The poisonous Keynesian prescription

Paul Krugman is clueless about the European economic crisis

By Nile Gardiner

New York Times columnist Paul Krugman’s latest piece “Death of a Fairy Tale” is yet another rant against austerity measures in Europe, especially in Britain. Such measures, he argues, would be disastrous for the United States, even though the world’s superpower is now more than $15 trillion in debt, with the highest deficits since World War Two. Krugman has consistently argued for a big government approach towards America’s economic problems – greater stimulus spending, higher taxes, and more bailouts.

The Nobel prize-winning economist’s article is highly misleading in its claim that austerity is the cause of Europe’s economic woes today, an assertion that is not backed up by any evidence. Last Friday, Krugman wrote that:

All around Europe’s periphery, from Spain to Latvia, austerity policies have produced Depression-level slumps and Depression-level unemployment; the confidence fairy is nowhere to be seen, not even in Britain, whose turn to austerity two years ago was greeted with loud hosannas by policy elites on both sides of the Atlantic.

… However, something has changed in the past few weeks. Several events — the collapse of the Dutch government over proposed austerity measures, the strong showing of the vaguely anti-austerity François Hollande in the first round of France’s presidential election, and an economic report showing that Britain is doing worse in the current slump than it did in the 1930s — seem to have finally broken through the wall of denial. Suddenly, everyone is admitting that austerity isn’t working.

Krugman singles out the British government for its cost-cutting approach, which he claims has significantly contributed to the UK slipping back into recession:

But while the confidence fairy appears to be well and truly buried, deficit scare stories remain popular. Indeed, defenders of British policies dismiss any call for a rethinking of these policies, despite their evident failure to deliver, on the grounds that any relaxation of austerity would cause borrowing costs to soar.

So we’re now living in a world of zombie economic policies — policies that should have been killed by the evidence that all of their premises are wrong, but which keep shambling along nonetheless. And it’s anyone’s guess when this reign of error will end.

There is of course a major problem with Krugman’s analysis – deep-seated austerity measures have barely been implemented across most of Europe, including in Britain. The reality that Krugman ignores is that real austerity has yet to be introduced in most European countries, whose governments are still in the process of drawing up plans for budget cuts – Spain, with an unemployment rate of nearly 25 percent after years of ruinous socialist rule, is a case in point.

There is a growing consensus across much of Europe that Keynesian-style stimulus measures don’t work. As Portugal’s finance minister Vitor Gaspar told The New York Times last week, his country tried “a Keynesian-style expansion” back in 2008, which was a failure and may have worsened the economic situation:

My country definitely provides a cautionary tale that shows, in some instances, short-run expansionary policies can be counterproductive.

In London, Institute for Fiscal Studies research has shown that just 6 percent of planned cuts in current public service spending in Britain have actually been implemented by the Conservative-Liberal Coalition. That’s hardly a recipe for plunging Britain back into “depression” as Krugman calls it. In fact, “88 percent of the cuts to benefits and 94 percent of the cuts to public spending are still to come” as Ryan Bourne of the Centre for Policy Studies notes. The planned cuts, if implemented by 2016-17 as planned, would merely take the UK back to 2004-5 public spending levels in real terms. And the same goes for much of the rest of Europe, which is only just starting to implement cuts in government spending and public services.

A far more compelling explanation for the lack of economic growth in Britain than the myth of austerity is the country’s excessive tax burden, which amounts to 34.3 percent of total domestic income, combined with a public debt which is now higher than 75 percent of total domestic output, and a budget deficit of more than 7 percent of GDP. Government spending in Britain has risen to more than 50 percent of GDP. All of this acts as a significant brake on investment, a deterrent to job creation and an incentive for high wealth individuals to flee the country.

The main reason why many of the largest economies in Europe are in trouble is the lack of economic freedom, and not because of any lack of state intervention. Europe has been dominated by big government for decades – suffocating business regulations, sky high taxes, mounting red tape from Brussels, and ever-rising levels of public spending needed to pay for vast welfare states and entitlement systems.

It’s no coincidence that the European economy least affected by the financial downturn is the one with the greatest level of economic freedom – Switzerland, which remains outside of both the Eurozone and the European Union. And Europe’s largest economy, Germany, has disavowed Keynesian solutions under Angela Merkel, and is in a far stronger position than other Eurozone members such as France, Spain, Italy, and of course Greece, which have been bastions of government intervention.

Europe has no solution to its current massive debt crisis other than cutting levels of government spending. And nor does the United States. But austerity measures both in Europe and in America must be combined with lower personal and corporate taxes, labour market deregulation, eliminating red tape for businesses, large-scale entitlement and welfare reform, and a firm commitment to free trade. Big government prescriptions have been tried and tested on both sides of the Atlantic and have significantly failed to create jobs and generate wealth. The Krugman approach of ever greater levels of public spending is the wrong prescription for Europe and would condemn the continent to decades of economic decline. It would also be hugely damaging for the United States, which is now going down the same path of profligate debt and overspending that has become Europe’s ruin.