Good advice for small countries

It pays to keep your head down and keep out of trouble – that’s advice from one small European country to another at the bottom of the globe.

I’ve heard a lot about some of eastern Europe’s brilliant economic managers who have steered their countries out of communism and then faced the eurozone crisis. Many have done so by avoiding government deficits and following sound monetary policies.

But it was not until this week I met one: Latvia’s Andris Piebalgs, who was attending the relative calm of a Pacific countries energy conference as the EU Commissioner for Development.

His career is not atypical of a Baltic politician, starting as a schoolteacher under Soviet rule, becoming minister of education under the first post-communist government and then moving up eventually to finance minister and deputy prime minister in the mid-1990s.

A polyglot, he speaks fluent English as well as French, German and Russian. His speech to the NZ Europe Business Council luncheon was animated and without notes, covering everything you needed to know about government finances, the eurozone and the role of small countries (yes, there was a little bit about the Pacific).

But the kernel of Mr Piebalgs’ speech was about the dynamics of the eurozone and the difficulty of merging 27 nations into one. It is not easy, nor will occur quickly, he says, making a plea for patience.

When the global financial crisis struck, which he blames on the US financial system, the small European nations had no choice but adopt austerity policies. Not all did so, course, which has led to the eurozone crisis; Cyprus being a case in point. The biggest problems are those economies considered “too big to fail,” illustrating the need for small countries to look out for themselves first.

It depends on what sort of austerity
Incidentally, theoretical justification for cutting both government spending AND taxes – essentially the policies followed by supplysiders during the Reagan administration in the US – has come in recent studies of austerity policies.

It compares them with those of the Keynesians – usually those on the left of politics – who favour big dollops of government spending and higher deficits.

This work, which is summarised by Wall Street Journal columnist Daniel Henninger, who quotes the work of Harvard economist Alberto Alesina.

While the conventional Keynesian view is to push up government spending and taxes,

Mr Alesina has identified the alternative. His, and others', work the past decade with how struggling economies revive suggests that the Obama spend-more solution is the opposite of what the US should be doing.

Mr Henning’s point is that Mr Alesina and his mainly fellow Italian colleagues base their findings on the history of fiscal plans that 17 OECD governments enacted between 1978 and 2009.

Their conclusion:
"Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments [that is, cuts] have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments [tax increases] have been associated with prolonged and deep recessions."

Henning summarises:
"Fiscal plans based on large, permanent spending cuts are associated with renewed growth more than any alternative policy mix that has been tried. Indeed, spending cuts without big tax increases look to be the only thing that really works."

This is precisely the formula followed by Mr Piebalgs and others in Latvia, Estonia and elsewhere (such as Canada).

For that reason, Mr Piebalgs says the crisis is not systemic but rather one of different nations taking different paths at a different pace in the integration process, which he describes as “complex and difficult;” something never attempted before in history.

All of the Baltic countries took their medicine and have survived with expanding economies. Latvia is keen on the euro and will join in January next year, following Estonia (2011).

Silencing the Merchants of Doom
On the home front, the merchants of doom have suddenly gone quiet. No wonder, the last quarter of 2012 was a pearler and no one picked it – GDP growth was twice the rate forecast by the Reserve Bank just a week before last week’s announcement.

But the signs were there for all to see.  At the beginning of the year, in a fit of optimism brought on I suspect by the fine weather, this column was called,
“We don’t know how lucky we are” (Jan 4).

It commented on a quality-of-life survey in The Economist that was last carried out in 1988. It found New Zealand had surged from 18th to seventh.

It was also obvious to me – if not most of the commentariat bashing the government – that the economy was running hot despite the news being dominated by factory closures, job losses and a so-called “high” dollar.

The economic good news continued over the summer, though the unpredicted drought will be felt in the next round of figures. But it pays to keep an eye on the bigger picture and The Economist index does that because it links the results of subjective life-satisfaction surveys – how happy people say they are – to objective determinants of the quality of life across countries.

Further backing for this has come in the just-released but unpublicised 2013 Human Development Index, prepared on the watch of Helen Clark, the UN’s human development commissioner. It shows New Zealand in sixth place after Norway, Australia, the US, the Netherlands and Germany.

This is a remarkable achievement and supports The Economist’s finding that

“Being rich helps more than anything else, but it is not all that counts  things like crime and trust in public institutions matter too.”

Readers may wish to reflect on why and how these changes occurred and whether socialist claims in New Zealand about “failed policies of the past” have any substance.

Certainly, on this evidence, those claims are plainly false. The examples of other top countries, and their adherence to pro-business reforms combined with sound social policies, speak for themselves.