The Case for Austerity

Most people know that Paul Krugman’s attacks on austerity have been wrong-headed and self-serving.

Krugman is laying down a predicate that will enable him to blame the political right if the world slides into another recession, or worse. 

In particular, he has been arguing that more government spending, more debt creation, and more income redistribution can solve Europe’s problems.

The ploy is so transparent that even someone who is not a trained economist can see through it. If the arguments were not sufficiently lame, Krugman’s typically shrill rhetoric gives the game away.

This morning in the Financial Times, Gideon Rachman, a writer who is far more knowledgeable on these matters than I, offers a cogent response to the Krugman anti-austerity crusade.

In Rachman’s words:

If building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming. The past 30 years have seen a huge splurge in infrastructure spending, often funded by the EU. The Athens metro is excellent. The AVE fast-trains in Spain are a marvel. But this kind of spending has done very little to change the fundamental problems that now plague both Greece and Spain – in particular, youth unemployment.

Krugman would want us to believe that the politicians who are cutting budgets are less intelligent than he. In truth, austerity is the bond market at work.

Rachman explains:

As for Italy and Spain, they are not cutting their budgets out of some crazed desire to drive their own economies into the ground. Their austerity drives were a reaction to the fact that markets were demanding unsustainably high interest rates to lend to them. There is no reason to believe that the markets are now suddenly prepared to fund wider deficits in southern Europe. The “end austerity now” crowd respond that it is the responsibility of Europe’s dwindling band of triple A rated countries to go on a consumption binge and so pull their neighbours out of the mire. But the assumption of unlimited Dutch and German creditworthiness is unconvincing – as the market reaction to the Dutch failure to agree a budget, last week, illustrated.

Rachman declares that austerity is inevitable. In order to soften the blow he proposes that policy makers reform the labor market by releasing the stranglehold that bureaucracy (and labor unions) hold over it.

He offers these examples:

My favourite recent example was a story in the New York Times of a Greek entrepreneur, whose efforts to start an internet business involved an odyssey of form-filling, culminating in an official demand for a stool sample. High rates of youth unemployment in countries such as Spain and Italy are closely connected to the excessive protections and benefits for workers on full-time contracts – which make employers wary of taking on new hires. As one Spanish businessman recently complained: “In this country, it is easier to divorce your wife than to sack an employee.”

Ask yourself this: how often has Paul Krugman argued in favor of labor market reforms? How often has he argued against the labor unions that have been instrumental in making the labor market less of a market and more of a racket?