Statists are in a tough position. For years, they’ve been saying the United States should be more like Europe.
And, as shown in these very funny cartoons by Michael Ramirez and Bob Gorrell, President Obama is a cheerleader for that effort.
But now Europe’s welfare states are collapsing, so the left is scrambling to come up with some way of rationalizing their support for ever-growing levels of taxation and spending
Paul Krugman’s been doing what he can to square this circle, complaining that Europe is in trouble because governments aren’t spending enough. Sounds preposterous, but at least he provides some comfort for the don’t-confuse-us-with-the-facts-we’re-Keynesians crowd.
But for those who prefer to look at real data, one of my Cato Institute colleagues has sorted through the numbers to see whether Krugman’s hypothesis has any validity. Here’s some of what Alan Reynolds wrote for Investor’s Business Daily, reprinted by Real Clear Politics, starting with a quick look at some nations that experienced growth during periods when the burden of government spending was falling.
In Iceland, which didn’t throw taxpayer money at the banks, government spending was slashed from 57.6% of GDP in 2008 to 46.5% in 2012. The deficit fell from 12.9% of GDP to 3.4%. The economy began to recover in 2011. Iceland’s economic boost from fiscal frugality was neither unorthodox nor unique. After all, the U.S. economy boomed in the late 1990s when federal spending was cut from 22.3% of GDP in 1991 to 18.2% in 2000. In Canada, total federal and provincial spending was deeply slashed from 53.2% of GDP in 1992 to 39.2% in 2007 with only salubrious effects.
But what about Krugman’s argument that spending cuts have hurt growth in nations such as Portugal, Ireland, Italy, Greece, Great Britain, and Spain?
Well, Alan points out that these nations haven’t reduced spending.
The PIIGGS imposed no austerity at all on the public sector in the past five years. Government spending on bailouts, subsidies, grants, salaries and entitlements commands a much larger share of these economies than it did just a few years ago.
If you break down the data on an annual basis, some of these nations have been forced by the financial crisis to finally reduce their budgets, but the cuts in the past year or two aren’t nearly enough to make up for the huge spending increases in earlier years.
But these governments have shown no reluctance to raises taxes. I’ve already discussed their unfortunate propensity to hike value-added tax rates. Alan explains that they’re doing the same thing for income tax rates.
European austerity has been focused on the private sector — namely, taxpayers with high incomes. That is the second thing the PIIGGS have in common. The highest income tax rate was recently increased in every one of the troubled PIIGGS except Italy (where it was already too high at 43%). The top tax rate was hiked from 40 to 46.5% in Portugal, from 41 to 48% in Ireland, from 40 to 45% in Greece, from 40 to 50% in Great Britain, and from 48 to 52% in Spain.
In other words, Veronique de Rugy is correct. The “austerity” in Europe generally has been in the form of higher taxes, squeezing the productive sector to prop up the public sector.
Though I would point out that there are a few bright spots. Switzerland has been doing quite well, thanks to a “debt brake” that limits how much the budget can grow each year.
And the Baltic nations deserve credit for imposing genuine budget cuts several years ago, a policy that has yielded big dividends since they’re now growing while most other European nations are mired in economic stagnation.
And they kept their flat tax systems, showing some appreciation for the common-sense insight that you don’t get more growth by punishing investors, entrepreneurs, and small business owners.
By the way, Alan’s column isn’t completely depressing. He writes that the burden of government spending is reasonable (at least compared to Europe’s bankrupt welfare states) in some of the major emerging economies.
And they’ve focused more on lowering tax rates rather than making them more punitive.
It is enlightening to compare the depressing performance of these tax-and-spend countries to the rapidly-expanding BRIC (Brazil, Russia, India and China) and MIST economies (Mexico, Indonesia, South Korea and Turkey). Government spending is frugal in these countries, averaging 32.1% of GDP in the BRICs and 27.4% for the MIST group. Rather than raising top tax rates, all but one of the BRIC and MIST countries slashed their highest individual income tax rates in half; sometimes lower. Brazil cut the top tax rate from 55 to 27.5%. Russia replaced income tax rates up to 60% with a 13% flat tax. India cut the top tax rate to 30% from 60%. Similarly, the top tax rate was cut from 55 to 30% in Mexico, from 50 to 30% in Indonesia, from 89 to 38% in South Korea, and from 75 to 35% in Turkey. In China, statutory income tax rates can still reach 45% on paper, but that is only for high salaries and is widely evaded. Investment income is subject to a flat tax of 20%, the corporate tax is 15-25%, and China’s extremely low payroll tax adds almost nothing to labor costs.
This doesn’t mean the BRIC and MIST nations deserve high praise. Many of them still get poor scores from Economic Freedom of the World, largely because the regulatory burden is excessive and also because more needs to be done to uphold the rule of law and protect property rights.
But at least most of them aren’t compounding those mistakes with Keynesian spending schemes and class-warfare tax policy.
For more information about nations that have benefited from spending restraint, here’s my video looking at Ireland in the 1980s, New Zealand and Canada in the 1990s, and Slovakia last decade.
The moral of the story, needless to say, is that good things happen when governments comply with Mitchell’s Golden Rule.
P.S. Paul Krugman received some much-deserved abuse when he made false attacks on Estonia’s admirable fiscal policy.
P.P.S. For some humor about the European fiscal mess, here are some laughable quotes from European leaders. This Robert Ariail cartoon also gets a laugh, as do these videos on a Greek view of Germans and a romantic conflict between Northern Europe and Southern Europe. My favorite, for what it’s worth, is this map showing how Greeks view the rest of Europe, with this Dave Barry column a close runner-up.
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[…] Paul Krugman and you already have a very long list of mistakes (see here, here, here, here, here, here, here, here, and here for a few examples), then why not go for the gold […]
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[…] Paul Krugman and you already have a very long list of mistakes (see here, here, here, here, here, here, here, here, and here for a few examples), then why not go for the gold […]
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[…] It didn’t work for Europe. […]
[…] It didn’t work for Europe. […]
[…] It didn’t work for Europe. […]
[…] It didn’t work for Europe. […]
[…] It didn’t work for Europe. […]
[…] It didn’t work for Europe. […]
[…] didn’t work for […]
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Reblogged this on Utopia – you are standing in it!.
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It would be perfectly consistent with Keynesian doctrine to argue for cutting taxes in recessions and cutting spending in booms. If that happened, both spending and taxes might tend to fall over time, or at least not go up.
However, political interests soon translated Keynesian dogma into raising spending always, but even faster in recessions, while (1) never cutting taxes because that might risk a boom, and (2) never cutting spending because that might risk recession. Debt-financed government spending is considered a net addition to real output and income, as if it was literally free. There is no logic or evidence for any of this, of course. It’s a mystical theology.
There are two issues that must be kept distinct; to simplify: whether governments should spend more money (socialism) and whether government should increase spending during recessions (Keynesianism). I am against both, but most of the trouble with the Club Med countries comes from socialism in good times, not from Keynesianism in the current crisis. So, to a first approximation, Krugman is right to say that European policies are not Keynesian (not much, anyway): where he is wrong, is in saying that they should be.
Also ignored by Krugman is how the Club Med could possibly increase spending, when nobody is willing to lend them money.
Dear United,
“Trust” professional economists!! I don’t think so!! Trust is not the way to go with Economists. Toss them all in a room with sufficient water and food for one day, adding the proviso that the doors will open as soon as they can “rank” and agree on the rankings of their 10 best real world schemes.
The conservative right would starve. Krugman would see me starve before he and his cohorts.
I would prefer to deal with –[ I am from the IRS and here to help you.] a known enemy, than a masquerating enemy
Very interesting responses, @Zorba and @Ned…
Only thing that would have made Zorba’s more interesting to me would have been the absence of the last paragraph with the assumption of lemmingness and statism on the part of all non-Hayekian (Misesian?) economists.
As a libertarian who was not very good at economics I have to say that I personally have little ability to judge who is right on macroeconomics. What I’m pretty sure of though, is that most professional economists seem somewhere in between Keynes and von Hayek (and you folks), and most of us amateurs have to trust the best professionals we can find.
This may be a bit muddled and is not a criticism of your post, and especially of your economic points. Just a request to see the other side in a bit more complex way.
the real tragedy here is human… imagine cities throughout much of Europe suffering the same fate as Detroit… or worse… we have seen it all before… the rise of fascism… distrust… racial and ethnic strife… hate… it’s all there… just below the surface… waiting…
if Italy and France collapse……….. who will bail them out? the taxpayers? Germany? the Chinese? can the European Union print enough money to make it all warm and fuzzy? so many questions… and so few answers…
Spot on Zorba
The problem with even a temporary Keynesian solution is that government spending puts people in the wrong jobs. Austerity will necessarily take them out of those jobs created only through mis-allocation of resources. Since it takes the free market a period of time to gain confidence that government won’t change its mind again, and it takes additional time to hook up the freed up personnel with the appropriate job, austerity will necessarily spike unemployment, as part of the recovery process.
If Keynesians had kept their mitts off the process in the first place it would have taken less time to recover.
I do not wish to defend Keynesianism but I also think it is unfair to conflate it with Krugmanism.
Keynesianism is an overall much softer form of interventionism. Keynesianism advocates primarily temporary and limited interventions NOT the permanent subjugation of an ever larger proportion of economic activity to the government, as Krugman advocates.
Keynesianism advocates temporary “strategic” interventions because, it believes, that free markets (or at least one instance of the 1930s markets) tend to get deadlocked, and government intervention is needed to get them “unstuck”. Whether one believes that or not, it is still quite different than permanently subjecting a majority of economic activity to government, i.e. collective, control and central planning. …So that the economy is propelled by a small group of select intelligent elites, like Krugman, rather than by the total aggregate intelligence of all people competing in a free market.
In essence, Krugmanism vs free markets is the choice of being driven by average vs cumulative intelligence.
And I’m curious..
What proportion of economic activity does Krugman believe should be controlled by collective economic management? 60%? Is France only a few percentage points away from finally seeing the light of success?
The western world voter-lemmings are witnessing the twilight of their civilization. A decline of their own making really. At a steady and fast pace, western voter-lemmings are descending into equality. Equality to the world average, that is. Their dream of equality is materializing, but not in the way they envisioned when they thought mandatory collectivism was a good and noble idea.