Austerity: A Balanced Approach?

Carolyn Phippen

Concerns are spreading that Germany is on the verge of losing its safe-haven status for investors.  According to Bill Blain, co-head of the special situations group at Newedge Group Ltd, “[Germany] isn’t a pure safe haven anymore.”  As it finds itself potentially on the hook for an additional 100 billion euros ($125 billion) after the EU bailout of Spanish banks earlier this month, investors are starting to see the cracks in the foundation of what has been a star in the EU economies.

Not only does the most recent bailout scare off private investors from Spain, who know they will be the last in line if the country does eventually default, but most analysts fear this bailout is only one of many.  Estimates of future liquidity injections in Spain alone are as high as 700 billion euros, which would decimate the EU rescue funds.

Despite German fiscal restraint, high worker productivity and relatively low levels of unemployment, apparently a system where a minority put in the serious work and everybody else lives off of their largess while sipping margaritas, is an unsustainable system.

As Angela Merkel recently stated, “Germany’s powers are not unlimited,” and “All the (aid) packages will ring hollow if you overestimate Germany’s strength.”  Even the German economy can be dragged down by too many dependents pulling at it for too long.

It’s time for the rest of the European countries to start playing by the rules of success, the rules of <em>true</em> austerity.

In Britain, promises to reform social programs and cut taxes and spending were made by Gordon Brown just before leaving office, but instead he increased the top marginal income tax rate.  In 2011-2012, spending increased, the public pension system is still not reformed and “the government increased the capital gains tax, national insurance tax and value-added tax along with other fees and duties.”

In Spain, while the retirement age was increased from 65 to 67, no structural reforms have been made to entitlements.  Additionally, myriad tax rates have been increased, from income and property taxes to tobacco taxes (up 28 percent). While the current budget calls for spending cuts as well as tax increases, there is little chance that the tax increases will bring in the expected revenue because of a lack of economic growth.  With entitlement spending unchecked, deficits are projected to continue rising.

France’s spending increased $33.4 billion between 2009 and 2010, and $29.5 billion in 2011.  The Socialist government there also plans to implement a new 75% top marginal income tax rate for anyone earning over $1.3 million, in addition to an increase in the corporate income tax rate. At the same time, they are promising significant public sector hiring, a decrease in the retirement age and an increase in the minimum wage, which has been shown to price the least skilled workers out of the labor market.

According to recent research, a “balanced approach” to austerity (isn’t that the new progressive catch phrase?) doesn’t end well.  An austerity program that involves both tax increases and spending cuts does not successfully stabilize debt and leads to economic contractions in the marketplace. 

Harvard economists Alberto Alesina and Silvia Ardagna looked at 107 examples of austerity in developed countries over a period of 30 years and found that spending cuts <em>without tax increases</em> were the key to significant debt to GDP ratio reductions.  They also discovered that when those spending cuts were accompanied by structural reforms, easy monetary policy and a liberalization of markets, economic expansion was most often the result.

Across the ocean here at home, the story is, unfortunately, much the same.   While we could continue down our current path of demonizing the rich and blaming them for not paying their fair share (who can possibly believe that the top 5 percent paying 59 percent of federal income taxes while earning only 35 percent of total national income is somehow not their “fair share”?!), all the while threatening onerous taxes and regulations, we wonder why corporations are sitting on massive amounts of cash and refusing to hire new workers.

President Obama’s claim that his policies would “have this done” (fixing the economy) within three years and Clinton’s encouragement in 2010 to “vote ’em out” if the economy weren’t fixed in two years lead me to think that this administration is honestly and genuinely surprised that their understanding of the economy just isn’t reality.

Welcome to the world the rest of us live in . . .

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