward stimulating production, freeing up Europe’s entrepreneurial spirit. This is a policy much more likely to succeed.

Comment on this article.

Frank Hollenbeck, PhD, teaches at the International University of Geneva. See Frank Hollenbeck's article archives.

You can subscribe to future articles by Frank Hollenbeck via this RSS feed.

© 2013 Copyright Frank Hollenbeck - 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.


© 2005-2014 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

Free Report - Financial Markets 2014