We are hearing a great deal at the moment about government austerity, especially in Europe, as various states attempt to deal with massive budget crises resulting from a combination of low growth, bad demographics, and overly rich welfare programs. European Central Bank president Mario Draghi recently gave an interview to the Wall Street Journal in which he made things quite clear:

WSJ: Austerity means different things, what’s good and what’s bad austerity?

Draghi: In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.

WSJ: Bad austerity?

Draghi: The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth.

Draghi’s insight is one American policymakers need to understand. If the government is spending a great deal of money simply to put dollars in people’s pockets, pay salaries, etc., then we are not getting nearly the good we could obtain with better government spending AND we go bust trying to afford it. The superior situation is one in which you can keep taxes low and government spending is on items that last and have the potential to spur growth into the future.

For example, consider the difference between a government paying for things like the interstate highway system or the Tennessee Valley Authority mechanisms of energy generation versus a government that sends out a lot of entitlement checks. The first government will see substantial returns over the long run. The second one is mostly just poorer at the end of the year.

In America, we used to have a government of the first type, but we increasingly have a government of the second type. I opposed the president’s nearly $1 trillion stimulus package, but it would have been a lot easier to swallow if it had been aimed at some truly valuable investment such as reinforcing America’s physical infrastructure (highways, electrical grid, etc.) rather than simply trying to push out cash as quickly as possible.