People and Politicians really don’t get it, austerity is something you should do when the economy is booming – not when it is weak.
Despite overwhelming economic evidence that austerity slows down economies – you hear people, and even more scary, politicians, preach we take a dose of Hoover’s medicine.
It’s important to understand that what we’re seeing isn’t a failure of orthodox economics. Standard economics in this case—that is, economics based on what the profession has learned these past three generations, and for that matter on most textbooks—was the Keynesian position. The austerity thing was just invented out of thin air and a few dubious historical examples to serve the prejudices of the elite. – Paul Krugman
Austerity: a policy of deficit-cutting by lowering spending via a reduction in the amount of benefits and public services provided. Austerity policies are often used by governments to try to reduce their deficit spending and are sometimes coupled with increases in taxes to demonstrate long-term fiscal solvency to creditors.
Essentially, cutting government spending coupled often with tax increases to reduce or eliminate deficits to show the world you can pay. I have already explained why we don’t have to show we can pay, and until countries have that inclination to think that we can’t, austerity, for austerity sake, isn’t the correct course.
Austerity measures can be a good thing, such as cutting government spending and raising taxes to help reduce the deficit when our economy is “hot” – it brings us towards our long-run equilibrium. Further, we can see improved efficiency also when we cut government spending in sectors that are private in nature, letting people with entrepreneurial minds and strong business acumen provide these services.
This sounds grand. There is one problem though, AUSTERITY DOESN’T MAKE SENSE IN A SLOW MOVING ECONOMY THAT LACKS INVESTMENT. Sorry for the caps, but it seems people forget too easily and I am hoping that helped.
The General Theory pointed out that the catastrophe facing America and, indeed, the whole Western world, was only the consequences of a lack of sufficient investment on the part of business. And so the remedy was perfectly logical: if business was not able to expand, the government must take up the slack. – Robert Heilbroner
Our banks are sitting on a record amount of cash, entrepreneurs cannot get loans, and people are wary of investing. Cutting spending without investment making up the difference leads to a net loss in productivity and increases unemployment. The result? A lower GDP.
Perhaps worse are the tax increases that are proposed by the Democrats. Tax increases further squeeze the investment potential of those who wish to invest, leads to less money in the pockets of those who would spend it, and thus results in a lower GDP.
We also see less tax revenues to make up for this loss in GDP, as less money is paid out to workers and production slows, tax receipts fall. Further, when our GDP goes down, something called our debt-to-GDP ratio increases – a key measurement of a countries indebtedness. When that goes up you are not signaling to investors creditworthiness, quite the opposite in fact, you look like a bad investment.
On the other hand, if we can increase our GDP we can lower our debt-to-GDP ratio – signaling that we are creditworthy.
We can look at Greece for an example of how austerity is a drug that is better taken with growth, not recession. Greece has seen multiple revisions to its growth and tax estimates since the onset of their crisis. From late 2011, new estimates due to the crisis had expected its GDP to contract by 2-2.5%, in early 2012 this was revised to -4.5% and now we are looking at more like -5% to -8%. At the same time austerity policies were announced and implemented.
Looking at social indicators of economic health we can also see that the make up of the greek economy has drastically shifted. Between the years 2010 and 2011, the amount of people living at the risk of poverty or social inclusion spiked over 20%. The deficit of Greece has gone down but the economy has been thrown into deeper depression. People sought NGO support to help feed and nourish their families (9.1% of Athenians visited food kitchens on a daily basis), 20,000 additional people were made homeless, 20% of prime real estate commercial property remained unoccupied, suicide rates rose 40%, unemployment soared and businesses went bankrupt. Seems pretty gloomy right?
We can turn away from Greece and look at the U.K. or Italy, both of which have announced austerity packages, made cuts, and raised taxes. Both of their economies are forecasted to contract, and have been revised downwardly since their announcements. The U.K. is expected to have a contraction of .3% this year, Italy is expected to see a 2.2% drop.
Austerity is almost certain to slow the economy, when we are already facing anemic growth we run the real possibility of throwing ourselves into depression and worsening our position in the recovery just like the U.K. or Italy.
Proponents of austerity suggest that the issue is confidence, and that by slashing spending and raising taxes we signal to the world that we are creditworthy – I just showed you why I don’t think that holds as confidence may in fact decline. Even if Austerity does instill confidence you cannot neglect the detrimental effect that contractionary policies such as spending cuts and tax hikes have on the economy. Noted economist and Nobel laureate Paul Krugman puts it this way:
To me, and to many other economists, the answer seemed clear: expansionary austerity was highly implausible in general, and especially given the state of the world as it was in 2010 and remains two years later… it’s not enough for these confidence-related effects to exist; they have to be strong enough to more than offset the direct, depressing effects of austerity right now.
Lets take another historic case for example. Herbert Hoover was the president that resided over the great depression, the biggest depression we have ever experienced. Hoover’s initial plans were to cut taxes, which were accomplished and later once the depression hit lead to severe deficits. The government then, in the face of depression and for the sake of fiscal solvency, raised taxes on individuals and corporations – the effect was an exodus away from investment and the prolonging of the depression.
We know that austerity doesn’t work and people just don’t look at the facts, in 2003 the IMF came out with a report that said just this: we consistently underestimate the disastrous effects of spending cuts to economy growth.
Standard economic history, thought, and practice suggest that when we are facing slow growth we should practice counter-cyclical expansionary policies – these are spending more and cutting taxes. The exact OPPOSITE of austerity. Doing both of these signals to investors and consumers that there is security in the markets and increases their aptitude to start spending and investing, driving the economy back to full employment. One full employment is reached, then it is the government’s turn to tap the breaks and reign in their spending and bring receipts back up.
We are in an unprecedented time where we face growing global threats that may hurt our recovery, while being able to borrow at historically low (negative) interest rates. A sensible economist looking at the situation would tell you that austerity is ludicrous.
So if you want a government with a lower deficit and are willing to sacrifice our wellbeing for it – vote austerity. Instead, if you want America to grow and be prosperous, re-consider your gut.
