Stimulus vs. austerity

John Maynard Keynes allegedly once said that, in a recession, it was smart for the US government to pay a man to dig a hole and then pay him again to close it. True? Well, that depends…

If that man spends all the money he earned on the purchase of a new car imported from Japan, the government has stimulated the Japanese economy and not the American one (except, perhaps, for some employees at car importing firms). If, on the other hand, that man spends all his money on purchases from an American supplier who, in turn, makes all of his purchases from American suppliers, and so forth…, well, then it is a stimulus for the domestic economy.

This simple example shows that it is very irresponsible to simply hammer in the headlines of stimulus versus austerity. It all depends on what stimulus money is spent on and where austerity hits. Thousands of businesses have closed in Greece since the beginning of the crisis. To make a purely theoretical example out of this: if all these business had been selling imported stuff and if all the resources set free could have been redeployed in new businesses involved with new domestic production and exports, this would have been the most perfect example of “creative destruction”. Obviously, reality turned out different from theory.

Some argue that the Eurozone must become a transfer union so that economies like that of Greece’s can get back on their feet again. Well, it helps to remember that the entire EU has been a transfer union from the start. I recently read (but cannot confirm it) that Greece has received 135 BEUR (in current Euros) in grants from the EU since it joined it. Only the four times larger Spain received a slightly larger amount. Those 135 BEUR are equivalent to about 60% of Greece’s current GDP. To put this into perspective: the often-cited Marshall Plan was equivalent to 0,5% of German GDP for a period of 4 years, that is about 2% of GDP for the total of 4 years.

The Marshall Plan was a form of seed-financing: drop a little gasoline on the charcoals so that the fire gets going. If the charcoals are not put into the right place or if there is no one to manage the fire, the gasoline will be nothing other than a strawfire.

When the government’s role as a “stimulator” is forced to shrink, someone else has to fill the resulting vacuum at least partially in order to avoid what we see in Greece today. To keep the government’s role from shrinking is self-defeating if the money it spends is spent on the wrong purposes. The external accounts of Greece show quite clearly: imports have come down in the last couple of years due to the recession. Should the government bring more money into circulation through more spending, much of that money would leave the country right away for imports. That’s like giving a hungry man a fish instead of showing him how to fish.

I have argued since the beginning of this blog that the above-described vacuum must be filled largely by the private sector and the only quick-growth options the Greek economy has are import substitution and export expansion. Suppose the government were to establish Special Economic Zones near Athens and Thessaloniki, large population centers with many unemployed, and invited private sector investments there for the above-mentioned purposes, new jobs for unemployed would come into existence. An employee loses his job in a shop selling imported stuff but has the chance to take up a new job in a business producing that stuff which was previously imported.

Two things are required for such Special Economic Zones: (a) an absolutely internationally competitive business framework and (b) guarantees for new investors for the political risk arising from political developments in Greece. Since investors would not trust the guarantee of the Greek state nowadays, those guarantees would have to come from the EU.

That way, the EU would use its strength not to transfer tax payers’ money to Greece for spending but, instead, to facilitate the transfer of private sector money to Greece for investment.

Last questions: what’s the point of investing in new production when demand in and all around Greece is evaporating? Well, import substitution does not require new demand. It only covers existing demand from different sources. And regarding new exports, Greece’s current share of EU exports is so small that an increase which is significant for Greece might not even be noticed in the overall picture. Greece would have to apply guerilla tactics instead of moving like a large army!

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10 Responses to Stimulus vs. austerity

  1. Phoevos says:

    Klaus:Let's first understand the problem in this false "sin & redemption" climate.I think you will find convincing evidence here that Greece is not the problem. It's Spain and Hellenising the crisis does no good to either Greece or Germany. Plassaras

  2. kleingut says:

    Welcome to this blog, Dean! If you think this post is part of a "sin & redemption" climate, please point me to the relevant paragraphs. I would like to think that this post – as well as my entire blog – is more of a "respect & responsibility" climate.On the demagogic phrase "the problem is NOT Greece", I have commented in the post below.

  3. Gemma says:

    Good morning, Herr my mind, the bigger picture is not about austerity or stimulus at all. It is about how to deal with the corruption in Greece's governmental administration. A special economic zone would be a great idea, as long as the money went into business and not just into the pockets of local bureaucrats. You are quite right about the guerrilla tactics that are needed to bounce Greece's economy into life. The problem is that most of the people who could do that live in Chicago. Whilst I am sure they would like to help, I doubt it would go as far as moving back home to an economy that they found difficult to do business in. What is more, your suggestion goes for any European country, it is just that Greece is the most needy right now.

  4. Phoevos says:

    Klaus:Krugman says that the whole narrative is wrong in the euro crisis (circa minute 11:30 of the video above). He basically says that the euro crisis is not "about countries living beyond their means" which how Germany wishes the issue to be framed. When the crisis started Spain did not fit any such description(by almost all metrics Spain was a model country); yet now Spain is THE problem and certainly in the eye of the storm.I further suggest that the approx. 1hr video at Krugman's home court and in front of a Yale audience is pretty much negating all almost all of your hypotheses. And unless we get right what it is that we ought to debate about, this focus on Greece seems a bit disjointed.Dean Plassaras

  5. kleingut says:

    Good thing you quote Krugman because he always stresses that he excepts Greece from his conclusion that it is a fallacy that it all started with government overspending (and I agree with him on that). But let's make sure we define "overspending" before we get further because if you miss the interpretation there, then you miss the solution, too. A country is overspending when it spends more abroad than it earns abroad (current account deficit). If the current account were in balance, then the government could overspend whatever it wants; it remains an internal problem of the country. See my link below.

  6. Renzie Doem says:

    Hello Mr. Klaus,Your articles are very easy to understand for us who has a few background on Macroeconomics.May I ask your opinion regarding the likelihood of Greece leaving the Euro?

  7. Renzie Doem says:

    Dear Mr. Klaus,Your articles are are very easy to understand and insightful.May I know your opinion regarding the likelihood of Greece leaving the Euro?

  8. kleingut says:

    Treaty-wise, no country can be expelled from Eurozone. Greece would have to declare departure unilaterally and I believe that Greece would first have to leave EU (treaty-wise, that is).If Greece left Eurozone, it would lose lifeline to Euro-liquidity but avoid long, drawn-out adjustment process. Instead, it would have the adjustment practically overnight and perhaps worse. With the comforting thought that, once the pain is over in 2 or 3 years, Greece could return to living a life within its means but far below the living standard it enjoys now.If Greece ever decided to leave the Eurozone, I would be very surprised.

  9. Renzie Doem says:

    Your thoughts are very interesting sir. It's the first time I came across a person that is considering the Greece exit least likely.You might be interested in reading this person's thoughts about the matter:

  10. kleingut says:

    The paper is very correct! If Greece left the Euro, there would be havoc for quite some time (everyone says at least 2 years!). Thereafter, real market forces would have driven the Greek living standard back to a level which its economy justifies. Probably more like the 1960s but at that level Greeks would get on swimmingly within their means.Greece's living standard today is light years better than that. Holding on to the Euro and going through enormous reforms and terrifically more pains would keep the hope alive (note: the hope, not the certainty!) that much of today's living standard can be kept for the next generation. Personally, I would think what's best for my children's generation and less of the cost to me. If Greeks don't do that, their children will enjoy their lives outside of Greece.

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