Ed Lotterman: Jury still out on austerity experiments

October 4, 2013 

Whether austerity is an appropriate policy for economies in recession after a large-scale financial crisis is a matter of debate among economists right now. In the real world, it is a political debate that becomes crucial in elections, including the recent one that extended Angela Merkel's term as German chancellor.

First, it is important to understand what the term austerity means to economists. I frequently get emails that suggest readers think it means having a small government or a balanced budget. That is not true. The government sector of the United States - local, state and federal combined - is much smaller relative to gross domestic product than those of Germany or France, and government employees here make up a much smaller fraction of the labor force. But that does not mean the United States is pursuing austerity and Germany is not.

Similarly, in the last four years of the Clinton administration, the federal budget was in balance for the first time in three decades. But this was not austerity, just a situation in which federal revenues slightly outweighed spending.

Austerity is rather a deliberate government policy of cutting spending and raising taxes. Historically, it was done by governments that found annual budget deficits unfundable and government debt unsustainable. In developing countries that experienced foreign exchange crises, the International Monetary Fund often required austerity measures as a condition for loans of the foreign currency the country needed to pay for imports and service foreign debts.

Historically, U.S. governments cut spending at the end of wars, but usually in tandem with offsetting cuts in taxes. This was not austerity per se since austerity usually includes both reduced spending and higher taxes.

In the view of John Maynard Keynes, particularly as expressed by his acolytes, a country should cut taxes and increase spending when facing recession and rising unemployment, but increase taxes and cut spending when the economy reaches an unsustainably fast pace that includes inflation. Though he did not use the terms, recessions should be fought with fiscal "stimulus" and unsustainable booms with "austerity."

There always were economists who opposed Keynesian ideas - the monetarists, led by Milton Friedman from the 1950s through the 1970s, and the Rational Expectations school after that. For them, trying to micromanage an economy by varying taxing and spending caused harm.

However, until recently, there were virtually no economists who advocated austerity measures as a deliberate response to a recession.

There still are precious few, although Alberto Alessina from Harvard is one. Ken Rogoff and Carmen Reinhart - whose warning that economic growth slows when national debts pass 90 percent of GDP was widely cited before being discredited - don't argue that austerity is good, but that it may be the least-bad option when national debts are high and rising. The largest group may be the "Austrians," who follow the ideas of Friedrich von Hayek, although they are more influential among tea party adherents than among economists.

Despite scant support among economists, implementing austerity measures became popular with conservative political parties in Europe, including the Tories in Britain and the Christian Democrats in Germany. Keep in mind that what is "conservative" in Europe may be "liberal" in our country.

Wolfgang Schauble, finance minister under Merkel since 2009, and Olli Rehn, the Finn who is the European Union's commissioner for economic and monetary affairs, strongly support austerity in a situation where the EU as a whole and most of its countries individually are in recession and when unemployment rates are high.

Some see this as a combination of traditional German thrift and the practical political judgment that it is unwise to promote stimulus in countries on a good fiscal footing while imposing harsh austerity on countries such as Greece and Portugal that have severe deficit and debt problems.

Within economics, the argument has gone on for four years now. Some suggest we have performed an experiment. The United States followed a program of mild stimulus that was about one-third tax cuts and two-thirds additional spending. The EU has pursued austerity. Which is doing better?

Now this is classic fallacious post hoc reasoning that ignores many other relevant factors that logically would play in. But to the extent such analysis has some validity, the pro-austerity camp does not come out well. The Germanic countries, including Austria and the Netherlands, have unemployment rates in the 5 percent range, well below that of our country. But other EU countries are higher, and the weighted average across the entire EU is 10.5 percent, three full points above us.

Moreover, no major EU country has increased GDP as much as the United States, and several remain well below prerecession highs. And the countries that have had the stiffest austerity programs forced on them as a condition of financial aid - including Greece, Ireland, Spain and Portugal - have had the poorest economic performances. Tiny Estonia is an exception.

It may be far too soon, however, to make any judgment. The U.S. budget deficit is falling sharply relative to GDP. But the long-run trends still are not good. And austerity advocates acknowledge their way includes short-term pain to achieve long-term health. Follow the news, but wait a few years before making any definite conclusions.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

Idaho Statesman is pleased to provide this opportunity to share information, experiences and observations about what's in the news. Some of the comments may be reprinted elsewhere in the site or in the newspaper. We encourage lively, open debate on the issues of the day, and ask that you refrain from profanity, hate speech, personal comments and remarks that are off point. Thank you for taking the time to offer your thoughts.

Commenting FAQs | Terms of Service