PUBPOL 556 - Macroeconomics

Adam Cowing

Neal Jagtap

PUBPOL 556 - Macroeconomics

Prof. Dominguez

Austria: A Macroeconomic Analysis

I. Introduction

Austria is wealthy nation with a well-developed social market economy. One of the original members of the European Union (EU), Austria began transitioning its currency to the Euro in 1999, and its economy remains strongly tied to the rest of Europe.[1] As a developed economy, the service sector accounts for about 70% GDP, with industry accounting for most of the remaining GDP.[2] Like many other developed European nations, Austria’s population is nearly stagnant, with a low growth rate of 0.09%, which may be significant for its economy. With employment of only 3.88 million out of a population 8.19 million, fewer than half the population participates in the labor force.[3]

Austria’s economy has grown at a healthy pace in recent history, with GDP growing at 3.3% in 2006, though growth was slower in the early 2000s.[4] This poor growth appears due mostly to Europe’s slow economy at the time, as well as a general downturn in the world economy. Since 84 % of Austria’s trade occurs with the rest of Europe, its economy is strongly influenced by the rest of Europe.[5] Austria’s trade is fairly balanced, with exports nearly equaling imports. Other economic indicators reflect a healthy economy: (1) low inflation (1.7%);(2) low unemployment (4.9%);(3) nearly even trade balance.[6]

II. Eurozone Considerations

Monetary Policy

Because Austria is a Eurozone nation, its currency is fixed with the rest of the EU nations, with the Euro floating in relation to other currencies. This fixed exchange creates trade fluidity within EU nations, which is positive for Austria since so much of its trade occurs within the Eurozone. The downside of the fixed exchange rate among EU nations is that it removes monetary policy autonomy from Austria. As a result, monetary policy is not an option for policymaking at the country level, though the European Central Bank is responsible for monetary policy for the EU as a whole. The European Central Bank mandates price stability as a primary goalwith a secondary goal of economic growth. This could be an issue for a nation most concerned with promoting growth. In general, the Euro limits Austria to fiscal policy when trying to improve the economy. An added concern is that Austria is not able to influence its exchange rates, which could make its exports more attractive to trading partners. However, the advantages of the Eurozone outweigh these disadvantages.

Euro Standards

According to the Maastricht Treaty, EU nations are expected to meet certain standards in order to maintain EUmembership. Some of these standards, such as debt to GDP ratio may restrict Austria’s fiscal policy. Of course, the standards are intended to ensure the economic health and responsibility of the member states, so meeting the standards should not be regarded as a major restriction of fiscal authority. Additionally, almost all EU members violate at least part of the Maastricht Treaty, so the standards may more appropriately be seen as guidelines. Austria meets standards regarding inflation, interest rates, and deficits, but its debt to GDP ratio (about 63% in 2006)[7]exceeds the Maastricht debt to GDP threshold of 60%. In recent years, the government has been more fiscally conservative, however, and this debt to GDP ratio has actually decreased from higher levels. It’s unclear whether Austria will be able to dip below the 60% standard in coming years, but the government is unlikely to tolerate large deficits, which would add to the debt, increasing.

III. Austria’s Economic Challenges

Austria’s healthy per capita GDP and growth in GDP indicate a healthy Austrian economy. In addition, Austria has a bright economic outlook as its economy continues to expand and the Euro zone continues to provide opportunities to maintain a healthy trade with its neighbors. Despite its success, however, the Austrian economy does face some obstacles.

The largest challenge for Austria’s economy is its relatively low rate of consumption compared with other EU nations.[8] This is a measure of the well-being of individuals in Austrian society, and a low rate of consumption is a rough indicator of a relatively low level of well-being for society. As an indicator of quality of life, Austria could benefit from an increase in domestic consumption.

The greatest benefit of increasing domestic consumption is an increase in the amount of goods and services that individuals can consume. However, in the context of the Austrian economy, increasing domestic consumption has additional benefits unique to middle-size EU nations such as Austria.

Austria’s GDP primarily consists of consumption, government and private, investment, and net exports. As a result of considerable trade between Austria and its EU partners, Austria relies to a great extent on exports to foreign markets.[9] Austria’s near even trade balance is an accomplishment. This strength, however, reveals a vulnerability to foreign markets that could be troublesome for Austria in the future. If the economies of its European neighbors and American partners go into recession or slow growth, this in turn will likely deflate Austria’s export market and possibly turn a positive net export level into a negative drain on GDP. In this fashion Austria’s economy is dangerously vulnerable to economic shocks abroad; the economic health of the EU community overall is closely mirrored in the health of the Austrian economy.

Increasing domestic consumption will minimize this vulnerability. Austria’s economy will be more stable as it will rely less on the economic status of its neighbors since shocks in trading partner economies will not have as detrimental an effect on GDP. Due to its membership in the European Union, Austria will never fully insulate itself from the economic fortunes of its European trading partners. By increasing the portion of GDP consisting of domestic consumption, however, Austria will have a more secure economic future.

Consumption (government and private), investment or saving, and net exports constitute national economic output measured as GDP. The challenge for Austria is to increase the portion of GDP that is domestic consumption without decreasing GDP overall. This will require policies that have a minimal impact on net exports and investment and increase consumption appreciably.

IV. Options and Recommendations

A useful model of the Austrian economy takes into account levels of consumption and output and suggests an economic method of increasing consumption. Given the healthy level of capital formation in Austria[10], the Solow growth model is appropriate for explaining the functioning of the Austrian economy in the context of capital formation, investment, consumption, and output.

The Solow growth model divides output between consumption and investment. Output per worker is determined principally as a function of capital per worker, and output per worker increases as capital per worker increases. This is a diminishing function since the marginal effect of capital per worker diminishes as it increases. Capital formation is also balanced by depreciation in capital, so that in a steady state economy investment or saving in capital equals capital depreciation. This results in a constant level of capital per worker.

For developed nations such as Austria, the Solow growth model suggests a Golden Rule steady state condition where consumption is maximized. Such a state is reached by controlling capital per worker levels so that the marginal product of capital equals the rate of capital depreciation plus population growth. This is the only point at which consumption is maximized in a steady state economy. Figures A and B in the appendix illustrate this condition.

National Savings Adjustment Option

One possible prescription for an economy with high levels of capital per worker is to decrease the national savings rate. This decreases investment and capital and in turnlowers levels of capital per worker. This increases the marginal product of capital and moves the economy and capital levels closer to a Golden Rule steady state under the Solow model where consumption is maximized.

The national savings rate could be reduced by increasing government spending, decreasing taxes, or modifying tax policies to discourage savings. These actions would decrease the level of investment in capital and bring the economy closer to a Golden Rule steady state condition. The cost of such policies, however, would be a decrease in national output resulting from lower levels of capital.

A lower level of output in the Austrian economy may be desirable if it is balanced by an increase in consumption. This tradeoff, however, is not optimal if an alternative method can produce higher levels of consumption while holding output steady or possibly increasing it. Such a policymight adjust the labor portion of the capital per worker ratio rather than the capital stock and investment portion.

Labor Adjustment Option

Potential changes in the Austrian labor market may present such opportunities. By increasing the number of workers in the economy, the capital per worker ratio may decrease without decreases in the amount of national investment. This would raise the marginal product of capital such that it would equal the depreciation rate of capital plus population growth. As a result the Austrian economy would presumably reach the Golden Rule steady state condition where consumption is maximized.

The advantages of such an approach are both political and economic. Not only does a labor increase potentially avoid a decrease in national output, but it would also avoid politically sensitive increases in government spending or decreases in taxes. Both of these actions would likely raise public deficits and increase the burden on future generations. This fiscal imbalance is unnecessarily harmful to the long-term health of the Austrian economy. Another important effect of an increase in the Austrian public debt would be greater noncompliance with European Union standards. Adopting a plan of increasing consumption by increased government spending or lower taxes would reverse this positive course and endanger the opportunity for Austria to achieve greater compliance with EU standards.

Labor policies which lower the capital per worker ratio include encouraging greater working hours among the existing workforce and expanding the national labor supply through immigration. Expanding worker hours would be especially effective among older residents. This segment of the workforce has comparatively low rates of participation in the labor market compared to those in other OECD nations, and additional working years among this segment would decrease the capital per worker ratio with an infusion of experienced laborers.[11]

One unique possibility might involve using tax policy to encourage older residents to work more hours or later into life. Lowering the tax rates for wages earned by workers over age 60 might accomplish this goal. Encouraging retirement closer to or past the statutory age of 65 and raising the retirement age of women to 65 would also likely increase labor force participation among the elderly.

By relaxing entry restrictions, Austria would likely increase the size of the labor force through increased immigration. With a growth rate of 0.09%, immigration is crucial for ensuring that the Austrian population does not decrease in size. In order to increase the number of workers in Austria by an appreciable level, immigration policies will have to allow a higher number of either guest workers or foreign residents.[12] This is perhaps the most direct means of adjusting the capital per worker ratio to reach the Golden Rule steady state level of investment and maximize national consumption.

V. Limitations

Austria’s aging workforce, combined with a European culture that values leisure time, may present challenges to policies that seek to increase labor, particularly among older workers. Even if economic incentives are great, they may be no match for a culture that appreciates shorter work weeks and earlier retirement ages. Many Austrians retire early due to generous pension programs and the average work hours per week is relatively low, though not as low as some European countries. Austrian culture and history also contribute to a challenging political environment.[13]

Increasing immigration may be difficult, politically, in a homogeneous nation like Austria, where attitudes toward immigration and foreigners can be mixed. Some citizens believe that increased immigrant populations will create social costs.[14] This may seem reasonable, given the significant social safety nets in Austria’s social market economy. While increased immigration may increase available labor, those unable or unwilling to work would burden the state’s social programs. Regardless of whether this is true—in fact, it appears unlikely—it presents a political obstacle to an increased immigrant presence in a homogeneous nation. However, even if immigration regulations are made more liberal, Austria’s 0.09% population growth is so low that a short labor supply may continue to present a challenge for robust growth.

VI. Conclusion

Like other European nations, Austria maintains a well-developed economy but is not without challenges. Following a short period of slow growth, Austria’s output is at a healthy level but its aging labor force and relatively low consumption rates threaten optimal growth. Meanwhile, although the European Union has brought many advantages, the EU’s unification of monetary policy restricts the tools available to Austrian policymakers. As a result, fiscal policies will have to suffice. Tax policies that increase incentives for older citizens to work present one option for boosting the labor supply. Additionally, non-fiscal policies can increase the supply of immigrant laborers, which could increase output and consumption in the long run. However, because political and cultural obstacles threaten to prevent such policies from taking form, Austria may have to take a hard look at its priorities if it wants to set itself up for even stronger, more sustainable economic growth.

1

[1]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[2]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[3]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[4]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[5] United States Department of State, “Background Notes: Austria.” Department of State website,

[6]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[7]Central Intelligence Agency, “World Factbook: Austria.” CIA website.

[8] Austrian consumption (government and private) as a portion of GDP growth for 2006 has been approximately 1.18% out of a GDP growth rate of 3.2%. These statistics for 2004-2006 are reported by the Oesterreichische Nationalbank (Austrian National Bank) at

[9] Austrian net exports (exports minus imports) as a portion of GDP growth for 2006 are approximately 1.29% out of a GDP growth rate of 3.2%. These statistics for 2004-2006 are reported by the Oesterreichische Nationalbank (Austrian National Bank) at Austria has an even trade balance. It also has a higher portion of GDP attributable to investment (over 21%) than the EU average and many other EU member states (e.g. Germany, United Kingdom, France), indicating that its GDP consists of more investment and less consumption relative to other nations.

[10] Austrian levels of capital stock for years 1960-2002 as measured in 1995 units of national currency are provided by the Kiel Institute for World Economy and can be found in Excel format at

[11] See “OECD urges Austria to do more to encourage older people to work longer” at In addition, an OECD report diagrams the relatively low number of working hours among Austria’s elderly. See

[12] For a discussion of Austrian immigration and labor policies, see report by the European Foundation for the Improvement of Living and Working Conditions entitled “Labour immigration examined,” found at

[13]OECD. “Austria.” Statistics. OECD website.

[14]Library of Congress. “Austria.” Library of Congress Country Studies. Country Studies.