The Unhappy Compromise Of European ‘Austerity’

Has austerity worked in Europe? Well, if “austerity” means savage cuts to government spending, then there has been no austerity.

Figuring out whether a particular policy approach to a given problem has been successful is complicated, and the answer is rarely clear-cut. This gets a lot harder when it’s not obvious that policy approach has even been taken.

The French election earlier this month was a referendum on Nicolas Sarkozy’s apparent austerity approach. But between 2007 and 2011 – that is, since the financial crisis began – France actually increased the size of government as a percentage of GDP from 52.6 to 55.9.

It’s the same in virtually every other major European economy. Italian government spending has gone from 47.6 per cent of GDP in 2007 to 49.9 per cent in 2011. Greece went from 47.6 to 50.1. The United Kingdom jumped from 43.9 to 49.0. Spain was at 39.2 in 2007, and is now at 43.6.

These figures come from the European Union’s statistics agency, Eurostat. There are other sources, and other ways you can slice and dice the numbers. The economist Veronique de Rugy looked at the raw and inflation-adjusted expenditure figures published by the OECD. She found the same thing.

Each approach tells a variation of the same story. All of the major European economies are spending more now on government than they did before the global financial crisis began.
That’s not to say there hasn’t been some cutting. In Greece, Spain, and Italy, spending peaked in 2009. A large part of the expenditure growth has been due to unemployment payments. But, as the free market economist Russ Roberts recently pointed out, the makeup of government spending shouldn’t matter – according to the Keynesian model, all government expenditure should boost demand.

There is no avoiding it: European spending is much higher now.

This simple fact ought to put a big question mark on claims of cruel austerity. After the French and Greek elections, Paul Krugman wrote in the New York Times that a “Franco-German axis … has enforced the austerity regime” on Europe. But European governments haven’t turned off the tap. They haven’t even decreased the water pressure. At most, they’ve slowed the pace of growth.
So why is there an electoral backlash against a policy that doesn’t exist? There are two things going on.

First: voters don’t like cuts. As a general rule, the public isn’t happy when governments announce they are going to spend less. The size of those cuts is a mere detail – after all, voters don’t respond to Eurostat data, they respond to impressions.

Political leaders have been stuck between two rigid forces. On one side, there is the economic need to demonstrate, loudly and confidently, to financial markets that they can keep their budgets under control. But on the other side, there is a political need to keep the faucet of government benefits flowing to voters and special interests.

The inevitable compromise satisfies nobody. There’s neither enough restraint to make serious headway into restoring fiscal credibility, but more than enough to upset groups that rely on taxpayers’ largesse.

This is doubly a problem because the usual benefit of cutting spending – cutting taxes – can’t be delivered. In many cases taxes have gone up substantially as governments try desperately to bridge the gap between revenue and expenditure. Raising taxes without corresponding increases in services is not the best way to buy popularity.

The second reason is more politically fatalistic. Voters punish governments when things are going badly. It doesn’t matter whether it’s those governments’ fault or not.

The Australian academic-turned-parliamentarian Andrew Leigh found in a 2009 paper that voters respond more to a government’s luck than its competence. If the global economy does well, incumbents benefit. If it does poorly, oppositions benefit – no matter who is responsible.

This effect might seem unfair, but it is remarkably persistent. Another paper, also published in 2009, built on Andrew Leigh’s work by looking at disaster relief in India. It found many voters even punish incumbent governments for bad weather.

So the foul economy was always going to make European voters hostile to incumbents.

Yet none of this explains why claims of European austerity are so overhyped outside of Europe – why our economic commentary is littered with moral lessons supposedly drawn from their mistakes.
Yes, advocates of aggressive fiscal stimulus would be no more pleased by the European experience than anyone else. There hasn’t been any austerity, but there certainly hasn’t been any ambitious increase in government spending either. After initial stimulus programs at the start of the crisis, governments pulled their horses back.

But those governments’ reluctance to toss budgets further into deficit on another round of stimulus has, somehow, been recast by Keynesians as a test of high-brow economic philosophy, rather than a test of policy compromise and half-heartedness.

So, despite a demonstrable lack of austerity, the “age of austerity” has become a legend – as if it is a natural experiment in free market economics, proving once and for all the efficacy of a small-government approach to dealing with recessions.

If only. Surely both Keynesians and free marketeers should be able to recognise the European approach for what it is: an unhappy compromise that satisfies nobody.