Comparative Politics

It Came from the Shlaespile!

May 18 '12

Amity Shlaes has some … interesting … “views on the US and the euro crisis”:

bq. Start with the nightmare the U.S. fears replicating: Europe. That financial disaster wasn’t just a crisis about pension obligations. It was a crisis of trust. First, markets and individuals trusted European governments when they said their budgets balanced over the long run. Stable governments with balanced budgets would leave the economy some room to grow and realize the advantages of a new continent-wide currency. Then the observers realized the governments were lying. Restoring trust is harder than killing it. …

bq. The simplest way for European governments to restore voter and market trust is to cut national budgets dramatically. Even by half. Such deep cuts, however, are deemed politically impossible. The Europeans will do just about anything to avoid seriously reducing their budgets, including raise tax rates, so they can get more revenue on paper. These tax increases are the kind of austerity that supply-siders have historically deplored. It’s true that higher taxes deter activity, but partly because they give license for larger government by supplying cash for future spending. …

bq. Because the dollar remains the currency of reserve in the world, the U.S. situation can proceed slightly more leisurely. But only slightly. The best move to assure that the U.S. won’t be trapped like Spain or JPMorgan Chase & Co. (JPM) in coming years is to cut the budget now, and lock in a future of lower tax rates with a law passed at the same time as the budget. But to earn the trust, the budget cut — the emblem of smaller government — must be prominent. It was disappointing to see Republican presidential candidate Mitt Romney the other day trash Congressman Ron Paul’s plan to cut a quarter of the federal budget. …

bq. The real way to establish trust isn’t to trash austerity. It is to find a way to reduce the budget, not for the sake of budgeting alone but to prove that the leaders really want the government to be smaller. The tax cuts must come along, and fast, but commitment to smaller government matters most. If that’s austerity, it’s time to don the scarlet letter.

The argument about ‘what markets want’ is nothing more than a standard rhetorical trope. Nobody actually knows what markets ‘want’ because markets aren’t individuals, and are known for “changing their minds with remarkable alacrity”: The claim that cutting national budgets by half in Europe, or by a quarter in the US, would increase trust among voters is a rather magnificent one, albeit one that has no empirical support whatsoever. As Shlaes acknowledges, such budget cuts would lower growth and increase unemployment. As this post by John notes, we have a pretty good idea of the “relationship between economic growth and citizen trust of government”:http://tmc.local/blog/2010/02/14/what_will_make_people_love_gov/. Shlaes is correct that it is a highly significant one. Unfortunately, however, it points in precisely the opposite direction than the one that she thinks it does.

Trust graph

It could be that this relationship is different in Europe (I don’t have Eurobarometer data to hand, and I’m in the throes of grading), but I very much doubt it. It could also conceivably be that the massive and dramatic cuts that Shlaes would like to see would boost trust in government rather than decreasing it (as incremental changes seem to). The experience of countries such as Greece, which have seen dramatic shocks to government spending, would seem to suggest that this claim, while not quite _impossible_, is wildly implausible. Massive cuts in government spending are far more likely to produce riots and political instability than to boost confidence in government. By far the more robust hypothesis is that Shlaes doesn’t know what she’s talking about.

It’s rather startling to realize that Shlaes was, until recently, a Senior Fellow for economics at the Council on Foreign Relations. I hope they feel proud. In the piece, Shlaes cites Arthur Laffer, who notoriously is supposed to have written the Laffer curve on a paper napkin. This reads instead like something found scrawled in crayon on the back of a crumpled Chuck-e-Cheese menu. Really terrible stuff.