Austerity and growth can coexist

The result of France's presidential election last month was widely interpreted as a severe repudiation of fiscal austerity. Socialist candidate Francois Hollande ascended to power on the back of a promise to replace the European austerity drive with a renewed focus on growth.

Many commentators, like Monsieur Hollande, see Europe's continuing stagnation as clear evidence that austerity and growth are mutually exclusive propositions. Nobel Prize-winning NY Times columnist Paul Krugman, a boisterous opponent of austerity from the very beginning, has stepped up his rhetoric on the issue.

All around Europe's periphery, from Spain to Latvia, austerity policies have produced Depression-level slumps and Depression-level unemployment; the confidence fairy is nowhere to be seen, not even in Britain, whose turn to austerity two years ago was greeted with loud hosannas by policy elites on both sides of the Atlantic.

Anti-austerity voices confidently state that the current European malaise is a direct result of savage spending cuts. But in actual fact, many of those savage cuts are either non-existent or have yet to be fully implemented.

Consider the example of the United Kingdom, whose sub-par performance has been eagerly highlighted by the likes of Paul Krugman. Ryan Bourne of the Centre for Policy Studies noted in February that, in the UK, 88% of planned cuts to benefits and a whopping 94% of cuts to public spending had yet to be implemented. Conversely, 73% of planned tax increases had already come into effect.

This brings to light an inconvenient fact that often slips under the radar of those who oppose government cuts. Across all of Europe, austerity packages have combined proposed spending reductions with sharp tax increases.

Whilst said reductions have often been delayed or simply carved out of the forward estimates, governments have quickly hiked up taxes in their thirst for extra revenue. If anti-austerity voices are so keen to find a culprit for the lack of growth in Europe, these tax increases would be a much smarter place to start.

Yet Mr. Krugman and his ilk continue to insist that the spending cuts are primarily responsible for dampening growth, and that higher government expenditures are the obvious remedy for Europe's malaise. They are indifferent to the plague of debt sweeping across the continent, and ignorant of Keynesianism's historically lukewarm results.

The United States implemented a gargantuan $787 billion stimulus package to combat the recession, yet is currently experiencing its weakest economic recovery since the Great Depression. America's biggest spending spree in more than sixty years has had remarkably little impact on growth. Clearly, there is only so much that public expenditure can accomplish. Government cannot value-add, it can only redistribute.

So if the current austerity policies have failed, and stimulus is an equally ineffective option, what is the answer to this growth puzzle? European success stories may be few and far between at the present moment, but those that do exist reveal the key to stronger growth for the rest of the continent.

Switzerland, with unemployment hovering around 3%, has the greatest level of economic freedom in Europe. Sweden, boasting one of the most impressive growth rates on the continent, responded to the financial crisis by slashing spending and lowering taxes. Germany, that universally recognised economic powerhouse, paved the way for its current strength with labour market and tax reforms.

Excessive government regulation and inflexible labour markets are both hallmarks of most European economies, particularly those in the troubled south. These are obvious starting points for any pro-growth reform initiative. But with such an intense focus on so-called austerity throughout Europe, there has been disappointingly little effort devoted to deregulation and labour market reform.

The challenge for Europe is to combine deficit-cutting austerity measures with reforms that will encourage growth by unleashing the private sector. These two propositions are not, as Messrs Hollande and Krugman would argue, mutually exclusive.

There is much to be done. Public expenditures must be reduced through structural reforms to entitlements and cuts to discretionary spending. Repressive levels of both red and green tape must be vastly reduced, as difficult as that may be within the vast European bureaucracy. The concept of flexibility must be radically reintroduced to the workplace, and tax reform should be implemented to create a friendlier environment for business.

The current malaise will not be healed by unimaginatively jacking up spending, nor by sabotaging growth with tax hikes. Only deep, structural pro-growth reforms will be sufficient to kickstart the ailing European economies and begin a long overdue recovery.