Austerity versus growth

Despite all the rhetoric, the latest figures show euro zone countries continue to spend.

There is arguably no greater gap between perception and reality in contemporary economic debate today than the trade-off between alleged fiscal austerity and economic growth.

Writing in The New York Times earlier this year, economist Paul Krugman stated that the euro zone's seemingly immovable state of economic weakness served as ''evidence that slashing spending in the face of high unemployment was a mistake''.

Krugman called for governments to defer their efforts to reduce budget deficits, ''because tax increases and cuts in government spending would depress economies further, worsening unemployment''.

The subsequent rise of far left parties in Greece, and the election of French socialist president Francois Hollande who campaigned against ''anglo saxonisme'' austerity, seemingly gave voice to European electorates resistant to rolling back the public sector.

However, there are two key shortcomings with the austerity-versus-growth theme presently holding sway in some economic policy and business media circles.

First, for all the intense rhetorical heat generated about persistently low growth attributed to significant public spending cuts there is little light by way of sober evidence demonstrating that reductions in expenditures by European governments have actually occurred.

Government financial statistics compiled by the European Commission's own statistical agency shows that all of the 17 euro zone countries continue to increase government expenditure, even if at a slower rate than previously in some instances, since before the global financial crisis.

Between 2007 and 2011 spending by euro zone member national governments increased on average by three per cent a year.

Almost two-thirds of these countries are growing their public sector spending levels at rates greater than the euro zone spending growth average.

Even with all the focus of the sovereign debt crisis trained upon Portugal, Ireland, Italy, Greece and Spain (PIIGS), they still increased their government spending by an average of two per cent a year, putting additional pressure on their budgets.

With economic weakness in the euro zone contributing to high unemployment, it is unsurprising that government expenditure on direct social security benefits has also increased across the euro zone, at an average rate of three per cent a year.

Among the PIIGS countries this spending component has risen by an average of four per cent each year between 2007 and 2011.

These statistical trends are also generally reflected in measures capturing changes to the size of government, such as public spending as a percentage of gross domestic product.

The second problem is that the fiscal policies pursued by European governments have hardly created conditions which are conducive to robust private sector investment and growth.  It is generally agreed among economists that increases in welfare state spending detracts from economic growth, since their provision reduces labour supply, including in cases where public pensions are made accessible to healthy individuals during their '50s or early '60s.

More broadly, numerous academic studies over the past two decades have shown that a growth in government size, as has been experienced in euro zone countries since the crisis, associated with slowing rates of economic growth as less efficient public sector activities crowd out more efficient private ones.

It should also be noted that European governments have wasted no time in raising taxes in their efforts to plug self-induced budget deficits courtesy of the beleaguered taxpayer (or at least those who do not evade their tax liabilities).

Reversing the income-tax-cutting trend over the past three decades in response to globalisation, euro zone countries such as Cyprus, France, Greece, Italy, Luxembourg, Portugal and Spain have increased taxes on personal or corporate income, including the imposition of surtaxes on the wealthy.

And since 2007, Cyprus, Estonia, Finland, France, Greece, Ireland, Italy, Portugal and Slovakia have implemented or announced increases in their value-added taxes.

Other tax increases or new taxes include the Spanish wealth tax, financial taxes in Austria, Belgium, France and Portugal, flight taxes in Germany, the Maltese cement tax, the Finnish confectionary tax, and repeated increases in petrol and tobacco excises in numerous countries.

Many of these tax increases have been rhetorically passed off by governments as ''solidarity contributions'', which is cold economic comfort for many Europeans whose businesses have already been shut down or have been laid off from salaried employment.

Another factor that has been largely ignored in the austerity versus growth debate is that governments also intervene in the economy through regulations, which often act as substitutes for taxation, and that deregulation can on its own accord boost economic performance.

Arguably the most comprehensive measures of regulatory burden are encapsulated in economic freedom indexes published by the Fraser Institute and Heritage Foundation, since they attempt to quantify the numerous dimensions of government regulations.

While there are mixed results across the non-fiscal dimensions of the freedom indexes, business, credit, labour market and trade regulations, and the security of property rights, have been assessed to have deteriorated noticeably among numerous euro zone countries since 2007.

The Heritage Foundation economic freedom index also suggests that an important aspect of the rule of law — freedom from corrupt activities — has deteriorated in 11 out of 17 euro zone countries.  Other proxy indicators of regulatory burden where available, such as growth in the number of pages of legislation passed each year by national governments and the European Commission, also show no signs of letting up.

The beneficiaries of big government, including politicians, bureaucrats and public sector unions, rent-seeking crony capitalists and dependants on publicly financed handouts, naturally tend to resist any reductions in the size of government.

But for these and other groups to suggest that European governments have trimmed down, but the private sector is suffering from anorexia as a consequence, is not only inaccurate but creates an intellectual climate conducive to postponing the necessary right-sizing of government that must take place.

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