Real austerity does work

In the last meeting of the European Union, the leaders of each country agreed to run a growth stimulus plan, composed of 120 billions of dollars to be spent in key infrastructures, the plan was perceived as a demand of the peripheral countries, with the special contribution of the recently elected French Prime Minister, François Hollande. I imagine that most of the leaders of the European Union haven’t done a tour around Spain admiring the results of our Plan E, designed by the former PM Zapatero, airports connecting small cities with nowhere, ghost high-speed trains or enormous public sport centres and public universities for all cities with no market criteria. Spain doesn’t need more stimulus plans to keep squandering money in trains, plains or whatever a politician can give to their citizens in order to win some votes, what Spain really needs is to make for a once the structural reforms that this country need to get back to the growth path again.

So, which is the path to follow in order to achieve positive stats in growth rates? I will try to give a couple of good examples that might serve as a guide for any country:

1-LATVIA

Can you imagine a country which its economy contracted by more than 17% in 2009 and just three years from then, in the first quarter of 2012, grew by more than 5,5%? Most of you would think it is rather impossible, but the truth is that these are the figures of Latvia. In 2009 Latvia was heavily affected by the financial crisis, but now they are on the top positions of growth every quarter in the EU. These are the key points for this spectacular turnaround:

-A real fiscal consolidation, in 2009 the Latvian government had a deficit of 9.7% as a result of the enormous impact of the financial crisis on the Baltic country, so in order to get back to the growth path the government has implemented some reforms that have reduced this deficit to just 2,5% prediction for this year.

Peg the Lat to the Euro, instead of taking the easy way of devaluating its currency, they took the decision of pegging its currency to the euro, which at the end was a key succeed in order to avoid more painful consequences of the ongoing financial crisis that have had already affected Latvia heavily.

More competitive, very related to the last point, wages in Latvia has reduced by more than a 14% since 2009 and specially remarkable the 20% reduction of the public sector wages, this painful process have given its results, making the Latvian exports grow by more than a 40% and achieving low taxes on unemployment compared with the figures of 2009.

2-ESTONIA

Like Latvia, in 2009 the Estonians suffer the effects of the tremendous financial crisis contracting its economy by more than 14% and hitting unemployment up to 19%. But instead of following the recipes coming from the Mediterranean countries that try to fuel their economies by running higher deficits and increasing its debt, Estonia decide to follow their own way:

A flat income and corporate taxes of 21%, this model of low taxes allow Estonia to attract foreign investments which heat its economy to achieve high growth rates in comparison with all its European colleagues.

Serious reduction of public spending, by cutting the number of government jobs and not increasing pension benefits, the Estonian government run current account surplus which allow them to reduce its debt/GDP ratio and stimulated private investors since 2008 when the financial crisis hit the country.

-Keep the Debt/GDP ratio at low levels, we all know that a great part of the deficit of most governments comes from the financial expenditures due to the enormous amount of debt they had, so the Estonian government did big efforts for keeping their level of debt controlled in order to don’t get into deficit troubles. In 2011 the ratio keeps stable at just a 6%, a great succeed compared to the levels of countries like Italy, France or Spain

-Cut whole programmes, most of the European Government, which had predicated with the austerity model, has just tried to shave a little bit next year budgets in some spending commitments. However, it has been proven that it’s much more effective to cut completely individual programs. Estonia have rightly chosen this model by removing subsidies to health benefits or job placement benefits for young people.

So, I hope that the rest of Europe understand that real austerity it is completely compatible with growth and that by engaging in these painful but necessary measures we all can be enjoying strong growth rates soon. What it is necessary is not just smaller governments but also smarter governments. Up to this time, all the Keynesian approaches for trying to solve this crisis have been a completely disaster, maybe now it’s time to change the system and develop a real growth policy by shrinking the state and liberate private animal spirits.

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