Tuesday, May 8, 2012

Austerity in Europe - Is It Accomplishing Anything?

In recent days, weeks and months, those of us who live in the overly-indebted so-called "developed" world have been subjected to repeated attempts by governments to cut spending in a last gasp effort to achieve some semblance of fiscal balance.  Those of us who live in Canada and the United States are well aware that the feeble efforts of our elected elitists are pretty well pointless; to make the expenditure cuts and tax increases necessary to balance budgets would be a surefire guarantee of losing in the next election cycle.

With all of the hubbub about Europe's debt dilemma over the past 18 months and, in particular, the talk of austerity among the most uncomfortably indebted nations, how deep have the spending cuts really been?  Fortunately, one of my favourite economists, Veronique de Rugy, a Senior Research Fellow at the Mercatus Centre at George Mason University in Virginia has answered the question for us.  How hard are European leaders really trying to achieve fiscal balance and reduce their debt and deficit load?

Ms. de Rugy's research shows that, while it appears that the results of recent elections in both Greece and Spain suggest that the citizens of these countries turfed their incumbent governments because of severe cuts in spending, that is not the case.  Apparently, austerity in Europe does not mean cuts in spending rather, the size of spending cuts were tiny compared to increases in taxes.  Ms. de Rugy notes that spending cuts are the most important form of austerity.  Increases in taxes, while helping to increase revenue, actually do not successfully reduce debt-to-GDP ratios.  As well, tax increases usually have a negative impact on the guilty nation's economy.

Ms. de Rugy looks at five nations in particular; Italy, Spain, France, the United Kingdom and Greece and examines their spending habits over the past decade.  Remember, these four nations are among those that supposedly have implemented the greatest austerity measures.  Here is a graph showing the spending habits of all five aforementioned nations between 2002 and 2011:

Quite clearly, United Kingdom and France have not cut spending as shown on these two graphs:

Spending cuts in Greece, Italy and Spain were actually very small when compared to the size of their budgets as shown on these two graphs for Spain and Italy:

Italy's expenditures in 2010 were only 0.75 percent lower than in 2009 and were actually 2.2 percent higher than in 2008.  Spain's expenditures in 2010 were 1 percent lower than in 2009 and were 6.4 percent higher than in 2008.  That's some austerity!

As shown on this graph, even using total government spending in constant 2009 U.S. dollars, only three of the nations, the United Kingdom, Italy and Greece, show very marginal drops in spending since the inception of the Great Recession when everything seemed to go off the rails for Europe's debtor nations:

In her conclusion, Ms. de Rugy notes that those European nations that did impose spending cuts, accompanied those cuts with larger tax increases.  Here is her analysis of that approach:

"This so-called balanced approach - some spending cuts for large tax increases - has been proven to be a recipe for disaster by economists.  It fails to stabilize the debt, and is more likely to cause economic contractions."

Recent economic data from Europe showing an overall contraction in some of Europe's strongest economies may be proving Ms. de Rugy's hypothesis.  An even moderate period of negative economic growth is about the last thing that Europe needs right now.  Perhaps our North American leaders could learn from Europe's example; showing some restraint on overspending now and resisting the temptation to overdo it on the taxation side of the ledger may be more important than they think.


  1. Much of government spending needs cutting, and the biggest target here should be the Military, which is more than 60% of discretionary spending. Cuts of ten percent a year for several years would benefit the country tremendously, without risking National Security. A portion of these savings should then be used to invest into socially beneficial projects, including infrastructure, and development of green energy and other technologies that would help our economy and jobs. We need a National Healthcare System, one that greatly eliminates private health insurance and pharmaceutical monopolies. Some government activities, such as the Department of Education, and Homeland Security, should be slashed to a bare minimum, perhaps a small fraction of what they are now.

    Current expenditures for Social Security and Medicare are part of government mandatory spending, and these entitlements are funded by payroll taxes, with proven social benefit. Thus, the long term stability of these programs should be insured by adjustments to their funding structures, as the necessity arises. There is other pork in government spending, but it's dwarfed in comparison to all the above issues.

    The tax structure needs to be changed in order to help reverse the growing gap between rich and poor. More tax money needs to be collected from Corporations and from the very rich, and it would probably be worth reducing taxes to small companies and those families with income below $200,000/year. A small tax should be excised on individual stock trades. Most of the tax subsidies for Big Oil and other large companies should be slashed to small fractions of their current levels.

    From a political perspective, we need a Constitutional amendment that prevents private contributions to politicians. All such elections should be publicly funded. Welfare should be accompanied by a nationwide educational drive to bring back the role of the family in raising citizens who can contribute well to society. These are formidable tasks that require extremely competent and well-intentioned leaders.

    The above rational approach cannot be accomplished now in this country because the government is corrupted by special interest groups. There first needs to be a radical departure from current government, and this cannot come from within the existing structure. "The system isn't broken, it's fixed." Thus, only a mass movement, on the level of a revolution, can be expected to bring about this needed change. The current polarity within the population suggests that a single mass movement against government is less likely than a movement that contains different, opposing factions. In any event, things should be much different 20 years from now, and I hope the country is able to survive it.

    1. "the Military, which is more than 60% of discretionary spending."

      While I am all for cutting military spending, it would be more honest to mention that it represents only 18% of the entire budget, the vast majority of the budget (over 60%) going to entitlements--over $2.3 trillion. The math is clear that if the $683 billion (FY2012) military budget were cut to zero, the Federal Government would still run a $644 billion deficit.

      You did at least mention Social Security and Medicare spending (but not Medicaid) but failed to point out they collectively comprise over half of federal spending. With Medicaid and other entitlement spending included, direct payments to individuals is forecast to eclipse over two-thirds of federal spending by 2015.

      Also, your suggestion that since Social Security and Medicare are funded by a separate tax they are somehow not part of the budget problem is fallacious. One could just as soon carve out a $683 billion portion of income and corporate taxes and declare it a "defense tax," and then assert that defense spending is not a drag on the budget since it is funded separately. Besides, Social Security is now running a deficit and Medicare deficits will soon explode (and would have already were it not for repeated emergency hikes in the payroll tax in the past).

      "Social Security and Medicare are part of government mandatory spending... ..with proven social benefit."

      Anyone who understands the price distortion effect of subsidized Medicare and how it has led to skyrocketing demand for medicine (and by extension higher prices) would disagree. The architects of Medicare also did not understand the effect that declaring medicine as "free" or "almost free" would have on the consuming and waste habits of seniors, and their 2000 Medicare budget forecast turned out to be 1,200% too optimistic. Even a superficial understanding of the artificially stimulative effects on demand that Medicare has created is enough to realize it is not so much a social benefit as a facilitator of rapid healthcare inflation and one of the three cornerstones of our healthcare crisis (the other two being the tax credit preference placed on employer-sponsored over individual health insurance and the HMO Act of 1973's provisions for eliminating indemnity deductibles and replacing them with smaller copayments).

      "The tax structure needs to be changed in order to help reverse the growing gap between rich and poor... ...Most of the tax subsidies for Big Oil and other large companies should be slashed to small fractions of their current levels."

      Yet just a single member of Big Oil, Exxon Mobil, paid over $36 billion in corporate taxes in 2007... more than the entire bottom half of the American taxpaying populace. With the bottom 48% of American workers paying zero income tax and many of them receiving the earned income tax credit (essentially a government payment for working), I don't see how revising tax policy can go any further in reducing the gap between rich and poor--not that that is necessarily a desirable policy. Unless you want to increase free payments to the poor even more, or raise taxes on the richest Americans (the top 5% of whom pay over half of all federal income taxes) who-- including state, local, sales, payroll, and property taxes--already routinely surrender over half their income to the government.

  2. The trouble with increasing taxes is politicians get their hands on the money and do not solve the problem... then they return to the taxed, regardless of class or wealth, and ask for more. As the managing partner of a small business we have had a couple of successful years recently only to see the tax bite consume our plan for expansion. Where did the money go... unlimited wars, endless social programs and virtually no investment in the infrastructure.

  3. Hi there! I am interested in one thing, could you be so kind and please tell us your place of birth?