This Friday night, teams from Melbourne and Monash will go head to head in ESSA’s annual economic debate. This year’s debate will revolve around austerity. Unless you’ve spent the last ten years in some sort of fiscal wilderness, it’s probably a term you’ve heard. But, if you’re anything like some of the students we spoke to last week (see video), you might still be a little hazy as to what it’s all about. So what is austerity? Has tough fiscal medicine done its job, or has it only exacerbated the pain of struggling economies? We’ll leave it to you to decide for yourselves after our debaters state their cases on Friday. In the meantime, though, we asked some of our ESSA writers to give their thoughts on this controversial topic to help you scope out the intellectual terrain before the debate.
The graph below is provided by the International Monetary Fund (IMF). It plots the errors in forecasts of real GDP growth made in 2010 for the years 2010 and 2011 against the amount of fiscal consolidation (i.e. the amount of ‘austerity’) that was forecast in each country over the same period. Those countries with more aggressive plans for fiscal consolidation disappointed more relative to forecast.
When a national economy falls into a recession, economists will normally advise that aggregate demand (the total demand for goods, services and investment across all sectors) should be stimulated. The flow-on effects increase output, stimulate the economy more broadly, and eventually pull the nation out of recession.
Austerity is exactly the opposite of this. Fundamentally, austerity is a fiscal policy mechanism which dramatically reduces aggregate demand in an economy by cutting government spending. Rather than stimulating aggregate demand, it lowers it even further.
A simple illustration of this involves comparing two countries: the United Kingdom and the United States. The United States avoided implementing a policy of austerity, instead engaging in a large monetary and fiscal stimulation program designed to expand and stabilise the labour market. This has largely worked; the US economy’s foundations are bouncing back. The United Kingdom chose a different path and implemented a relatively mild austerity program. Data suggests that austerity, if anything, extended the duration of the UK recession. This is a poor outcome by any definition.
To be strictly truthful, austerity is never really meant to stimulate the economy. It is a policy designed by politicians and accountants who profess to believe in small government (when they rarely do), and is actually an exercise in balancing the government’s books. That reduction in government services often has enormously harmful human costs, which only compound the poor economic situation that spurred action.
In short, austerity is both economically stupid and morally deficient. It doesn’t solve the economy’s problems, it just makes them worse, and last for longer. But then, I’m not convinced it was ever meant to solve the economy’s problems.
Austerity is one of those issues where there are perfectly legimitate arguments that can be made on either side. Common sense and history suggests that it is never good for states to reach dangerous levels of public debt, and run substantial budget deficits for long periods. However, Keynesian economics tells us that cutting spending and thereby reducing aggregate demand during a recession has the potential to merely accentuate the problem. If governments “tighten their belts,” the consequences could lead to a far more severe downturn which may have far worse effects than rising debt.
Where, then, to fall in the debate? While there certainly are arguments for the use of austerity measures in some situations, we must be careful to not treat economic management as a morality play, and to let this obscure our interpretation of policy prescriptions. Greece’s current fiscal woes, for instance, are not some sort of moral punishment for “irresponsible” reckless spending. Greece’s welfare spending, prior to its current crisis, was not especially spectatcular by European standards. Rather, its problems have their root in a lax and grossly inadequate taxation system. Moralistic assertions aside, this is something that should be fixed. The ‘austerity’ moniker may even be misapplied here. Far too often, we see austerity invoked as some sort of natural moral response to the sin of supposed fiscal ill-discipline. Proponents and opponents alike have been known to tout it as such. This is not helpful, and should be separated from a balanced assessment of the relative merits of policy proposals.
An abnormal obsession with deficits coupled with a strong sense of political nihilism is not the ideal base upon which to build sustainable policy. As such, austerity has failed! It is bad economic logic stitched together to conceal poisonous political agendas. The fact that the world is still struggling with such high debt to GDP ratios should be evidence enough to suggest that austerity has failed at the one thing it set out to conquer. This has come at no small price either. With unemployment still rampant in countries like Greece, Spain, and Italy, this five year experiment has come at the expense of consumer and investor confidence – ultimately eroding any hope of accelerated growth in the medium term. It has also come at the expense of livelihoods and, in some instances, lives.
Although evidenced by the continuing deficits and stagnation faced by the economies who have employed its measures, its greatest failure though has been in terms of political moral decay. Not only have political and academic supporters of austerity failed to convince society of its worth, the very idea that one should consider it necessary, in the name of efficiency, to cut lifelines in a time of crisis is absurd – all whilst large banks and corporations continue to dodge taxes and reap corporate welfare. The result has been ever greater political apathy and polarisation. Austerity has exhausted much of the political capital needed for real change now, leaving only the rather bitter after taste of political resentment.
Austerity has neither succeeded nor failed. Hailed as the answer to the dangerous prescriptions of Keynesianism, the implementation of prudence has not cleared the muddy waters of economic debate. The truth is that stimulus or austerity are not answers within themselves – neither will produce a workable solution in all situations. Economics is the study of circumstance. The prescription of stimulus or austerity is heavily contingent on the situation. Prescribing austerity in the Great Depression would have been foolish. Likewise, advocating stimulus to governments during stagflation of the 1970s would have been equally short-sighted. Yet economists still insist on having this conversation – the debate rages on. In searching for the answer to recession, economists seem to ignore complexity. The past matters as much as the present. The question shouldn’t be ‘austerity or stimulus,’ but rather, ‘supply or demand?’ ‘Inflation or confidence?’ ‘Public or private?’ Economic growth cannot be achieved by committing to one policy over another. If stable, long term growth is to be achieved, we have to stop asking the question ‘austerity or stimulus?’
Economics is not a perfect science and, as a result, we don’t have any infallible theories. But if you had to nominate one idea that should lose all credibility after the events of recent years it’s that of imposing austerity on struggling economies.
Economics is also not a morality play. Punishing the offenders in the world of crime may lead to rehabilitation, but in the economic world, it only leads to further depression. The Eurozone, and more specifically Greece, is an example for all time. Greece has done everything its lenders have asked for. They have cut back on their deficit through harsh cuts to the public sector and pensions, they have raised taxes and yet, as it stands, Greece is on the brink of total economic collapse. Even in the best-case scenario, Greece is likely to lose a generation or two to chronic unemployment and stagnation.
The Euro was essentially a political project. The idea was if European economies were more integrated, they were less likely to engage in the kinds of infighting that decimated the continent throughout the 20th century. As a result, economic wisdom was compromised, and a monetary union was set up without a banking and fiscal union. Economies were smuggled in that were realistically not ready to be part of this sort of project, like Greece. As a result the core idea, that of European unity, which is one worth pursuing, is being compromised every day by a set of policies that have alienated its periphery. If European integration does fail as a project, austerity will be what brought it to its knees.
What do you think? Comment below to join in the debate, and come along tomorrow night to hear Melbourne and Monash battle it out for economic glory.