Readers know I divide the world of economics into three schools. There is the Austrian or “Tough Love” school that argues a balanced budget is essential every year. There is the Keynesian school that argues deficit spending is essential when the economy is weak. Then, there is the Supply-side school that argues a cut in the highest marginal tax rate is always essential. No one school is better or worse than the others. Different situations demand different solutions.
Back during the dark ages of 2009, there was fear that the world financial system was bordering on collapse. In the U.S., we enacted the $787 billion stimulus bill. That was a Keynesian solution, which I supported, despite being an Austrian-at-heart.
In eastern Europe, there is the small (1.2 million people) nation of Estonia. They took the Austrian approach of cutting spending AND raising taxes. The government froze all pensions, cut salaries by 10%, and raised their value-added-tax a whopping 2%. They did not borrow money to keep going. In other words, they did not borrow money to pacify their people. Their debt remained about 7% of GDP, compared to our debt level of approximately 100%.
Despite our stimulus bill, our GDP shrank 6%. The Estonian GDP shrank a stunning 14% — over twice as bad as ours. Unemployment soared to a heart-breaking 16%! The Estonian people suffered greatly . . .
Today, unemployment in Estonia is “only” 10.8% but dropping. It is dropping because GDP is growing — rapidly — 7.5% last year (think China-like growth), compared to the U.S. rate of about 2%. The Estonian people suffered greatly . . . but not for long! They just ripped-off the scab!
When facing dire economic circumstances, the U.S. took a Keynesian approach of increasing debt. Estonia took the Austrian approach of cutting spending AND raising taxes, rebuking the Supply-siders. So, which is the right approach?
As always, it depends . . . it depends on how the populations will react. Can you imagine the outcry if we froze all pensions, cut government salaries 10%, and raised taxes significantly? The Estonia people accepted hardship stoically, which permitted their government to do the right thing. I don’t think anyone ever called Americans stoic.
Now, would you rather be President of the U.S. or Estonia?