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How NOT to Fix the Economy

May 15, 2012

The 50 separate states in the US are laboratories where we can see what works and what fails.  In this age of rapid communication, we can also learn from countries around the world as they struggle with a worldwide economic depression.  Greece, France and California are examples of failure.  Sweden, the Baltic nations and Texas are examples of success.  (Sweden?  Yeah, Sweden!)  What are the differences between them.. besides barbeque and country music?

Back in 2009, Alberto Alesina and Silvia Ardagna of Harvard University published a paper examining what happens when countries begin to reduce their debt.  They agreed that government spending and regulation dragged down an economy.  What is surprising is what governments did to recover.

Typically, the government waits until it is deeply in debt to change its pattern of taxing and spending.  It then announces “painful draconian cuts to essential services” while, in fact, it does not cut spending at all.  The government simply restricts the usual rate of increase in annual government spending.  It does not change entitlement or work rules so it simply goes broke more slowly.  This gradual approach to collapse failed every time.  We now have data to prove that you will fall down no matter how slowly you step off a cliff.

The study by Alesina and Ardagna also documented the economic policies that led to growth.  Growth came from less government spending, but mostly from lower taxes.  This isn’t theory.  This is example after example from forty years of data.  The reason is obvious.  Taxes come from income and income comes from economic activity.  If you want income, even government income, then you shouldn’t kill business with high taxes and regulation.

Well..duhh.  So why do we see governments fail financially given that the solution is obvious?

We observe that governments make excuses for their political payoffs, and that those payoffs are in fact more important than actual economic improvement.  Despite rhetorical claims about wanting jobs and growth, governments operate for the benefit of the political blocks that put politicians in power.  Politicians rationalize that cutting government spending will hurt the economy despite decades of evidence to the contrary.  Data showed that even large cuts in government led to growth.  A free and active press is supposed to save us from vain politicians, but the press cannot.  The popular press is too ideological or economically illiterate to question the claims of free-spending politicians.

This is not an abstract problem.  The US could easily become Greece.  (Said another way, Greece could become Detroit where a third of the homes and businesses are abandoned and half the population has left the city.)  Greece, Spain, Italy and France NEVER reduced their government spending year to year.  Never.  Yes, we heard about cuts, but their taxes and spending did not get smaller.  Not by one Euro.  They never reduced the painful government regulation that protected some industries and professions while it strangled all.  They were all talk and no real reform.  We are no better; this could easily be replayed in California and Illinois.  Pease remember this when you read about “failed” European economic austerity.

Read about it yourself.  Two Kinds of Austerity  Tax Cuts Versus Stimulus: the Evidence Is In


Rob, who trusts an ounce of data more than a pound of economic theory

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