Good and bad austerity

I've been a friend and admirer of David Malpass for a long time, even though we have not always agreed on the outlook for the economy. Today, David has a very nice op-ed in the WSJ, "Greece's False Austerity," that makes a critical distinction: austerity that shrinks the public sector is good, while austerity that imposes increased burdens on the private sector is bad. This is excellent advice for Greece, just as it is for the U.S. Some excerpts:

The conflict between growth and austerity is artificial and framed to favor bigger government. Growth comes from economic freedom within a framework of sound money, property rights, and a rule of law that restrains government overreach. Businesses won't invest or hire as much in an environment where governments dominate the economy. Thus, government austerity is absolutely necessary for economic growth in both the short and long run. 

Economics has often ignored the critical distinction between austerity for the government and government-imposed austerity on the private sector. In the former, governments which are over-budget sell assets, restrain their hiring, and limit their mission to essentials. That's growth-oriented austerity. 

In the private-sector version of austerity, governments impose new taxes and mandates on the private sector while maintaining their own personnel, salaries and pensions. That's the antigrowth version of austerity prevalent in Europe's austerity programs.Many economic models, including the U.S. Congress's budget scoring system and Keynesian stimulus, ignore national debt levels and disregard whether spending decisions are made by the private sector or the government. This creates the absurd result that an economy in which the government spends and invests increasing amounts—even 100% of GDP—has the same projected growth rate as an economy where the government spends and taxes less. 

As the U.S. struggles with tax reform, deficit reduction and the year-end fiscal cliff, it will be critical to distinguish between reforms that downsize the government and reforms that downsize the private sector and put the dollar at risk. One approach points to growth, the other to Greece.

UPDATE: The Centre for Policy Studies yesterday published a study of 28 OECD countries that finds "that the size of government as a proportion of GDP is a major influence, controlling for other factors, on a country's rate of economic growth. If you want growth, scaling back the state should be an aim whether you have a deficit or not." Furthermore, the study finds that "other things equal, countries with small governments and with small tax burdens grow faster," and "pupils in small-government countries achieve significantly better results in reading, math and science than those in big-government countries."

The good news is spreading: cutting back on bloated government spending is not austerity, it is one of the best ways to stimulate an economy.