Smart Reforms Now Preclude Austerity's Pain Later

Not one to lose out on a messaging opportunity (never let a good crisis go to waste after all) liberals have already begun to revise the history of the Great Recession.

Here’s Mr. Head in the Sand himself, Paul Krugman, explaining just how silly all of this austerity is.

“[I]n early 2010 austerity economics – the insistence that government should slash spending even in the face of high unemployment – became all the rage in European capitals.

. . . Now the results are in – and they’re exactly what three generations worth of economic analysis and all the lessons of history should have told you would happen. . . None of the countries slashing spending have seen the private-sector surge.”

It’s an argument that conveniently leaves out one of the most important variables – enormous deficits, incurred because of profligate governments and overgenerous social welfare programs, was the reason for the policy choices that came next.

There is no austerity without unsustainable budgeting.

Krugman’s argument is the logical equivalent of buying a house you can’t afford, losing your job, being forced to cut back on other expenditures in order to make your mortgage payment, and then telling your creditors, “I know, I know, I should have really built that extra wing onto the house I couldn’t afford.”

The spending that many of the most troubled European nations racked up is astounding. Greece has a government debt to GDP ratio of 142.8 percent, followed by Italy at 119 percent, Ireland at 96.2 percent, Portugal at 93 percent, and France at 81.7 percent.

The history of Greek debt is particularly illuminating. Their flirtation with default is nothing new. Indeed, prior to joining the Euro, its public debt was already more than 100 percent of GDP and it’s interest rates neared 17 percent (higher than they are today). But after joining the Euro, the nation’s bond prices, and therefore cost of borrowing, plummeted. Their economy grew, but as The Economist describes it was all a mirage.

“Lower interest rates spurred a spending surge. The economy grew by an average of 4% a year until 2008. But strong GDP growth masked the underlying weakness of the public finances. The public-debt ratio fell, but only because GDP in cash terms grew more quickly than debt. Large budget deficits continued. Once it was safely inside the Euro, indeed, Greece relaxed its fiscal grip.”

With no impetus for reform the government’s spending habits spun out of control. Government workers were able to retire as early as age 58 and receive 80 percent of their basic salary. An incredible bonus system that gave workers extra money for things as commonplace as using a computer and arriving for work on time enriched government workers at the hands of the private sector. The size of the federal workforce grew to the point where one in three Greeks works for the government. And an onerous regulatory system marred by corrupt bureaucracy created a shadow economy that reduced revenue.

Greece was fundamentally broken. Does Paul Krugman really believe that it shouldn’t be fixed? Because Greece already tried that, and while it papered over unsustainable habits for a while, it ultimately only delayed and deepened the inevitable pain.

To be sure the austerity that is now being demanded of Greece is agonizing. But that is not a reason to stray from the course. Milton Friedman explained why through the analogy of an alcoholic,

“The cure for alcoholism is simple to state: stop drinking. It is hard to take because, this time, the bad effects come first, the good effects come later. The alcoholic who goes on the wagon suffers severe withdrawal pains before he emerges in the happy land of no longer having an almost irresistible desire for another drink.”

Of course the better path is simply to not become an alcoholic from the start. That advice may come too late for Europe, but policymakers in the United States should take heed. Smart reforms now preclude the need for blunt austerity later.