The global economic recession that began in 2008 has prompted sundry reactions from governments across the world. While increasing government spending was the initial reaction of most leaders (most notably in the United States and China), debates have recently focused on the success of stimulus compared to austerity measures. The reason stimulus is more effective is because during economic recession both business investment and consumer spending drop so dramatically that government must spend money in order to maintain economic stability. Spain’s reaction to the global recession has provided empirical proof that austerity measures do not lead to economic recovery, while Germany’s reaction provides evidence of stimulus successfully bringing a nation out of recession, or at least into economic stability.
The global economy, in the 21st century, is powered by spending. People in one country make money and use it to buy goods manufactured in another country. Workers receive money for manufacturing these goods, and in turn go out and spend that money as well. Businesses also spend money when they invest in buying new equipment, raw materials, office supplies, and services. Government pumps money into the economy when it pays for infrastructure, government employees, and social programs. So consumer spending, business investments, and government spending make up three key elements to economic growth and stability. In economic recessions, consumer spending and business investment decrease and government must make up for that decrease by spending more than usual or risk further economic downturn (Krugman 2009). Austerity measures are policies that cut government spending and often increase taxes in an attempt to decrease government debt. The idea is that a government with sound finances will generate confidence from its lenders and its consumers, and maintain economic stability. This does not, however, prove to be absolutely true.
Spain’s reaction to the global recession was initially one of the largest stimulus programs in Europe, but quickly became a harsh austerity measure that damaged Spain’s recovery. Including increased unemployment aid, Spain’s stimulus was €82 billion, or 11.2% of their GDP. It included tax cuts as well as money for infrastructure projects and to help the auto industry. Later in 2009, however, Spain bowed to pressure from the European Union to get its finances under control by withdrawing some of the stimulus planned and implementing austerity measures instead. They increased taxes and cut government spending in an attempt to reduce the budget deficit from 11.2% in 2009 to 3% in 2013. The Spanish economy, however, couldn’t afford to make these cuts because in order to get out of economic recession they would have to make major changes to their institutions. They needed to invest heavily in education, research, and development since they weren’t leaders in productivity, quality, innovation, or educational achievement (Spanish citizens complete three less years of schooling on average than Germans or Americans). The tax increases and spending cuts simply exacerbated these problems and Spain slipped into further economic recession (Salmon 2010). In 2009 and 2010, despite austerity measures, Spain’s GDP growth was negative, and unemployment has steadily risen from a low of 8.3% in 2007 to 20.2% in 2010 (EuroStat 2010; OECD 2011).
Germany is often cited as an example of austerity measures bringing a nation’s economy out of recession, but Germany’s recovery is actually evidence of the power of stimulus. While it is true that Germany has been making vociferous arguments for austerity more recently, they did not do the same when the fate of their economy was uncertain. In 2008, Germany passed a €31 billion stimulus package and also increased their debt ceiling by €8 billion (Forbes 2008). Germany’s GDP growth was negative in 2009 during the worst of the recession but returned to normal by 2010 (EuroStat 2010). Unemployment has also been dropping in Germany, even returning to pre-recession levels by the end of 2010 (OECD 2011).
There are two reasons why Germany’s rebound has been so successful. One is because of a unique short time worker program imbedded in their stimulus package. It allowed companies to decrease people’s working hours dramatically without laying off anyone, and the government paid 60% of the workers’ lost wages. This way companies could save just as much money as laying people off, but not lose any of the talent that they wanted to keep. Also, money remained in German pockets as if they were still fully employed so consumer spending remained near pre-recession levels and consumer confidence didn’t take a huge dip as in most countries (Kopinski 2010). The other reason for Germany’s success is that they export to nations that passed large stimulus packages (notably the United States and China). Since 26.8% of German GDP is based in industry, the stimulus programs in the U.S. and China have fueled demand for German manufactured goods and put Germans back to work (U.S. Department of State; Evans 2011).
One can look to both the present and the past to see how preferable stimulus is to austerity. The oil supply shock of 1973 to 1982 had the same effect on the economies of both Western Europe and the United States. After 1982, however, the U.S. started spending money and creating deficits almost as fast as Europe was cutting spending and creating surpluses. The 1980’s were a time of economic prosperity for the U.S., while Western Europe saw unemployment rates nearly double (Blanchard 1987). It became clear then that stimulus was the best way to climb out of recession. Recent events in Spain have proven how austerity can worsen an already bad situation, while events in Germany have shown that stimulus – by both a nation and its trade partners – can successfully bring a country out of recession. History and recent evidence shows that in this time of global recession it is stimulus that will keep the world from falling into another Great Depression.
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