The Corner

Public-Sector Austerity vs. Private-Sector Austerity

For a few weeks I have been saying that pro-growth austerity imposes austerity on the public sector. That means reduction in government spending, reform of entitlements, reduction in the the rolls and salaries of government employees, and reduction of the government footprint in the private sector. Unfortunately, in most cases, governments would rather address their debt problems through an anti-growth version of austerity, meaning more taxes and more government intervention in our lives.

David Malpass has a very good piece in the Wall Street Journal this morning that illustrates this point. As he explains, there is no conflict between growth and austerity:

The conflict between growth and austerity is artificial and framed to favor bigger government. Growth comes from economic freedom within a framework of sound money, property rights, and a rule of law that restrains government overreach. Businesses won’t invest or hire as much in an environment where governments dominate the economy. Thus, government austerity is absolutely necessary for economic growth in both the short and long run.

The only people who think that there is a conflict between growth and government austerity are economists (such as Keynesian economists) who believe that government spending decisions are as productive if not more productive than spending decisions made by the private sector or that disregard the impact of high level of debt on the economy. These assumptions, unfortunately, are reflected in every government scoring models and give us misguided policies like the stimulus.

#more#As Malpass correctly lays out, these absurd assumptions have produced the model for European austerity: one that requires the private sector to pay more taxes and pay for debt it didn’t incur so the governments can stay bloated. Case in point, Greece:

The Greek government has been practicing a particularly aggressive form of antigrowth austerity. While the private sector shrank in 2011, Greece’s government grew to 49.7% of GDP from 49.6% in 2010. To accomplish this bad outcome, Greece’s government increased its value-added tax to 23%—a hidden sales tax so high that no one should be asked to pay it or support it—and created a national property tax that transfers private-sector wealth to the government and through it to foreign creditors.

Meanwhile, Greece’s parliament kept full pay, full benefits, its fleet of BMWs, and a full staff. Greece maintained its sweetheart subsidies for businesses, banks, the army and those who choose not to work. Its sizeable delegations and facilities in Brussels, Vienna, Geneva and Washington are still large, as are the life-time pensions for politicians. Last week, Greek officials suspended work on the sale of government assets, one of the most pro-growth conditions in its IMF program.

The reality is that Greece’s government is imposing too much austerity on others and not enough on itself.

Now, the U.S. government is hoping it can get away with the same false austerity in here. You will see it play out in the next debt-ceiling debate and in the many debt-reduction proposals that will be introduced in the next few months and years. The president’s budget, which illustrates his idea to address our debt problem, is a good example of the government imposing austerity on the private sector so the public sector can stay bloated. That’s what Washington calls the balanced approach. (The various plans introduced by Republicans don’t reduce the size of the government enough either but at least they don’t insist on shrinking the private sector further.)

This is also the path that Governor Brown in California wants to pursue in order to close the state’s $16 billion budget gap. But it won’t work. Like in the U.K., Ireland, Italy, Spain, and other European countries, California will see its private-sector growth slow down even further and its debt grow. And so will the U.S., if the federal government continues resisting the necessary reforms.

You don’t believe it? Read the new paper by Carmen M. Reinhart, Vincent R. Reinhart, and Kenneth S. Rogoff on impact of debt on economic growth. It’s called “Debt Overhang: Past and Present.”

They document 26 cases of debt overhang (at least five years during which debt exceeds 90 percent of GDP). What’s happening during that time?  Economic growth is 1.2 percentage points lower than in other periods. It could go on for a long time: Their research finds “the average duration of debt-overhang episodes is 23 years, and it produces a ‘massive’ shortfall in output that is almost one-quarter less, on average, than in low-debt periods.”

Moreover, the fact that bond markets in countries perceived as safe, such as the U.S., don’t seem to mind our high level of debt tells you very little about how well these countries are doing. For all we know, these countries’ economy could even be shrinking: “Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time,” the authors wrote in their paper. That’s what happened to eleven out of the 26 cases in their samples.

This paper turns on its face the theory that, as long as investors are willing to put their money in the U.S. and keep rates low, we have nothing to worry about. No, actually, we should worry because low interest rates in a high-debt environment could just mean that we aren’t the ugliest in the Investors’ Beauty Pageant. Oh and by the way, the U.S. is close to entering the Debt Overhang Gang.


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