Spain Proves that Austerity can never “Ensure” a Balanced Budget

By William K. Black
(Cross-posted from Benzinga.com)

The Wall Street Journal recently printed an economically incoherent and dishonest discussion of Spain’s budget deficit.  It begins its discussion with these paragraphs.

“Spain’s central government reported a new deterioration in its finances and struggled to impose budget discipline on the country’s restive regions as data showed a surge in capital flight from the euro zone’s fourth-largest economy.

The central government in Madrid said it had a budget deficit equal to 4.04% of gross domestic product in the first half, up from 2.2% a year earlier, as tax revenue remained weak and Madrid moved to extend emergency support to the country’s financially ailing regional and municipal governments.”

Twelve paragraphs later, the article finally informs the reader about unemployment.

“Spain’s economy continues to deteriorate. Unemployment figures for the second quarter of 2012, released last week, showed the jobless rate reached a record high of 24.6%, the highest in the developed world, and the government recently warned that the country’s economic contraction would drag through next year. Seasonally adjusted retail sales, an indicator of consumer confidence, fell 5.2% on the year in June, compared with a 4.9% yearly drop in May, Spain’s National Statistics Institute said Tuesday.”

The fact that the two subjects are intrinsically linked appears to have escaped our nation’s most famous financial newspaper.  Instead, they treat the following claim by the Spanish government as if it were a fact rather than an assertion falsified by the events recounted in the WSJ article.

“Government officials also expressed confidence that new austerity measures pushed through in July—valued at a total of €65 billion over the next 2½ years—will help ensure the government meets its [budget deficit reduction] targets.”

Austerity can never “ensure” meeting a budget target.  Austerity means some combination of raising revenues and reducing expenditures.  A severe recession produces large budget deficits by causing an enormous drop in tax revenues and a material increase in spending, e.g., in payments to the unemployed who are unable to find work.  As the 25% unemployment rate demonstrates, Spain is in a depression.  A recession typically occurs when private sector demand becomes so inadequate that the economy contracts and cannot employ large numbers of workers seeking jobs.

Reducing government expenditures during the recovery from a severe recession can cause public sector demand to decrease.  Raising taxes during the recovery from a severe recession can cause private sector demand to fall.  Both austerity measures can make the recession worse (or throw the economy back into recession).  If the recession becomes more severe, austerity can cause the budget deficit to grow.  Austerity can never “ensure” that the national budget deficit will fall.  The assumption that it can do so ignores the dynamic interaction of the economy, fiscal policy, and the budget.

In the United States, conservative Republicans have long championed one aspect of this essential truth – the demand for “dynamic scoring” in calculating the likely federal budgetary outcome of reducing taxes.  This “supply-side” claim is vastly overstated – very large reductions in taxes undertaken while the economy is near fully employment have not caused economic growth to increase so rapidly that the net effect of the tax cuts is an increase in tax revenues.  Reducing the marginal tax rate for the wealthy during the recession is a poor means of increasing private sector demand.  The supply-sider claim that the Congressional Budget Office (CBO) should employ “dynamic scoring” to predict that the net effect of tax reductions is increased tax revenues rests on an economic theory that has failed empirically, but the insight that there is a dynamic interaction between the economy, fiscal policy, and the budget is correct.

The fact that Spanish austerity has deepened its budget deficit is no mystery.  Spain increased taxes and cut public spending.  It fell into an even deeper depression.  Having seen austerity fail and impose ever more terrible costs on its citizens has no effect on dogma.  The Spanish government remains certain that if it simply pushes a few more millions of its citizens into unemployment it will “ensure” that it will meet its latest budget deficit reduction targets.

Catalonia as the cur which must be brought “to heel”

Recall the article’s statement that the Spanish government “struggled to impose budget discipline on the country’s restive regions.”  Regional governments face all the urgent needs to spend that are increased by a depression, suffer the severe drop in tax revenues, and have very limited ability to borrow.  A humane and economically rational national government would follow counter-cyclical fiscal policies to combat the depression, including greatly increased financial aid to the regions.  These very real problems that the regional governments struggle with are causing great human misery.  The article briefly notes some of the facts establishing that misery.

“Citing severe liquidity strains, Catalonia’s government has delayed July payments for social-service providers, including hospitals and retirement homes. As many as 100,000 employees could suffer payment delays as a result, local media say. Spanish regions are responsible for over a third of spending in the highly decentralized country, including politically sensitive areas such as health and education.”

The WSJ conveys no real sympathy for their struggle or the misery and no analysis of why it is the national austerity policy that is the problem rather than the solution.  “Health and education” are not merely “politically sensitive areas,” for the economic, political, and social future of the nation rests largely on health and education.  The article treats the regional government leaders as undisciplined, profligate children who require adult supervision by Spain’s national leaders.  The victims are demonized and the Spanish national leaders who have gratuitously thrown their nation into a depression and intend to double down on their failed austerity policies are lionized.  The metaphor that the article presents treats the regional governmental leaders as curs who must be brought “to heel.”

“Some analysts worry the new target is already at risk, given the central government’s deteriorating finances and its difficulty in bringing the country’s regions to heel.”

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @williamkblack