Wednesday, June 20, 2012
As Greece, and now Spain and Italy, struggle with the
crushing burden of debt brought on by the modern welfare state, perhaps we
should shift our gaze some 1,200 miles north to see how austerity can actually
work.
Exhibit #1 is Estonia. This small Baltic nation recently
had a spate of notoriety when its president, Toomas Ilves, got into a Twitter
debate with Paul Krugman over the country’s austerity policies. Krugman sneered
at Estonia as the “poster child for austerity defenders,” remarking of the nation’s
recovery from recession, “this is what passes for economic triumph?” In return,
President Ilves criticized Krugman as “smug, overbearing, and patronizing.”
Twitter-borne tit-for-tat aside, here are the facts:
Estonia had been one of the showcases for free-market economic policies and had
been growing steadily until the 2008 economic crisis burst a debt-fueled
property bubble, shut off credit flows, and curbed export demand, plunging the
country into a severe economic downturn.
However, instead of increasing government spending in
hopes of stimulating the economy, as Krugman has urged, the Estonians rejected
Keynesianism in favor of genuine austerity. Among other measures, the Estonian
government cut public-sector wages by 10 percent, gradually raised the
retirement age from 61 to 65 by 2026, reduced eligibility for health benefits,
and liberalized the country’s labor market, making it easier for businesses to
hire and fire workers.
Estonia did unfortunately enact a small increase in its
value-added tax, but it deliberately kept taxes low on businesses, investors,
and entrepreneurs, refusing to make changes to its flat 21 percent income tax.
In fact, the government has put in place plans to reduce the income tax to 20
percent by 2015.
Today, Estonia is actually running a budget surplus. Its
national debt is 6 percent of GDP. By comparison, Greece’s is 159 percent of
GDP. Ours is 102 percent.
Economic growth has been a robust 7.6 percent, the best
in the EU. And, although the unemployment rate remains too high, at 11.7
percent, that is down from 19 percent during the worst of the recession. It’s
hard to see how a Krugman-style stimulus would have done much better.
Next door, Latvia has also embarked on a successful
austerity program. In 2008, facing a deep recession — the worst in Europe, with
a 24 percent drop in GDP from 2007 to 2009 — and a run on the country’s largest
bank, Latvia turned to Europe for a €7.5 billion bailout. But unlike Greece and
other countries that seem to look at such assistance as a form of permanent
welfare payment, Latvia used the EU loan as an opportunity to make the painful
government reforms necessary to restore long-term economic health.
Latvia embarked on the toughest budget cuts in Europe.
Half of all government-run agencies were eliminated, the number of public
employees was reduced by a third, and public-sector wages were slashed by an
average of 25 percent.
In the end, Latvia borrowed just €4.4 billion of the
available €7.5 billion, and its economy is on the rebound. Unemployment, which
reached 19 percent at the height of the recession, has declined to around 15
percent. Real GDP growth was 5.5 percent last yearCanada and is expected to be
at least 3.5 percent this year. This year’s budget deficit will be just 1.2
percent of GDP, and the national debt is just 37 percent of GDP and declining.
The credit-rating agencies recently upgraded the country’s credit-worthiness.
And, while Greece mulls leaving the euro zone, Latvia has been pronounced
eligible for membership.
The third Baltic country, Lithuania, also dramatically
cut government spending — as much as 30 percent in nominal terms — including
reductions in public-sector wages of 20 to 30 percent and pension cuts of as
much as 11 percent. Unfortunately, Lithuania may have undermined the effects of
those cuts by also raising taxes, including a significant hike in corporate
taxes. Still, Lithuania is expected to see its economy grow by 2.2 percent this
year.
Krugman and others do have a point in saying that the Baltic
countries benefit from strong trade opportunities with neighbors such as Sweden
and Finland that have growing economies. And it is true that, while their
recoveries have been strong, none of the Baltic countries is expected to fully
return to pre-recession levels of prosperity until 2014 at the earliest. On the
other hand, when are Greece, Spain, or for that matter the United States — none
of which has done much if anything to reduce government spending — likely to
return to pre-recession growth?
If the Baltics are not a sufficient example of the value
of cutting government, we can look a bit to the west, to Switzerland.
Switzerland’s constitution includes provisions that limit the country’s ability
both to run debt (the growth in government spending can be no higher than
average revenue growth, calculated over a multi-year period) and to increase
taxes (taxes can be increased only by a double-majority referendum, meaning
that a majority of voters in a majority of cantons would have to approve the increase).
As a result, total government spending in Switzerland at
all levels of government is just 34 percent of GDP, compared to an average of
52 percent in the EU, and more than 41 percent in the United States.
Switzerland’s national debt is just 41 percent of GDP and shrinking at a time
when other European countries are becoming more insolvent. Switzerland’s
economic growth has not yet returned to pre-recession levels, but it is better
than the growth in, say, Greece or Spain. And its unemployment rate is just 3.1
percent, the lowest in Europe.
If that’s not enough evidence, we can just look to our
own neighbor Canada. The Canadian federal government has been reducing spending
in real terms since the 1990s. As a result, federal spending as a share of GDP
has fallen from 22 percent in 1995 to just 15.9 percent today. Compare that to
the United States, where the federal government spends 24 percent of GDP,
roughly half again as much. And, while Canadian provincial governments spend
appreciably more than do most U.S. states, total government spending at all
levels in Canada has declined from 53 percent in the 1990s to just 42 percent
today — still far too high, but clearly moving in the right direction.
Canada has also cut taxes. Corporate tax rates at the
federal level were slashed from 29 percent in 2000 to 15 percent today, less
than half the U.S. federal rate. Capital-gains taxes were also cut, as were, to
a lesser degree, income taxes.
When Canada — led for so long by the ultra-liberal Pierre
Trudeau — has smaller government and lower taxes than the U.S., something is
seriously out of whack.
As a result of these changes, Canada’s national debt is
now less than 34 percent of GDP. Its budget deficit this year will be just 3.5
percent of GDP, while ours will be 8.3 percent. Canada’s economy will grow at
2.6 percent this year — a modest rate but faster than ours — and its
unemployment rate is 7.3 percent, again better than ours.
All these countries are following the successful examples
set by other nations such as Chile, Ireland, and New Zealand in the 1980s and
’90s, and Slovakia from 2000 to 2003.
Of course, none of these examples is perfect, and cuts in
government spending will not, by themselves, cure all ills. These countries
often benefited from circumstances aside from fiscal discipline. Still, the
evidence is there. Cutting government spending, reducing taxes, and
liberalizing labor markets brings more economic growth, increased employment,
less debt, and more prosperity. The opposite is also true: Bigger government
and higher taxes result in more economic misery — see Greece, Spain, etc.
As the United States looks to its future, it is time to
decide which path we will follow.
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