In his last NYT column Paul Krugman discussed the current Dutch debate on austerity. According to estimates in February additional cuts of 4 billion euro (0.7% GDP) are necessary to reach the Maastricht criteria of 3% in 2014. He stated that these new deficit cuts are unnecessary and will hurt the Dutch economy furthermore. He cited Coen Teulings, the director of the CPB, and Bas Jacobs, professor of public finance at the Erasmus University Rotterdam, who are both sceptical about new austerity measures. At the end of his column he wonders why Dutch policymakers “can be sure that prominent macroeconomists were all wrong and bureaucrats with no predictive track record were right.” However, I am not sure that this policy makers are so wrong and consensus is that large as Krugman suggests, but first of all let me give the key arguments in this important Dutch debate.
In recent years there has been a large increase in Dutch public expenditures. As for previous years, for 2007 the public expenditure/GDP ratio was 45.4 percent. However, as automatic stabilizers did their work this ratio worsened due to the financial crisis in 2008 and 2009. In 2009, the public expenditure /GDP ratio was 51.0 percent, more than five percentage points higher than before the crisis. After these crisis years the public expenditure ratio fell only slightly to 50.1 percent in 2012. Despite the various Dutch austerity plans in recent years summing to a total of 46 billion euro (7½% GDP), the public expenditure/GDP ratio will not fall substantially. For 2014 the CPB estimates that this ratio will be 50.0 GDP. So, tax increases are more important for this austerity plans than spending cuts despite the rhetoric in the public debate. However, it is well-known from the international literature that tax increases hurt economic growth more strongly than spending cuts.
Remarkably, the situation in Germany is totally different. In Germany, in 2008 the public expenditure/GDP ratio was 44 percent, somewhat lower than in Netherlands. This can be explained by the lower German expenditure level for long-term care. In Germany an (elderly) person is only entitled to institutional care if home care and similar benefit forms are not adequate. Due to the financial crisis also in Germany the public expenditure /GDP ratio worsened to 48.0 percent, more than four percentage points higher than before the crisis. However, after the crisis this public expenditure ratio fell to 45 percent in 2012, five percentage points lower than the Netherlands. Not only long-term care, but also the labour market and the large increase of social security expenditures for is an important explanation for this. In addition, current GDP growth in the Netherlands is lower due to problems in the housing market.
In his column Krugman cited some previous work of Blanchard and de Grauwe: in the current recession the fiscal multiplier is higher and therefore cutting deficit does more damage than usual. However, there is much empirical evidence that fiscal multipliers for small open economies like the Netherlands are quite low (see for example Beetsma and Giuliodori (2011) in the Economic Journal). More importantly, postponing deficit cuts keeps the Dutch public sector unduly large and scares off international investors. In my view it is the only way out of the crisis: give space to the private sector and therefore prospects for growth will become better.Author : Raymond Gradus