Greece, Latvia, And "Austerity" As An Economic Policy

The incompetent conventional wisdom sees the two poles of economic policy as "austerity" and "stimulus."  Exemplifying the incompetence is the IMF, which put out a report back in October comparing countries engaging in "austerity" to those following programs of "stimulus."  The conclusion (no surprise here from these fools) :  "stimulus" is better!  Summary of the IMF report and link here.

What's amazing to me is how many news organizations and bloggers buy into this terrible terminology, which seems specifically designed to obfuscate the only important issue, namely the relative size and growth of the state sector versus the private sector.  Here is really everything you need to know about economic policy:  large private sector, small state sector, successful economy;  small private sector, large state sector, unsuccessful economy.

The term "austerity" just completely confuses the issue.  "Austerity" means some combination of government spending decreases (usually not very much) and tax increases (generally onerous) -- a totally muddled mess.  So the state shrinks maybe a little for a while, but gets more revenue to keep the private sector from growing and let the government grow more as soon as the heat is off.  The chance that will work is about zero.  The thing that will work is massive spending cuts and no tax increases.  But the dopes like the IMF, New York Times, Krugman, et al. will cite the poor results of "austerity" in support of their preferred program of a blowout of government spending.

Consider Greece.  You would have to be in a cave for the past couple of years not to know that government of Greece is undertaking a program of "austerity" in order to earn bailouts from the various European bailout providers.  Greece's economic performance is, of course, terrible.  Do you have the impression that Greece has been engaging in big cuts in government spending?  The answer is that there have been some cuts, but not enough to actually shrink the state sector meaningfully as a percentage of the economy.  From Anders Aslund writing at Bloomberg News on January 7, 2013: 

Greece . . . maintained high public expenditures of 50 percent of gross domestic product in both 2010 and 2011, when it was supposed to be pursuing austerity.

According to the New York Times here, in the current budget passed in November, Greece has promised government spending cuts of about $10 billion, which would be about 3% of gdp.  That's maybe something, although in my view not nearly enough from a start of 50%.  Also, I don't believe that they will actually follow through and do it.  But meanwhile, how about taxes?  Oh, those are going up, and a lot. The Telegraph reports that on Friday the Greek parliament voted for tax increases to raise revenues by 2.5 billion euros -- that's also about 3% of gdp.   The corporate income tax rate is going from 20% to 26%, a sure economic killer.  The top personal income tax rate is going from 40% to 42%.  Well, that's what it means to do "austerity."  I think we can count on continuing economic failure in Greece.

It's actually hard to find a clean example of a country that has cut government spending massively without also engaging in destructive tax increases, but probably the best recent example is Latvia.   Again from Aslund's article at Bloomberg:

In 2009, Latvia carried out an arduous fiscal adjustment of 9.5 percent of GDP. . . .  Cuts in public spending accounted for two-thirds of the Latvian fiscal adjustment. It decreased government expenditures from a high of 44 percent of GDP in the midst of the crisis to a moderate level of 36 percent of GDP this year. Latvia has kept a flat personal income tax now at 21 percent and a low corporate profit tax of 15 percent.

Latvia did raise their VAT somewhat, so they are not as clean a case as one would like.  According to Anne Applebaum in the Washington Post here, Latvia's economy shrank 24% in 2008-09, but has been growing at a rate of about 5% since.  To the extent that some of that 24% shrinkage reflects the cuts in government spending, keep in mind that gdp accounting records a dollar of government spending as equivalent to a dollar of private spending, which it is not.