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The Wrong Medicine: Why Fiscal Austerity Is a Bad Idea for a Slumping Economy
As protesters take to the streets in Europe to oppose government spending cuts, proponents of austerity in the United States and Europe claim that immediate moves to reduce government deficits are the way to renewed economic growth. Accepting a little pain now, they argue, will reduce the pain in the long run.
Those familiar with Keynesian economic theory will find the austerity-to-growth claims surprising. Fiscal austerity, or a “contractionary fiscal policy,” means either spending cuts or tax increases, or a combination of the two. Reductions in government spending reduce total demand directly. Government spending on real goods and services is just as much a part of total demand as private consumption or investment spending. Spending cuts can also reduce demand indirectly, as those who would have received income as a result of government spending cut back on their spending as well. Tax increases reduce demand by reducing the disposable incomes of private individuals, who then spend less. Either way, lower demand for goods and services can translate into less output and employment.
How, then, is fiscal contraction supposed to lead to growth? Austerity proponents argue that balancing government budgets and reducing public debt will boost private-sector “confidence.” As public debt increases, the argument goes, people may become wary about spending, since they will be on the hook (through taxes) to pay down that debt in the future. Individuals and firms will spend more freely now if they do not have future taxes hanging over their heads.
The pro-austerity faction has relied heavily on a few recent studies, especially one by Harvard economists Alberto Alesina and Silvia Ardagna claiming to have identified 26 cases in which fiscal contraction led to renewed growth. This conclusion, however, has not stood up to careful scrutiny. Economists Arjun Jayadev and Mike Konczal, after studying the cases that Alesina and Ardagna describe, find that “in virtually none did the country a) reduce the deficit when the economy was in a slump and b) increase growth rates while reducing the debt-to-GDP ratio.”
In 20 of the 26 cases, Jayadev and Konczal argue, the government did not carry out a fiscal contraction during the low (or “slump”) phase of a business cycle. (Budgets are much easier to balance, and debt easier to pay down, during the “boom” phase of a business cycle. With output and incomes high, total tax revenue is bound to be high as well, while expenditures on things like unemployment insurance are bound to be low.) Out of the six remaining cases, they find, the rate of economic growth actually declined in five. Looking at a broader sample of countries engaging in austerity, Jayadev and Konczal find that, in most cases, deficit cutting during a slump results in lower growth. Even in most of the cases where the growth rate did increase, the ratio of debt to gross domestic product actually increased as well. This suggests that, even if fiscal austerity had some effect in reducing the growth of total debt, it also resulted in such weak overall economic growth that the debt burden (relative to GDP) continued to rise.
Austerity can actually undermine a country’s ability to reduce its government deficit and debt, and increase the interest rates a government is forced to pay on its debt. A government’s ability to borrow depends on the size and stability of the economy that it has the power to tax. By cutting demand, a government may prolong a slump. The longer the slump goes on, the longer tax revenues will remain below normal, and the longer the government will have above-normal expenditures on items like unemployment insurance. If investors conclude that the slump is bound to go on for a long time, and that the government will therefore be a bad credit risk for the foreseeable future, they will demand a higher interest rate (to compensate them for that risk). This, too, will tend to increase the government’s debt burden.
Austerity advocates present themselves as tough-minded and pragmatic—not flinching from the painful sacrifices necessary for a better future. The facts might suggest, instead, that fiscal austerity during a slump amounts to cutting off one’s nose to spite one’s face. Except that, as the protests raging in Europe show, it is other people’s noses that the pro-austerity faction aims to lop off.
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Show AllIt seems to me that it is misinvestment that causes recessions: investments that didn't yield returns results in debt. What has America invested in in the last 20 years? Rich people (tax cuts), war, and the WallStreet casino (deregulation). Hence, if we are now in a deep recession, what else can we blame? (I know we are blaming big government and poor people, but what misinvestments actually caused the slump.)
If you find yourself mired in debt from misinvestments that didn't yield returns, the first thing to do is to stop doing what you have been doing. Invest in something else. Money sent to rich people is horribly invested, because they don't really care what their returns are (hello, they are already rich). Money spent on war is basically money burned. And money sent to the WallStreet casino demonstrably disappears overseas.
Raise taxes, stop war, reregulate WallStreet. New investment must be on green energy infrastructure, and bringing our ailing existing infrastructure up to code. Also, it wouldn't hurt to invest in a new healthcare system patterned on the single payer system used everywhere else, for demonstrable enormous savings. We just can't afford to misinvest as we have been doing. Money is short, and clearly what we have been doing is not working.
Those who want to blame 'all those big government social programs' for the recession, must first explain why the gov't is, if anything, less a fraction of GDP than it has been the last 50 years (as of 2006, of course it's 'grown' since then because GDP has shrunken).
The "austerity" currently being imposed by global finance (and the politicians they own) is not really austerity as defined in the dictionary.
Today's "austerity" redistributes money from programs that benefit 98% of the population and into tax breaks and corporate welfare programs that provide a net benefit only to the wealthiest 2% of the population.
Since none of the current deficit reduction schemes being imposed on the US and other nations will actually reduce the respective deficits, global finance (and the politicians they own) are now serial deficit reducers who will keep this wealth transfer scheme going until the wealthiest 2% own everything and 98% of the population is left with nothing...at which point the deficits will not have been reduced by one penny.
It is myopic to continue to speak of a 'bad economy' or 'austerity' as harmful for EVERYONE. It is truly bad for workers, for unions, for the poor, for the Middle Class, for people on fixed incomes, for the general public, etc.
It has NOT been bad of late for most major corporations (now awash in trillions of cash), for the large banks (now made whole and immensely profitable by taxpayer bailouts), for Wall Street, for the hedge fund managers, for weapon's industries, etc.
These 'folks' are the authentic constituents of import for both the GOP and Obama.
This is why Obama can be so blase about home foreclosures and joblessness-- and now cuts to the poor, medicaid, social security, pensions, etc. as part of 'austerity'-- and why the GOP is utterly gleeful over economic ruination among the peasantry.
This is simply class war by the plutocracy-- and their enablers among the politicians and corporate talking heads -- on everyone else below them on the food chain.
So when rational economists continue to be mystified by this fanatic drive for austerity among the political elites -- despite the likelihood that it will result in disastrous results for the general economy -- they really, really, really need to ask themselves a simple question:
Cui bono?
And then maybe a little light will flick on in their heads.
I just saw on the News that the DOW dropped 400 points in trading today...'Great Job!!!' Congress and President alike...
The PPT will move into action soon no doubt. Too many members of the Senate and Congress own shares .
I agree with raydelcamino totally. Our legislators are OWNED by the THIEVES who have tanked our economy ... so we give the THIEVES even MORE and TAKE FROM THOSE WHO REALLY NEED IT!!! These "Austerity Hawks" are EVIL TREASONOUS CRIMINALS who only think of THEMSELVES. THEY HAVE BETRAYED THE AMERICAN PEOPLE. I CALL IT TREASON! Can you think of a better word for it??? MEANWHILE THE THIEVES CONTINUE TO LINE THEIR OWN POCKETS. You want to save money?? DON'T PAY THE SENATORS AND CONGRESSMEN WHO HAVE NOT SERVED OUR INTERESTS. They will not miss the money because their corporate masters have filled their pockets with TAINTED GOLD.
"If investors conclude that the slump is bound to go on for a long time, and that the government will therefore be a bad credit risk for the foreseeable future, they will demand a higher interest rate (to compensate them for that risk)." The good news here, I guess, is that the US bond rates continue to fall. Investors must still conclude that we will someday get our shit together. Of course, since they are falling, these investors also conclude that economic stagnation will also continue, or else they think most other investment opportunities in the world really suck.
Economic growth is only possible in the context of an environment that is relatively unpopulated and unexploited. Once a critical density of consumption of energy and resources is reached, such that these become limiting factors, then quantitative growth is no longer possible. The US is particularly conditioned to a high throughput of fossil fuel energy. Energy, food, products, transport all grew on cheap resources in economic boom times. Thanks to global adoption and global markets, everyone wants some of it.
Supply of raw energy and materials has stopped keeping up with demand. The only way that none-negotiable nature will accept, is a reduction in the throughput available for everyone, and enforced change of lifestyle. Some corporations instigate wars and occupations to try and control the profits in energy and resources by controlling the spigot heads, but the actual global throughput rates will be dropping fast relative to increasing demand. No matter how many wars the US instigates, it will not be able to stop the decline in livings standards of its own peoples. The harder it struggles, the more it wastes its energies and efforts.
Those people the government considers unnecessary to the functioning of the nation will be cut out first.
Increases in demand desperation for energy and materials, lead to the consequence that not enough is done to transition from growth to sustainability.
Cutting economic growth and bringing down fossil fuel infrastructure is a first step. In desperation, hungry people will rebel. If the riots and their suppression seem to be a current feature of the Middle East, it is not long to wait in US, Europe, Russia and China, for the same thing. I would expect their armies to be shooting their own people to quell rebellion. After all, the nature of peoples and governments is not so different around the world. Colour, ethnicity, religion are skin deep compared to the need to have food and a future, and the tendency of governments to react harshly to problems they cannot solve by other means.
There is no better future until humanity is cut down from its fossil fueled plague.
There's no government austerity. There is plenty of government borrowing and spending . . . for the MIC.
Terms like "austerity" and "privatization" are just euphemisms for theft.
Asking if they "work" is sort of missing the point. They work extremely well in doing what they were designed to do, which is to transfer public assets to the wealthy and reduce the standard of living/bargaining power of everyone else.
So long as analysts continue to pretend that "we're all in together" (in Obama's words) -- that appeals to fairness and logic will actually persuade policy planners -- we will continue running around in circles. You might as well plead with Jeffrey Dahmer not to eat human flesh because it's unethical and may cause obesity.
NO, NO, NO, the economy is doing exactly what is wanted: they want the civilian economy to tank.. no jobs, but to have lucrative employment opportunities "being all you can be" with the military. It also grows the political support for the military with more "volunteers" signing up. Soon we will recognize WWIII has begun for real. This is the goal of the world's political and financial elite.
It will only be with a polarity change: that is, when the poor stop supporting the rich, and the rich are eliminated and their wealth confiscated, that the world can heal itself. This will be a great victory for mankind and will at last put an end to the horrible waste of money, resources, human potential, etc., that the world has had to endure by the hands of the criminal financial cabal.