Austerity is Hot

Warning – No matter how hard I tried I could not write on this topic in less than three encyclopedias. 

Here’s the plan. Those of you who don’t have six months to read this veritable Gone with the Wind masterpiece, I have divided the post into two parts. Read down to the repeated happy faces (JJJJJJ) and stop. Those of you who apparently do not have a life may keep reading to see what groovy facts I used to support my conclusions…

Austerity is hotter than a Britney Spears /Beyonce hook-up. I wrote about austerity on May 1 and then my guest blogger Robert Klemkosky said more last week. Robert Barro piled on in the Wall Street Journal (May 10, page A15, “Stimulus Spending Keeps Failing”). No matter how you come at it, much of the wailing about austerity is overdone and inappropriate. It reflects the ongoing misdirected love of the Keynesian short-run. Barro makes two points. First he used Germany and Sweden as two examples of cases wherein governments imposed fiscal austerity while “sustaining comparatively strong growth.” So austerity must have some benefits. Second, he pointed out strong biases which accept the validity of Keynesian stimulus without requiring strong supporting empirical evidence. He likened preferences for more stimulus (and less austerity) to religion.  Amen.

Let’s back-up a minute and define what we are talking about. What do we mean by austerity? Let’s face it – austerity is a pretty austere word! Dictionary.com says austerity means “severe in manner or appearance; uncompromising, strict, forbidding; rigorously self-disciplined and severely moral….” L Makes you want to weep. Had enough? Want to say uncle? If that is what austerity means then most of us would rather run and hide than be austere. It sounds a lot like my fourth grade teacher at Coconut Grove elementary School, Mrs. Montgomery.

Luckily there is more to this term austerity. Wikipedia helps – it says

            “In economics, austerity is a loose term referring to policy of deficit-cutting by lowering spending often via a reduction in the amount of benefits and public services provided.^[1] Austerity policies are often used by governments to try to reduce their deficit spending^[2] and are sometimes coupled with increases in taxes to demonstrate long-term fiscal solvency to creditors.^[3] "Austerity" was named the word of the year by Merriam-Webster in 2010.^[4] However, regarding policies designed to address fiscal problems, a more accurate term is fiscal consolidation^[5], whereas "austerity" may as well mean countercyclical policies, eg in periods of high inflation. Critics argue that, in periods of high unemployment, austerity policies are counter-productive, because deficit cutting reduces GDP (which typically means less tax revenue to pay off the debt); and that short-term stimulus is necessary to deal with deficits in the long-term.…”

Wikipedia took that definition from a Paul Krugman article titled “Europe’s Economic Suicide”. Despite the source it is okay and useful and gets us on the right road. It does a couple of things. First it gets us to a way to measure austerity by looking at government budget positions. Second, it makes clear that we have more than one way to look at government budget positions. According to this definition it is okay (J) to have a policy of austerity if inflation is the country’s main problem but it is not okay (L) to reduce government deficits if the country’s main economic disease is recession and/or high unemployment. It hints, furthermore, that austerity might be a way to demonstrate to creditors a commitment to long-term fiscal solvency.

This definition puts any country in a real quandary if it has a debt problem AND high unemployment. A real debt problem implies that creditors are worried that the country in question may not pay its debts. Stimulus driven larger deficits make creditors even more uneasy and makes it harder to borrow what it needs to finance those larger deficits. Therein is the rub. Therein is Greece. Therein will be the US. Therein is a really cool word.

My analysis below the happy faces comes up with two conclusions. First, this austerity worry is a red herring. According to IMF statistics there has been much talk but very little action with respect to austerity. The evidence supports just the opposite of austerity – countries have piled on stimulus. Except for Greece, there has been very little austerity. These dour faced commentators who decry the negative economic impacts of austerity can find it in one and only one place – Greece. Now those folks have done austerity. Of course, only Greece REALLY needed it. Greece had a major government deficit problem even before the global crisis of 2008. While most countries fit the case that Keynesian stimulus was more popular than paying creditors right away, Greece did not. Their structural government deficit (this is a precise term that is defined more below) went from -10% of GDP in 2007 to -17% in 2009. Greece was a basket-case before the global recession and therefore was an even bigger problem once it joined the others in a cornucopia of government stimulus. But then Greece quickly moved to reduce their deficit to -6.8% of GDP. That was a major move to fiscal austerity.

My second conclusion is that despite historical amounts of government stimulus, there is no real evidence, a la Robert Barro, to support a further round of economic stimulus. While I would agree that too much austerity too quickly might not be prudent in Greece or anywhere else, the data nowhere supports the view that another round of solvency-threatening increases in government deficits is warranted. These deficits were not successful for many reasons – many reasons that I have been writing about for years now. The deficits do not in any way attack the root causes of the global recession and therefore have nothing better than fleeting impacts. Worst, they raise the specter of financial calamity and in so doing undermine the very goals they hope to achieve.

So there you have it. Austerity hardly exists today and doing the opposite of austerity – the chosen mantra of liberal politicians everywhere – will not work. It is too bad that government officials would rather lob austerity bombs back and forth at each other rather than sit down and patiently design policies that actually correspond to widely known financial and structural  problems.

One last point. Some of you would like to rip my brain out right through my eyeballs. Let me point out that the above summary does not stand on its own. The data and analysis below helps you see the basis for my conclusions…

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The fun starts here.I looked at International Monetary Fund (IMF) data on government deficits and conclude that very little austerity has been tried. That is, there is much ado about almost nothing. There is much concern and worry about austerity that simply has not happened yet. Or as austerity’s defense lawyer might proclaim to the jurors – ladies and gentlemen my client is not guilty!

So why is everyone so sure that austerity is behind the world’s most current economic crisis?  As in many of my previous posts I liken the wailing about government cuts to a disconnection between “cuts” and what amount to sensible retractions of temporary changes. It is as if these folks believe that no matter how much government spending is increased – there is never any case to be made to bring down temporary increases to something more sensible. It is like me when I gain five pounds in a week and promise to only gain three pounds next week. Would it really be that hard to lose one of those five pounds? 

Some of you are answering YES it would be that hard. You believe that the recent economic slowdowns in Europe, China, Brazil, and other places warrant more economic stimulus. You would say that now is not the right time to withdraw stimulus…or to even discuss reducing it. You want to wait until the dust settles a bit before pulling the rug out from under a very fragile world economy. To that I would say a couple things. First, aside from Greece, almost no one has shown any predilection to seriously reduce stimulus. The data below will support that little austerity has been tried. Second, there is some data to support the idea that more austerity is planned by a larger number of countries. But please notice that the plans do not involve reducing stimulus until 2013. The world economic recession started in late 2007 and was over before the end of 2009. That means we have given stimulus 4-6 years to work. If that is not evidence to make one rethink the effectiveness of more stimulus, I am not sure what would be. Some of you might retort that it just shows they didn’t try enough stimulus. The data below show massive stimulus. Please!

The data I use comes from the online version of the data appendix to the April 2012 IMF World Economic Outlook.  http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/tblpartb.pdf   I used data from Table B7. Advance Economies: General Structural Balances. 

General Structural Balances are the closest measurements we have for changes in a government’s budget position based on intended legislated policy decisions.  The widely reported data on government budget balances are also impacted by automatic changes in government spending and taxes that arise because spending and revenues can change without any real changes in policy. When a country experiences slower growth, for example, under existing laws more will spent on open ended social programs and less revenue is collected from firms and individuals who report smaller incomes. The structural budget balance ignores those automatic changes and reports only changes in government spending and taxation that are the result of new legislation. Thus the structural balance better measures the intent to change policy.

The IMF data I am using reflects actual recorded structural budgets for 30 Advanced Economies from 2007 to 2011. It then forecasts the same information for each country for 2012 and 2013. In 2007 before the full onset of the global recession, these countries averaged structural government deficits of about -1.6% of their combined GDPs. Seven of these countries had structural budget surpluses in 2007; 22 had deficits, and one country had incomplete data. The deficits ranged from -1% for Australia to -8% for Ireland and -10% for Greece.  Thus most countries were in good shape but Ireland and Greece were not.  Only six countries had deficits that exceeded 3% of GDP. One would expect small deficits or surpluses in a strong year like 2007.

By 2010 these governments had time to change fiscal policy in response to a severe economic downturn and they did.  Some countries reached maximum budget stimulus in 2009 – others in 2010. At the maximum in 2009 or 2010, 22 countries had structural government deficits greater than 3%. Only Luxembourg, Finland and Korea had surpluses – though their surpluses were considerably smaller than in 2007. Thus – all countries in the IMF Table stimulated their economies. Whereas the average structural deficit in 2007 was -1.6% it had more than tripled to -5.2%. The biggest structural deficits were registered by Greece (-17%), Ireland (-12%), Portugal (-9%), Spain (-9%) and Japan (-8%).  Emphasis – their actual deficits were larger. Recall that I am quoting structural deficits.

What matters more for measuring intended policy stimulus is the CHANGE in the Structural Balance between 2007 and the maximum year. Below are some of the changes that underscore the intended fiscal stimulation. Whereas there was a more-than-tripling of stimulus for the whole group, Spain’s structural deficit increased about 7 times! Australia and New Zealand had large swings to stimulus that took them from surplus to large deficits. Notice that a swing of 5% means 5% of GDP. This is unambiguous stimulus. A swing of 5% of GDP is a major stimulus for any country. The table below shows this swing to stimulus for selected countries.

                                                2007    Max     Change

All countries                -1.6      -5.2      -3.4%

            Spain                           -1.1      -9.1      -8.0

            Greece                       -10.0    -17.3    -7.3

            New Zealand                 2.1     -4.5      -6.6

Japan                           -2.2      -8.1      -5.9

Australia                        1.0      -4.6      -5.6

            Portugal                       -3.8      -8.8      -5.0

US                               -2.8      -7.8      -5.0

            Ireland                          -8.0      -11.9    -3.9

To what extent did these countries move to austerity after reaching maximum stimulus in 2009/2010? To answer that question I examine the structural budget balance changes between the max year and 2011; and between the max year and 2013. If austerity had been imposed by 2011 then that would mean the structural budget position would have returned to its value in 2007. That is, if full austerity was in place by 2011, the structural balance would have widened during the recession and then gone back to its original value when the recession was over.

In the case of Greece, the structural deficit was down to -6.8% in 2011. Since it was -10% in 2007 and -17.3% in 2010 , this is a remarkable move towards austerity. But the data do not show that kind of result in general. The average for all countries was a structural budget deficit of -3.8% in 2011 of GDP. This means that there was 2.2% more stimulus remaining than the -1.6% in 2007. Below I describe the austerity changes by country. The details can be found in the table below.

No Austerity: 4 countries had no change in structural budget balance between the max value and the value in 2011. They had removed no stimulus. Thus they had no austerity.

Minimal Austerity: 9 Countries reduced their deficits from the maximum value attained in 2009 or 2010 by 0% to 20%. For example, Italy’s deficit fell from a peak of -3.6% of GDP in 2009 to -2.9% in 2011. That amounted to 0.7% of GDP during a two-year period or a 19% reduction in the structural deficit from its value in 2009. For the other 8 countries in this group, the declines were smaller.

Moderate Austerity: 11 countries reduced their deficits by between 25% and 50%. Malta, for example, was able to reduce its deficit from -5.4% in 2010 to -2.9% in 2011.

A total of 24 countries, therefore, did not halve their peak deficit by 2011. They did not go half-way toward removing the large stimulus to government from 2007 to the peak value.

Large Percentage but small absolute Austerity: 4 countries had very small deficits or surpluses at the max in 2009 or 2010. They had very small surpluses or deficits in 2011 too. In some cases the changes look large in terms of percentage changes but in no case was there a large change in the deficit or surplus. For example, Korea’s surplus went from 0.7% of GDP in 2009 to a surplus of 2.4% in 2011. That amounts to a 243% change but represents a 1.7% of GDP move over two years.

Country	Max Stimulus	2011	Austerity	% Austerity	Comment
New Zealand	-4.5	-4.5	0	0	No austerity
Japan	-8.1	-8.1	0	0	No austerity
Netherlands	-4.6	-4.6	0	0	No austerity
Denmark	-0.6	-0.6	0	0	No austerity
Norway	-5.8	-5.6	-0.2	3	Less than 20% Aus
US	-7.8	-7.2	-0.6	8	Less than 20% Aus
Cyprus	-6	-5.5	-0.5	8	Less than 20% Aus
Advanced	-5.8	-5.2	-0.6	10	Less than 20% Aus
Australia	-4.6	-4.1	-0.5	11	Less than 20% Aus
Canada	-4.1	-3.6	-0.5	12	Less than 20% Aus
Luxembourg	-0.8	-0.7	-0.1	13	Less than 20% Aus
Belgium	-4.4	-3.7	-0.7	16	Less than 20% Aus
Italy	-3.6	-2.9	-0.7	19	Less than 20% Aus
Euro	-4.4	-3.2	-1.2	27	27% to 46% Aus
Spain	-9.1	-6.5	-2.6	29	27% to 46% Aus
Other Advanced	-2.1	-1.5	-0.6	29	27% to 46% Aus
Slovak	-7.5	-5.3	-2.2	29	27% to 46% Aus
UK	-9	-6.3	-2.7	30	27% to 46% Aus
Slovenia	-5	-3.4	-1.6	32	27% to 46% Aus
France	-5	-3.4	-1.6	32	27% to 46% Aus
Ireland	-11.9	-8	-3.9	33	27% to 46% Aus
Austria	-3.6	-2.4	-1.2	33	27% to 46% Aus
Portugal	-8.8	-5.7	-3.1	35	27% to 46% Aus
Malta	-5.4	-2.9	-2.5	46	27% to 46% Aus
Germany	-2.2	-1	-1.2	55	Large % but small
Greece	-17.3	-6.8	-10.5	61	Very large Aus
Sweden	-1.2	0.2	-1.4	117	Large % but small
Korea	0.7	2.4	-1.7	243	Large % but small
Finland	-0.1	0.5	-0.6	600	Large % but small
Estonia	Na	na	Na	na	NA
Average	-5.3	-3.8	-1.5	na
Median	-4.6	-3.7	-0.7	29

What about beyond 2011? The IMF estimated structural budget balances for these countries in 2013. As you might expect, they forecast continued improvements in budgets. By 2013 the IMF sees 14 countries at or better than the structural deficits they had in 2007. That is, the IMF sees about half of these countries returning to the deficit levels of 2007 by 2013. Among those with the best forecasted austerity performances through 2013 are Greece, Italy, Ireland, and Portugal. The countries that remain with higher deficits and less austerity in 2013 are Japan, New Zealand, Luxembourg, Canada, Norway, and Finland.

While these future projections were done in early 2012, much has been happening in the EU that would put these improvements in doubt. Inasmuch, I would guess that if the IMF did the forecast process again today, it would estimate even less improvement in structural budgets in 2013. Thus they would find even less austerity between 2011 and 2013. 

This data suggests several things. First, there is no wild and crazy movement toward less government stimulus and more austerity when measured by changes in structural budget balances since 2007. Greece remains alone in this category. Greece needed austerity because it stood alone in terms of fiscal laxity before and during the recession. Second, there is no clear relationship between economic recovery and government stimulus/austerity. Germany had little stimulus and significant austerity and was among the strongest in terms of economic growth. The US had plenty of stimulus and little austerity and also had above average economic growth – though not necessarily any better than Germany’s. Third, countries doing the most austerity are not easy to categorize. For example, Spain had a dose of austerity which only reduced 29% of the stimulus before it; Ireland’s austerity removed a third government stimulus; Greece’s austerity removed more than the increases generated during the recession.

I am not sure what the issue is over Italy’s austerity. Italy’s structural deficit did not increase very much so there was little to remove. Italy’s structural deficit went from -3.2% in 2007 to -3.6% in 2009 and then down to -2.9% in 2011. In contrast the US structural deficit went from -2.8% in 2007 to -7.8% in 2010. It remained at 7.2% in 2011. Why are people focusing on Italy and ignoring the US so much?

As the world economy weakens in 2012 it is likely that the government budget numbers will look much worse than the structural budget data published by the IMF. So the level of alarm about deficits in any of these countries might be higher pitched than this data might indicate. But the question of intended stimulus versus intended policy austerity is unaffected by this dimension. It remains that much stimulus was added and much remains – very little of what we have seen governments implement can be called austerity. The Greeks appear to be the only exception.  Perhaps they could dial it back a bit. The rest should pay attention to their knitting.