Monday, December 2, 2013

So How Are the Netherlands in an Austerity Trap?

In response to Standard and Poor's decreased credit rating of the Netherlands, an Oxford professor wrote a blog entry about how the Netherlands was suffering from what is labeled as an austerity trap. The idea behind the austerity trap is that the government imposes [steadily] deeper spending cuts via pro-cyclical fiscal policy in response to large budget deficits. According to Keynesian economic theory, spending cuts during a recession beget an even higher debt-to-GDP ratio, in which the country can neither meet its deficit targets nor crawl out of its debt-ridden state. Much like with the case in Britain, I have to wonder if there was actually austerity or not. Looking at Eurostat data, I compiled government expenditure data:

If this theory is to be tested, there need to be spending cuts in the first place. Instead, what we have here is an overall upward trend both in expenditures in absolute euros and expenditures as a percent of GDP.  There is a bigger definitional issue here. For some, the definition of austerity is a combination of spending cuts and tax increases. If we do decide to include tax increases as part of the definition of austerity (as opposed as the definition solely including spending cuts), then yes, the Dutch government has increased taxes (Eurostat), which would make the fiscal-adjustment packages very much on the tax side.

If austerity is defined solely by spending cuts, then the austerity is non-existent. If tax increases are included in the definition of austerity (which they theoretically are), then yes, there is austerity because the taxes have a slight upward trend. For me personally, I prefer that the definition encompasses both spending cuts and tax increases because it better reflects the full extent of what government attempts to do to remedy debt-to-GDP ratios during a recession. I also prefer it because when there is a discussion about austerity with the tax increases, the austerity that has been taking place in European nations over the past few years usually do not entail actual spending cuts, but even when they do, the spending cuts are significantly smaller than the tax increases. For those who have read my blog, one can surmise that I am hardly an aficionado of tax increases, which is to say that with this definition of austerity, I would not be 100% for it as a remedy for mitigating an increased debt-to-GDP ratio.  

Economic theory and the usage of political buzzwords are two separate notions. For those who prefer the tax-and-spend method, which is popular for those on the Left, when the word "austerity" is used by economists like Krugman, it is code for "spending cuts," which are anathema to proponents of advancing stimulus packages to boost aggregate demand. Since the definition of "austerity" in political discourse typically refers to only spending cuts, it makes me wonder where the austerity trap is.

Do the Netherlands need to make some improvements? Fitch and Moody's seem to think so. Given that it's part of the Euro zone and the Euro zone has its issues, so do I. However, let's not blame the credit rating downgrade on non-existent spending cuts.

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