Another European Austerity Warning

I have warned on numerous occasions that unless Congress immediately starts reforming our welfare state, we will be hurled into the dungeons of European austerity. I have also, on numerous occasions, explained what that dungeon would hold for us (see, e.g., this video) and in my new book Ending the Welfare State: A Path to Limited Government That Won’t Leave the Poor Behind, I offer a path out of the austerity danger zone.

As yet another reminder of what happens if we do nothing and keep our welfare state, the EU Observer has another report on the state of austerity in Europe. It is written by Klaus Heeger of the European Federation of Independent Labor Unions and is in essence a left-leaning criticism of austerity. Heeger’s conclusions are wrong, but the analysis of some of the consequences of austerity are correct:

Eurostat unveiled in its latest report that unemployment in Europe has again reached record numbers with Southern European countries being particularly hardly hit. Especially worrying is the on-going increase of youth unemployment. Spain alone has a 50.5 percent joblessness rate amoug its young people. These data also expose the weak side of the current austerity measures for which Portugal provides a good example: Despite the fact that the Troika (EU, IMF and ECB) has positively assessed Portugal’s programme of economic reforms, it’s economic situation is alarming. According to Eurostat and the latest interim forecast of the European Commission, Portugal’s real GDP contracted by 1.5 percent in 2011 and is expected to further decline by 3.3 percent in 2012. Its unemployment rate was almost 14 percent in 2011 and is expected to further increase this year. The youth unemployment rate in February 2012 already exceeded 35 percent,with no apparent signs of economic recovery in sight. It is difficult to imagine a worse impact than austerity measures on economies already hit by economic slowdown. With economic activities halted, neither employment nor state income is generated and public spending cuts prove completely ineffective (given that the parameter used to measure public deficit, the GDP, continues to fall). It is a vicious circle.

Austerity means that government tries to fight a budget deficit with spending cuts and tax increases. When government raises taxes it takes more from the economy; when it cuts spending, it gives less back. This constitutes a net drain on the private sector, which has precisely the effects described here: slower growth – even shrinking GDP – and higher unemployment.  

The remedy for austerity, on the other hand, is not what Heeger, a typically European voice, is calling for:

But voices calling for a revival of stimulus measures are getting louder. At the last European Summit – although the Fiscal Pact was signed- there was recognition that the EU needed to move beyond austerity measures. The conclusions of the European Council praised the “recent measures taken by the ECB as regards long-term lending to banks.” Experts agree that further ECB intervention will take place in the foreseeable future and in the long term. Of course, such scenarios give rise to concerns that the Eurozone is rushing towards inflation and … that incentives for reducing state deficits could vanish. Yet what are the alternatives when it becomes evident that apart from the economic consequences, the socio-political impact of the austerity measures may be devastating? What actually remains of a state when its citizens do not have jobs, when public coffers are empty and productivity is down? When this happens citizens often deploy their last democratic weapon and turn against themselves, letting extremism and totalitarianism rise.

As for extremism and totalitarianism, I raised the exact same warning some three weeks ago. The problem with Heeger’s view, which is shared by Europeans in general and liberals in America, is that he sees government as the solution to the problems caused by austerity. But this is like asking the elephant in the china store to tap dance:

  • the problems that austerity addresses are caused by the welfare state;
  • austerity deepens the problems caused by the welfare state;
  • “stimulus spending”, as Heeger is calling for, means expanding government;
  • expanding government means expanding the problems that brought about austerity in the first place.

Heeger’s call for easier monetary policy and an abandoning of the attempts to balance government budgets in Europe are frighteningly similar to what liberal-minded politicians and economists here in America are calling for. But as was shown by the ARRA “Stimulus bill”, one of Obama’s hallmark legislations, more government does not mean more growth and prosperity. The same thing holds true in Europe, where some countries have governments that gobble up more than half of GDP.

The right way to deal with the problems of budget deficits and sluggish growth is to do away witht he cause. That cause is the welfare state. Only an orderly retreat of government from its spending commitments can permanently shield the economy against austerity.

Once we slip in to the austerity trap, it is harder to reform away the welfare state. The free sector of the economy rapidly weakens, and the number of people who critically depend on government grows fast. But despite this, there is no other remedy than to structurally phase out the welfare state. The price for doing so increases for every year of austerity: as Greece is proving, the line between the welfare state and the totalitarian state is erased little by little as a country digs itself deeper and deeper into the trenches of spending cuts and tax hikes. But every other alternative has consequences that are far worse.