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  • In Europe, Reducing Spending Necessary, but Not Sufficient, to Restore Economic Freedom

    If the 2012 edition of Heritage’s Index of Economic Freedom has bad news for the United States, the news for Europe is not much better.

    The 43 nations of the European region did manage to lose less economic freedom than did the United States, but a decline is still a decline. And the European decline was broad-based: Only nine countries made gains, and every one of the top 10 declined—in some cases, dramatically. The underlying driver of the declines in many cases will come as no surprise: higher levels of government spending.

    It’s important to recognize just how high these levels are. In the U.S., government at all levels is equivalent to 42 percent of the entire gross national product. Spending by governments is not exactly the same as personal spending—partly because the government can print and borrow money—but it is still shocking that, in this mostly free country, the government is responsible for spending about 42 cents out of every dollar’s worth of goods we produce.

    In Europe, though, the situation is worse. In Germany, government spending is equal to 47.5 percent of GDP. In Britain, it’s 51.2 percent. That would be the equivalent of increasing U.S. taxes by about 20 percent—though in spite of its higher taxes, Britain still runs annual deficits of over 7 percent of GDP, suggesting that deficit spending is the financial equivalent of a narcotic: both addictive and deadening of initiative.

    The Index also points out that higher levels of debt are closely linked to lower economic growth. Common sense would suggest that it’s not possible to borrow your way to prosperity, and in this case, common sense is onto something.

    The Index is a bit more pessimistic about the impact of debt than some other studies, but it agrees with them in finding that, while developed countries can sustain higher debt levels than developing ones, once debt reaches somewhere between 60 and 90 percent of GDP, it hurts growth going forward. Like the U.S., many European countries have rocketed past the 60 percent level and are approaching or beyond 90 percent.

    But the Index also makes a broader point. Reducing the burden the government imposes on the economy is a good thing, but it is not the same as having a plan for growth. Greece is now perilously close to defaulting on its massive debts because its government has been unable to make the fundamental structural changes that are necessary to restore its economic competitiveness. Trying to balance a budget by conducting a fire sale of assets is no substitute for maintaining a flexible economy over the long run.

    Britain is another case study. While its annual deficits have come down, the government’s share of the economy has grown thanks to a series of tax increases and the very slow growth of the British economy. There has been widespread criticism of the Conservative-led coalition government’s growth strategy on the grounds that cuts in spending are a necessary but not sufficient condition of growth—and even the cuts that have materialized are more properly described as a decrease in the previously planned rate of growth. Much more is needed—including tax reform and simplification, a transportation and energy policy that emphasizes efficiency, and labor market reforms. With the U.K. forecasted to slip into recession in 2012, the weaknesses of mistaking an austerity strategy for a full-blown growth one are going to become steadily more obvious.

    Of course, the U.S. is well behind Britain in that we don’t even have an austerity strategy—except for our armed forces, of course. But the take-away from the Index as far as Europe is concerned is two-fold.

    First, if you want higher economic growth, you can’t regulate or borrow your way to it. Everyone recognizes that markets cannot exist without a framework of law, but more rules are not better rules. Europe (and the U.S.) are dropping down the ranks of the Index in large part because of high government spending—but economic opportunity is not just a function of the size of government. Other things matter, too, which is why the Index measures 10 categories.

    Second, the importance of a nation or region to the rest of the world is ultimately connected to the size and modernity of its economy. Money isn’t all that matters, obviously, but it’s difficult to believe that the Obama Administration would be “pivoting” to Asia if Europe had anything like Asia’s growth levels. If Europe wants to know why the U.S. is looking East instead of West, it might start by glancing in the mirror.

    By the same token, if the U.S. wants to remain the world’s superpower, it had better realize that what’s happening in Europe could happen here, too. We may be an exceptional country, but that doesn’t mean we’re immune to the laws of supply and demand.

    Posted in Economics [slideshow_deploy]

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