Is Austerity Killing Us?

The European economy is turning from stagnation to contraction. Financial journalists are concluding that “austerity” is the reason.

They say that forced reduction in government services is sending not only the continent, but the U.K. into an economic tailspin and — heaven forbid — the same could happen to the United States. Look and panic: America’s various levels of governments are contracting, laying off workers and cutting services.

The whole civilized world is doomed, they say, by this reduction in government. To their minds, an expanding government leads to an expanding economy, as measured by gross domestic product (GDP). Cuts in government do the opposite.

But have there been actual cuts? Veronique de Rugy of Mercatus has looked at this claim government by government and finds throughout the U.K. and Europe mostly higher taxes, higher spending, more regulation, and a near absence of serious and substantial structural reform. The cuts that have taken place have been forced by economic reality.

If for one night a drunk can’t get to the slot machines, this does not amount to gambling austerity.

But here is a more-important question: Does government drive the economy? Look around at all the things you love, all the services that are most beneficial to your life, all your material aspirations and dreams. How many of them were or are produced by politicians and bureaucrats?

As Albert Jay Nock said, government has no resources or power of its own. Everything it has it has taken from us. It produces nothing, but exists only to the extent it can feed off its host — wealth creation aimed at serving customers in the private economy.

It seems like a simple and incontrovertible observation, but it must not be, because otherwise-intelligent people seem to miss it. The New York Times’ Eduardo Porter complains about Americans and their aversion to taxes. He was just in Italy, he says, with an economy in shambles, a government bloated with debt and corrupt bureaucracy, yet his son, who developed an untimely rash while vacationing, was served lickety-split by an Italian doctor, gratis.

Porter figures that’s government as it should be.

A good share of Italians may be unemployed and their economy may be shrinking, but their social safety net stretches farther than ours and supposedly their poverty rate is lower. Their free health care covers even tourists.

To believe Porter, the laws of economics have been repealed in Italy. Great food, great wine, free health care, and no one has to work in this paradise.

According to Porter, America has plenty to learn from Italy and countries like it that tax their citizens at an appropriate level, unlike the good old US of A that can’t seem to get its citizens to cotton to the idea of handing over more of their property to the state.

Porter doesn’t talk about individual tax rates. He focuses on the percentage of taxes collected to GDP. That percentage in the developed world averages 35%, while America is falling behind, at less than 25%. Only Mexico and Chile are less taxacious.

Of course, as Bill Bonner told the Agora Symposium crowd in Vancouver, GDP is just another phony government number. He wrote in Whiskey & Gunpowder in 2010:

GDP growth alone is a fraud. The gross number just doesn’t tell you anything worth knowing. It doesn’t really matter how fast an economy is growing. What counts is how fast it is growing per person… and whether that “growth” is real or phony. Growth is not the same as prosperity… Someday, we promise you, modern economists will be ranked below doctors who bled their patients to death and jungle tribes who threw maidens into volcanoes. They are quacks.

According to Porter, America is not only not taxing enough, it’s not taxing the right way. Consumption needs to be taxed, instead of taxing labor and capital “that damp people’s drive to work and invest, putting a drag on economic growth,” Porter writes. “And the tax code is riddled with preferences and loopholes that further distort people’s economic behavior.”

I agree with his point about distortions and disincentives to work and invest, but he’s implying that governments in the rest of the world are living off the VAT (value-added tax) exclusively and not taxing income and capital gains.

This, of course, isn’t true. Europe taxes everything. And despite taxing everything, their countries are broke, and getting more so.

As Margaret Thatcher once said, “The problem with socialism is that eventually you run out of someone else’s money.”

Here in the U.S., private business is adding workers, but as Shaila Dewan and Motoko Rich report in the Times, governments are handing out pink slips, and that is hurting the recovery. Some 706,000 government positions have been axed since April 2009:

“The unfortunate reality is our revenue streams have not rebounded,” said Timothy R. Hacker, the city manager of North Las Vegas, which has cut its workforce to 1,300 from 2,300 and is about to lay off 130 more. “Shaking this recession is becoming increasingly difficult”…


More than a quarter of municipal governments are planning layoffs this year, according to a survey by the Center for State and Local Government Excellence. They are being squeezed not only by declining federal and state support, but by their devastated property tax base.

The federal and state governments depend upon private-sector economic growth that can be taxed. In turn, local governments are dependent upon that same economic vitality — none of which is generated by the government. It’s backwards to think government jobs create economic growth when, in fact, government jobs can be supported only by economic activity in the private sector.

State and local governments expanded mightily with the housing boom. Mr. Hacker’s employer — the city of North Las Vegas — moved into lavish new digs during the bubble Each and every demand made by the public employee unions was accommodated because the city’s growth was thought to be endless.

When local housing markets crashed, so did local government finances.

But President Obama doesn’t understand economics or cause and effect any better than those writing for The New York Times. He thinks the public sector must grow to compensate for the private sector, not hiring. “Each time there was a recession with a Republican president,” Obama says, “we compensated by making sure that government didn’t see a drastic reduction in employment.”

The Wall Street Journal makes the same claim. Without increases in federal spending, the recovery doesn’t have a chance, write Ben Casselman and Conor Dougherty:

Recent economic data show that long before the fiscal cliff hits, federal spending already is falling — and taking a toll on the recovery. Federal spending and investment fell at an annual rate of 0.4% in the second quarter and has fallen 3.3% in the past year. Federal employment has fallen by more than 52,000 jobs in the past year and for the first time is lower than when the recovery began.

They even found an economist to provide a juicy quote to support their argument. “It’s unbelievable how much the economy is getting hurt already by the sharp drop in federal spending,” Deutsche Bank chief U.S. economist Joe LaVorgna said.

All of this implies that all jobs are homogeneous. If a worker isn’t needed in the private sector because consumers aren’t buying that particular good or service, then government can just replace that job with a job in government doing something that consumers in the private marketplace won’t pay for.

Politicians and Keynesians believe that swapping these two jobs will preserve economic growth. Life will go on as before.

This is nonsense. The worker had a job because he or she produced more than he or she cost the employer in the pursuit of satisfying customers. Fewer customers means fewer jobs are needed. Less economic activity means fewer tax dollars going to government. Fewer tax dollars means government doesn’t have the resources to hire more people.

The idea that hiring more government workers stimulates economic activity stands reason on its head.

Economics professor Tyler Watts makes the point in The Freeman online:

Perhaps we’ve been spoiled by hundreds of years of a generally prosperous and growing market economy into assuming that all workers necessarily add to economic output by exactly the value of their paychecks. There is a strong tendency toward this result in a strictly market-based competitive economy.

But professor Watts quickly makes the point that government workers don’t provide the same value. There is no market test to determine if government workers are generating value. Only political rules apply.

The fact that government employment is shrinking is only a signal that economies worldwide are attempting to recover from decades of debt and malinvestment, which includes too much government.

Government layoffs are a good thing. They put more resources into the private sector, which is the only real source of growth. Whether the GDP number is up or down doesn’t mean a thing. After all, since everyone believes China’s GDP number is inflated, why shouldn’t we assume governments deflate the number when it suits their purposes?

Government austerity is, in the long run, a blessing to the rest of the population.

Doug French

Written By Doug French

Douglas French is a Senior Editor for Agora Financial. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, Early Speculative Bubbles & Increases in the Money Supply, the first major empirical study of the relationship between early bubbles and the money supply, and Walk Away, a monograph assessing the philosophy and morality of strategic default. He is founder and editor of LibertyWatch magazine.

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