For the past few years, economists and policymakers have been locked in a philosophical debate: Austerity vs. Stimulus.
Another test of the competing theories kicked off this week as Spain announced new tax hikes and spending cuts while China increased government spending in order to jump-start its economy.
If recent history is any guide, China's economy will get a short-term boost from the stimulus while Spain will fall further into its economic morass as a result of their respective choices.
Of course, these two countries find themselves in starkly different positions: China is sitting on huge surplus and thus can "prime the pump" without going into debt while Spain is struggling to bring down its budget deficit, which hit 8.9% in 2011.
Indeed, the latest austerity measures -- the fourth Prime Minister Mariano Roy has announced in roughly 7 months -- are the price Spain is being forced to pay for the EU's decision to provide an accelerated $123 billion bailout to the nation's struggling banks.
"We have very little room to choose," Rajoy said before the Spanish parliament. "I pledged to cut taxes and now I'm raising them. But the circumstances have changed and I have to adapt to them."
Totaling around $80 billion, Spain announced a series of measures designed to bring down its budget deficit to 6.3% this year and 4.5% in 2013, including:
- Raising the Value Added Tax to 21% from 18%.
- Taxes on energy consumption.
- Reversing property tax cuts granted last year.
- Cutting jobless benefits.
- Cutting pay for state employees by 7%.
With unemployment already near 25% in Spain and its banks saddled with billions of bad loans, it's hard to see how raising taxes and cutting benefits will do anything but harm its already battered economy, at least in the near-term. If Spain follows Greece's example, more austerity will lead to deeper economic stagnation and societal upheaval.
Opposition leaders objected to Rajoy's move and the nation's mining union marched in protest.
"These measures are not pleasant, but they are necessary," Rajoy told parliament. "Our public spending exceeds our income by tens of billions of euros."
Government spending exceeding income is a problem in America too. Many here believe we should pursue austerity measures now -- before the financial markets force us to, as has been the case in Greece, Spain and Portugal.
But comparing America to Greece (or Spain) misses a critical reality: The U.S. controls its own currency and is currently paying record-low rates on U.S. Treasuries. As a result, there's a strong case to be made America should issue more debt now and use the proceeds to rebuild infrastructure, which puts people to work now and has tangible economic benefits for many years following.
Unfortunately, any such proposal is D.O.A. in Washington, where proponents of austerity seem willingly blind to the results of Europe's experiment with the strategy.