Patrick Luciani: How austerity saved Greece

Austerity is more effective at maintaining or increasing growth than tax increases alone
In this photo taken on Wednesday, July 1, 2015, pensioners try to get a number to enter inside a bank in Athens. Daniel Ochoa de Olza/AP Photo.

In the latest Hub book review, Patrick Luciani dives into two books on the topic of austerity, examining their theses in light of a relevant, real-world example of these policies in action: the case study of Greece embracing austerity to kickstart its current economic resurgence. The two books are The Capital Order: How Economists Invented Austerity and Paved the Way to Fascism by Clara E. Mattei (The University of Chicago Press, 2022) and Austerity: When It Works and When It Doesn’t, by Alberto Alesina, Carlo Favero, and Francesco Giavazzi (Princeton University Press, 2019).

It’s remarkable to witness Greece’s economic resurgence in Europe. From being on the verge of being kicked out of the Eurozone, Greece’s economy is now growing faster than the European average, unemployment has been halved, and its debt has transitioned from junk to investment grade, attracting more foreign investment.

After the financial collapse of 2008, government spending spiralled out of control, pushing the national debt to a staggering 180 percent of GDP, while trombone players and pastry chefs got to retire at 50 on government pensions. Unions also ran amok in state-owned and heavily regulated industries where employees at Olympic Airlines and their families enjoyed free global travel. A staggering 80 percent of the budget in the defence ministry went to administration. Tax evasion had become a national sport, particularly among the wealthy, where doctors and professionals got paid under the table in envelopes stuffed with cash. 

In early 2015, in the midst of Greece’s third international bailout, the newly elected anti-austerity party, Syriza, decided to take a bold step. They appointed the swashbuckling Yanis Varufakis, a Marxist economist, as finance minister to negotiate for better terms with the Troika, the European Commission, the European Central Bank, and the IMF. The negotiations didn’t go well as Varufakis insisted on educating the Troika on how they were exploiting Greece. The Germans, who were paying the bills, would have none of it. 

Prime Minister Alexis Tsipras finally faced reality. After only five months in office, he fired his arrogant finance minister and agreed to strict austerity measures for Greece’s third bailout. A deep recession quickly followed, but the economy started to turn around. 

According to the anti-austerity crowd, this wasn’t supposed to happen. They put their faith in more spending, not less. Many on the Left claim that austerity is a conspiracy to save capitalism from itself by protecting corporate profits through the exploitation of the working classes. Clara E. Mattei makes this argument in her new book The Capital Order: How Economists Invented Austerity and Paved the Way to Fascism. Its subtitle pretty much gives away her position. Even John Maynard Keynes comes in for a scolding in salvaging capitalism.

Mattei, who teaches at the New School for Social Research, argues that austerity undermines workers to rescue profits and capitalism. She goes back to the First World War, showing how economists in Britain and Italy deceived their people into believing that austerity was good for society. She starts with the thesis that socialism is better than capitalism but that it is never really given a chance to flourish; after all, in a 2015 referendum in Greece, a majority opposed austerity. No surprise there since people would rather have others pay for their benefits. She forgets to mention that in the same year, the Greeks themselves re-elected Tsipras and his Syriza party.  

Whether austerity programs work or not is essentially an empirical question. For that, we turn to another book, Austerity: When It Works and When It Doesn’t, by Harvard economist Alberto Alesina and his co-authors at Bocconi University in Milan, Carlo Favero and Francesco Giavazzi. Rather than speculate from a pre-determined political position as Mattei does, Alesina et al. ask if cutting government spending is more effective than higher taxes in forgone output and employment. For an answer, the authors analyze the data from 16 advanced countries and their experience with austerity programs. 

The authors conclude that austerity measures are effective when governments face financial crises. Substantial cuts in spending (expenditure-based austerity) tend to impose lower costs than programs that increase taxes. This was demonstrated in the U.K. and Ireland after 2008, where their economies outperformed other European countries.

In Canada, the austerity programs in the 1990s under both Conservatives and Liberals showed growth rates above 3 percent while debt over GDP also started to decrease. Italy, a potential candidate for austerity measures, has never tried it, and its economy hasn’t grown for the last two decades. Austerity also shows that politicians who pursue vital austerity programs don’t always suffer the political consequences. The book gets high praise for its scholarship and will “serve as a touchstone for future studies.”

Albert Alessina, who passed away in 2022 at the age of 63, reminded us that austerity programs are only necessary when governments make economic policy mistakes that can no longer be ignored. When this happens, the evidence suggests that austerity is more effective at maintaining or increasing growth than tax increases alone. Greece was saved by following that formula rather than the progressive program of more spending. 

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