Austerity aims to use harsh measures – tax increases, mass unemployment, reduction in public services, cuts to support for the poor and needy – so as to bring “balance” to the relationship between Government spending and government revenue. It is generally pursued due to the understanding by some that the debt : GDP ratio and level of annual deficit for Government is too high. Such “austerians” are committed to balanced or near balanced budgets and to the idea of small governments and the efficiency of markets.
Austerians tend also to be committed to what is known as “trickle down” economics – lowering taxes on the rich and corporations, since doing so enables them to invest in an economy and stimulate growth. They also believe in using austerity to trigger “confidence” amongst investors in the economy and its firms. They suggest that high levels of public debt reduce confidence, austerity increases confidence.
The Problem with Austerity
Austerity tends to increase unemployment and, by doing so, lower tax revenues for government. High unemployment and a government unable to meet budget targets because of lower than expected revenues leads to a lowering of investment, protests by citizens and a lowering of market expectations and confidence.
This in turn leads to a lowering of spending on goods and services, which further reduces economic activity, tax revenues and growth. Governments generally miss targets, as can be seen in the case of the UK, Greece, Spain, France, Ireland and Portugal. This sometimes leads rating agencies to lower their ratings of Government bonds, which further adds to economic pressure and increases the need for austerity in the eyes of austerians.
At the present time, only Canada and Germany has maintained the highest possible rating by all of the bond rating agencies.
The second problem with austerity is that it leads to massive unemployment. This is both a moral issue – how can government take actions which knowingly increase inequality, poverty and misery? – and an economic one. The higher the level of unemployment the lower the demand for goods and services. This is a vicious cycle, triggered by austerity. In Europe at this time, there are some 20 million unemployed and many young people aged between 18 and 24 have no realistic prospect of employment and have been unemployed for two years or more.
The third problem is the unintended consequences of austerity measures. For example, major cuts in capital expenditure on roads, bridges, schools, hospitals and infrastructure leads to major infrastructure deficits, overcrowding in schools and hospitals and lower educational performance and health outcomes, lowering the attractiveness of the social infrastructure. In the US at this time, a large number of bridges are so fragile that they may soon be declared unsafe.
Another example is that of wage freezes. When Britain imposed wage freezes on all workers during the Callaghan era, employers used “perks” (cars, vacation time, benefits packages and pension deals) to attract and retain workers. When the wage freeze ended some time later, these “perks” were embedded and workers now sought to “catch up” wages “lost” during the freeze. This led to inflation and the lack of competitiveness of many sectors of the UK economy. A temporary austerity fix led to long term challenges for employers and industry.
A related problem is that there is no compelling evidence that trickle down economics works. Lowering taxes on the rich so as to encourage investment simply means that they are richer and they will find more places to stash their cash which they don’t have to invest.
The final problem with austerity is that it doesn’t work. Greece is no nearer to being a stable, vibrant economy than it was before the EU bail-out and austerity measures. Neither is Spain or Portugal. The UK is probably the leading example of austerity as a failed strategy.
An Alternative to Austerity
The Keynsian approach to the recessionary forces at play at this time is not to cut public spending, but to increase it in focused ways so as to stimulate demand. Focused public spending on infrastructure and needed long term investments – education, for example, but also science, technology and innovation – leads to a growth in economic activity, employment and demand for goods and services. This in turn creates employment which increases tax revenues, in corporate taxes, in sales taxes and income taxes. If non future focused spending patterns are adjusted and lowered – holding the growth of spending on health, for example – occur at the same time, then balance can be restored.
There is also no such thing as the “confidence fairy”, as the Nobel prize winning economists Paul Krugman likes to point out. Markets do what markets do and their behaviour is rarely a rational response to public policy, evidence or the strategic intentions of firms or governments. Psychologists can better explain herd behaviour.
Psychology
One interesting aspect of being an austerian is that evidence that austerity is not working makes no difference to the view that it is the only option. Paul Krugman, Nobel prize winning economists and journalist, frequently observes that very serious people who support austerity are so convinced that they are right (after all, they are very serious people), that no amount of evidence that their claims are wrong or that there is a paucity of data to support their view will change their mind.
Daniel Kahneman, in his prize winning book Think Fast and Slow , suggests that this is a psychological problem. He says
..overconfident professionals sincerely believe they have expertise, act as experts and look like experts. You will have to struggle to remind yourself that they may be in the grip of an illusion.”
He also observes:
“Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed. The mind does not digest them”.
So austerity is not working in Europe and yet “it is the only policy choice on the table”. Such group think is getting in the way of sensible economic action.
Stephen Murgatroyd, Chief Scout