Why Spain’s New Government is Drinking Austerity Kool-Aid and How This Threatens the Global Economy

Spain's new government said late last month that this year's budget deficit would be much larger than expected and announced a slew of surprise tax hikes and wage freezes that could drag the country back to the center of the eurozone debt crisis. The government plans to enact public spending cuts of 8.9 billion euros ($11.5 billion) and tax hikes aimed at bringing in an additional 6 billion euros a year to tackle the shortfall. Given what has happened to Greece, and now Italy, it is almost certain that this will have the opposite impact of that which the Spanish government wants: there will be HIGHER public deficits at the end of the day, as the cuts curtail economic growth even further.

Self-inflicted Catastrophe

Spanish employment fell by a whopping 72,075 in November, which came on the heels of an even bigger 82,944 decline in October. The Spanish employment data is really terrible. To get a feel for these numbers, you have to realize that Spain’s employment is about one-eighth that of the U.S. We are talking about employment declines in the last two months that would correspond to monthly declines of more than 600,000 if it were the U.S. economy. In the prior three months Spain’s employment declines corresponded to the equivalent of almost 300,000 job declines a month in the U.S. Would anyone doubt that the U.S. was in a deep recession if it reported such horrible employment data? Of course not.

The eurozone, indeed, the entire global economy, continues to experience a self-inflicted catastrophe, largely because of dangerously destructive myths about fiscal policy. In spite of the shrill rhetoric of the fiscal austerity brigades, the evidence in Europe continues to mount that a nation cannot have a fiscal contraction expansion when all other spending is flat or going backwards. Unless you want an economic disaster.

Let’s look at some macroeconomic issues in a simplified form:

1. In any given country, how many sectors are there that can spend? Answer: three.

2. What are they? Answer: The foreign sector, the private domestic sector, and government sector.

3. What happens if firms in the private domestic sector cannot sell their goods and services because people can’t afford to buy them? Answer: They lay off workers and refuse to spend on new equipment, etc.

4. What happens if income in the local economy is lost to the foreign sector – that is, is not recycled back into domestic demand? Answer: Drain on growth, fewer exports, more imports.

5. If the economy is looking bad, what happens to private domestic sector households? They will not spend.

6. If the foreign sector isn’t spending on a country, and the domestic sector isn’t spending, either, then the economy will ground to halt unless the one remaining sector fills the breach: the government sector. This is true, regardless of what the anti-government mythologists from Germany, the University of Chicago, and others, argue to the contrary.

Free Market 'Miracles' are a Myth

This is particularly true in a situation when an economy is suffering from the after-effects of a PRIVATE SECTOR debt bubble. And let’s set aside this nonsense about the miracles of “letting the ‘free’ markets work. The notorious ‘Invisible Hand’ –that mythical self-regulating aspect of the market–turns out to look like 1995-2000 with all that wonderful allocation of capital to tech and telecom, or perhaps more along the lines of 2000-6, with the brilliant decisions made by hundreds and thousands of equity investors, bank loan officers, and credit analysts made regarding real estate allocations (of which Spain was a notable example). Doesn’t work too well in reality -- and ordinary people are left holding the bag.