We’ve corrected Paul Krugman in the past, when he mistakenly invoked imaginary British spending cuts as proof that undercutting Keynesian hydraulics will demolish an already limp economic recovery. This time he points to Greek austerity – or “spending cuts” – as he characterizes it.
“Not a day goes by without some politician or pundit intoning, with the air of a man conveying great wisdom, that we must slash government spending right away or find ourselves turning into Greece, Greece I tell you,” he proudly advances. “What Greek experience actually shows is that while running deficits in good times can get you in trouble, trying to eliminate deficits once you’re already in trouble is a recipe for depression.”
Krugman’s right that Greece has slashed spending. And indeed its unemployment is about 20 percent and likely to rise further. However, the Greek austerity plan also contains a plethora of tax hikes, which nearly everyone agrees damage economic growth. In fact, according to the Organization of Economic Cooperation and Development (OECD), about 60 percent of the Greek austerity plan is tax hikes, 40 percent is spending reductions.
In light of that, it’s rather tricky to say the least to claim spending cuts are responsible for devastating the Greek economy. These statistics alone leave it difficult to disentangle whether spending cuts or tax hikes or both have contributed to economic hardship. Observing other historical examples helps flesh it out.
Downturns like those in the 1830s, 1890s and 1920s that were met with fiscal restraint and spending reduction succeeded in ushering in robust economic recoveries. Alternately, experiences like those of 1932, 1937, and 1993, when taxes were hiked, destabilized weak economies and weakened robust economies.
For now, Greece is going to suffer badly from past policy mistakes no matter what it does today with spending or taxes, no matter what the IMF does to bail it out, no matter what the ECB does to prop up its bonds, no matter how matter what the European Union does to keep Greece afloat. The question is, how long mustGreecesuffer? How long until Greece has a reasonable prospect for recovery? Getting its finances under control is only the first step, and the historical record suggests that cutting spending lays the groundwork for a stronger recovery sooner; on the other hand, raising taxes just damages growth even more now, and makes the rock-strewn road to recovery longer and steeper.