Is Austerity Failing?
n his latest New York Times column, economist Paul Krugman criticizes the “pain caucus” in Europe, notably the European Central Bank (ECB), for insisting that sound money and balanced budgets will somehow fix all of the continent’s fiscal woes. Austerity, he argues, is failing and American policy makers would be ill advised to repeat it in their own country.
Krugman’s column is unfortunately so filled with mischaracterizations and outright blunders that it is difficult to purely dissect his Keynesian alternative. In fact, he doesn’t offer much of an alternative to austerity at all except to suggest “debt reduction,” which means restructuring. He has traditionally championed stimulus though and blamed the “arrogance” of Europe’s policy elite for “pushing” the continent into adopting a single currency well before it was supposedly “ready for such an experiment.” Krugman then is no fan of the euro and hasn’t ever had much respect for Europe.
The ECB, writes Krugman this week, claims “that raising interest rates and slashing government spending in the face of mass unemployment will somehow make things better instead of worse” but only half of that statement is perfectly true. Frankfurt has been urging budget cuts but kept interest rates low at the same time not to make matters worse in the highly indebted eurozone countries of the south. Austerity, moreover, is not supposed to get people back to work directly. The point is to avert sovereign bankruptcy as would have happened in Greece and possibly Ireland without European support by restoring confidence on bond markets.
Krugman characterizes this as “belief in the confidence fairy—that is, belief that slashing spending will actually create jobs, because fiscal austerity will improve private sector confidence.” That’s more accurate although budget cuts in themselves won’t create jobs. The private sector will if it has confidence in future growth.
But, “the confidence fairy hasn’t shown up,” writes Krugman. Case in point? Greece, Portugal and Spain where unemployment remains high. He is right but also disingenuous in pretending that those countries have fully implemented austerity measures yet—while not considering the nations that have.
Greece has made cutbacks, laying off public sector employees and reducing the salaries of those that weren’t fired but it’s protracting on necessary privatizations and making very little progress in getting its fiscal house in order. The government remains heavily involved in energy, health care and public transportation. The country’s railway system alone needs €1 billion in yearly subsidies to keep afloat. Pharmacists have retained their monopoly and continue to enjoy fat profit margins. Law firms still cannot open branches in different cities. Greek competitiveness overall is lacking far behind many other European countries.
Portugal’s highly inefficient public sector accounts for nearly half of gross domestic product and has gravely undermined the nation’s competitiveness. Its labor laws are inflexible. Regulations on dismissals and the use of temporary contracts are burdensome. The government maintains majority ownership of air- and seaports, railways and sanitation. Tax evasion is a problem and while corruption is limited, it is more widespread than is the case in most of the rest of Europe.
Spain is suffering from similar mistakes. Before the crisis, its government invested in renewable energies, bioengineering and infrastructure but in the process, probably destroyed more jobs in traditional industries than it created. Homeownership was heavily subsidized like in Britain and the United States, leaving people today with gargantuan debts that they’re unlikely to ever be able to pay back. Banks are naturally cautious about lending money and anxious about the prospect of losing even more if their loans to sovereign states aren’t fully repaid.
It’s no coincidence that in all of these countries, socialists have been in government throughout their recessions. In the immediate aftermath of the 2008 financial shock, they attempted the very Keynesian stimulus measures that Krugman at the time proposed.
In Spain, government spending already amounted to nearly 40 percent of GDP in the years preceding the downturn. Its stimulus provided for public works investments, support of the auto industry and increased social benefits. Yet one in five Spaniards remains unemployed today. For all the money that their government poured into the economy, the country did not recover.
What is Paul Krugman recommending these countries do now? Spend more! he says. Whatever you do, don’t cut back. But what about the countries that have?
Krugman doesn’t mention in his column that fiscal prudence in Germany enabled a relatively quick and export driven recovery. He doesn’t mention Latvia where austerity brought on a dramatic 18 percent drop in GDP in 2009 but where growth and jobs are returning less than two years later. He doesn’t mention Slovakia which pushed through huge market reforms earlier this decade and opted for austerity in recent years. Like Germany, it has seen a rise in exports and enjoyed two consecutive quarters of growth while unemployment is decreasing. He doesn’t mention the Czech Republic where a conservative government is reining in public sector spending and confidence among business owners and consumers is high. Nor does Krugman mention countries as Austria, Finland and the Netherlands where fiscal restraint and a considerable dependence on demand from Germany is fueling growth.
Finally, Krugman fails to consider lessons of austerity from the past, including Mexico during the 1980s and East Asia during the late 1990s, where each time international rescue efforts were conditioned on spending cuts and liberalizations that helped nations recover from terrible crises within just a few years.
Perhaps the most striking example of nation mired in recession and faced with the choice whether to spend or to cut was Britain during the 1970s though. There and then, Margaret Thatcher proved Krugman wrong. Despite hundreds of economists who told her that austerity would deepen the nation’s recession, Thatcher cut spending and privatized old, unprofitable industries held in government ownership for many decades. By the end of her prime ministership, Britain was back on a path for growth. It was “heartless” and “unsocial” and unpopular but it worked.