"Austerity With Growth"
May 31, 2012
(This item originally appeared at Forbes.com on May 31, 2012.)
Now Europe’s leaders say they want “austerity with growth.” Sounds
nice. They have no clue how to achieve it.
Back in 2008, I said that the typical response of mediocre
governments to the economic problems would be a combination of “austerity”
They actually use exactly those words. They can’t even manage to
make up some new words, for generation after generation.
I didn’t expect things to follow this blueprint quite so exactly.
Governments find that they bounce
back and forth between these “austerity” and “stimulus”
strategies, discovering that they are both
What tends to happen is that “stimulus” means more government
spending. Soon, people discover that this “stimulus” spending tends
to be directed to abject waste and crony capitalists, and the
government’s debt burden explodes. Thus, the political system
careens back toward “austerity.”
“Austerity” usually means less spending and higher taxes. The higher
taxes are implemented, but it is soon discovered that nobody wants
to reduce spending, especially when the economy is crumbling due to
the higher taxes. What small reductions in spending there are tend
to be directed toward genuinely beneficial services, while the
waste, graft and crony capitalist payoffs continue unabated. The
sagging economy leads to shortfalls in tax revenues, and the deficit
may even expand.
The public soon complains that important services are being cut,
while the excessive bureaucrat headcount and absurd benefits
continue unchanged. And the crony capitalists – today the
banking and defense industries in particular – still receive a river
of unearned largesse. Taxes, already too high to begin with, head
higher – as if the problem was insufficient taxation! The economy
crumbles, and the public begins to complain. The government
immediately spins this into a story: “see, we can’t reduce spending
one little bit!” And we lunge back into a cycle of “stimulus.”
The end result is: higher spending (from “stimulus”), and higher
taxes (from “austerity”). This eventually leads to a moribund
economy and sovereign default, as we have seen so clearly.
So, what’s the solution? What is “austerity with growth”?
I suggest a different strategy: lower taxes (to help the economy),
and less spending (to deal with the deficit).
“Lower taxes” should, in the first instance, take the form of a tax
reform, which will probably turn out to be revenue-neutral in terms
of tax revenue as a percent of GDP. Basically, a flat-tax type
solution, as dozens of governments have implemented in recent
decades, with repeatably fantastic results.
Perhaps the government or electorate would wish to go further than
this, and reduce both government tax revenues and expenditures as a
percent of GDP. However, quite a lot can be accomplished with even a
“Less spending” should focus on maintaining the desired government
services, but providing those services in an efficient and low-cost
manner. Government employee headcount should be reduced to what is
needed to provide the services desired, and compensation should be
realistic and sustainable. Some aging programs (Medicare for
example) could be restructured to provide an equivalent service
(healthcare) with a much lower cost.
Payoffs to crony capitalists should be curtailed, or, ideally,
How could a voter complain about that? They get a dramatically
better tax system, the same services, and much less government waste
and theft. The improved tax system helps the economy, and the
reduced government waste and theft frees up more resources to be
used in the productive private sector, which can then create more
Politically, it is far easier to reduce government spending when the
private economy is booming, or at least has the potential to due to
the better tax regime. Businesspeople will immediately sense that
the wind has shifted in their favor.
There’s nothing new about this strategy. It’s the same as Ronald
Reagan and Margaret Thatcher tried to implement (with varying
degrees of success) in the 1980s.
It’s the same strategy the Japanese leaders used soon after the
Meiji Restoration in 1868. A tax code containing 1500 taxes was
discarded and replaced with a minimalist system that derived almost
all revenue from a simple property tax. Most of the remaining
revenue was raised by a tax on alcoholic beverages.
The new Japanese leaders then eliminated their unneeded government
bureaucrats in one mass purge.
The Japanese leaders also introduced a new, uniform national
currency, the yen, which was linked to gold and originally worth the
same as the U.S. dollar (1/20.67 of an ounce of gold.)
The result? The first great era of industrial expansion in Japan.
Even today, almost 150 years later, Japan remains the only
ethnically non-European country to be fully and completely
considered a “developed economy.”
How could a government implement such a strategy today? Let’s take
1) Default and restructure the
existing government debt. The consequences of past error are here,
and now it's time for the enablers to take their losses. The
inability to access debt financing will help a lot in the process
of reforming spending.
2) Put insolvent banks into receivership and restructure their
liabilities, so they can emerge soon after fully solvent and fully
capitalized. This does not need to cost the government anything
3) Institute a top-to-bottom tax reform, with something like a
flat-tax-type income tax system with a low top rate of perhaps
18%, a VAT of perhaps 12% (compared to 23% today), and nothing
4) Reform spending on a vast scale, with a focus on preserving the
most important services while eliminating needless headcount,
overly generous compensation, and various forms of crony
5) Maintain a stable, reliable currency, which today probably
means keeping the euro, while refusing foreign meddling in
domestic affairs. At some point, the euro may not be acceptably
stable or reliable. Then, another solution may be necessary.
“You’re dreaming,” comes the response. Yes, so what? You can’t
implement a plan, successfully or unsuccessfully, if you don’t have
a plan. It sure beats bouncing back and forth between “stimulus” and
“austerity” as governments are today, with the usual bad
As unrealistic as it may sound, government do sometimes manage to
accomplish all this and more. Usually, it is during a crisis. Which
is what we have in Greece today. Perfect timing.