Kevin Spires, CFA, FRM

At National Review online, Victor Davis Hanson rants about the false choice of Austerity vs. Growth.  Dr. Hanson bulldozes the idea that we have even begun to see Austerity.  He sees the current language as obscuring what is actually happening - a debate of not of 

     “growth” versus “austerity” but of “borrowing and spending” versus “fiscal discipline,”

Personally, what I believe we are seeing is the end game of democratic socialism.  Past a certain point, if the State's share of the economy grows too large, the perverse incentives - to not work, to cheat on one's taxes, for cronyism, for graft and corruption, for entrenched public unions to gorge themselves at the public trough - turn into a massive economic self destruct mechanism. 

A program of economic self destruction is what has been wrought.  Vast swaths of the Western world have been taught that Keynesianism and Socialism are a sort of perpetual motion machine - that the more profligate a society - that if they borrow enough, then prosperity will follow.  The math has never worked to anyone unwilling to believe that 2+2 does not equal five - especially when our eyes tell us that those portions of the economy run by the government (think the DMV or Post Office) tend to turn 2+2 into three.

Kevin Spires, CFA, FRM

In yesterday's Wall Street Journal, Tim Know and Ryan Bourne presented the results of research showing that the smaller the size of government, all else equal, the faster the growth rate of an economy.  In their own words  "our results suggest that reducing the ratio of taxes or spending to GDP by five percentage points increases the growth rate of GDP per capita by 0.5 to 0.6  percentage points per year. "  Over 25 years those .5% to .6% a year matter, leading to a smaller government economy outgrowing a larger government economy by "115% to 64%."  

Their suggestion for resolving the European Economic Crisis is to put government on a diet.  They correctly point out that "Austerity" as the Europeans understands the word is higher taxes on the private sector and no cut backs in the bloated state sector (some editorializing on my part-ks).  To create sustainable, higher growth rates, a small state sector and smaller taxes are warrented.  Seems pretty straightforward to me.

The combination of smaller government and smaller taxes can also be a winner politically as well.  Scott Walker, the Governor of Wisconsin, who pushed through "Austerity" by cutting into the inefficiencies of the Government Union Bureaucracy and did not raise taxes to close a big budget hole.  The European political parties should take note - as whomever is in power has been getting bounced from power at the next election due to their failed policies.

Mark Perry of the Carpe Diem Economics blog and AEI visiting scholar profiles the Swedish Finance Minister and the solution that his party implemented during the financial crisis.

Sweden implemented permanant tax cuts (not the temporary tax cuts that Bush, and now Obama, favored) combined with a paring back of some of Sweden's massive welfare state.  Surprise, Surprise - Sweden was the fastest growing economy in Europe last year.  Anders Borg, the Finance Minister in question, is shocked that anyone would expect a return to the loose monetary and fiscal policies of the 1970's to produce anything other than the stagflation that reigned during the 70's and early 80's.

It is pretty fascinating to see changes on the margin lead to improved, or in the case of much of the world, worsening performance.  Sweden still has an economy dominated by the government, but paring back just a bit over 2% of the governments share of the economy has lead to 5% average growth rates the past two years.

The results of the French and Greek elections are being heralded as a rebuke to "Austerity" as a path away from the fiscal brink.  As National Review online writer Veronique de Rugy says in - "Show me savage spending cuts europe please,"  Europe has not cut spending in general and the trend in spending is still higher, although the slope of spending growth has turned as bit shallower.  As long as voters keep voting for less austerity expect the European debt crisis to move inward from the periphery and northward from the Mediterranean.

I view the European debt crisis as a preview of what the United States will face in the next 5-10 years if we do not get entitlement spending under control.  I am dismissive of the ability of tax increases to close our fiscal gap as we are already so far down the road towards insolvency that tax increases are more likely to lead to the massive unemployment and negative tax growth that Greece and Spain are experiencing today.  Just my opinion, but the Europeans have been running a grand experiment along the lines of higher government spending and higher taxes for the past 30 years - and we see where that has led.