The Austerity Delusion

You would think that a crappy idea which has failed before wouldn’t get much attention, but somehow economic austerity tends to get more attention from politicians than it should.

Austerity is a seductive idea because of the simplicity of its core claim — that you can’t cure debt with more debt. This is true as far as it goes, but it does not go far enough. Three less obvious factors undermine the simple argument that countries in the red need to stop spending.

The first factor is distributional, since the effects of austerity are felt differently across different levels of society. Those at the bottom of the income distribution lose proportionately more than those at the top, because they rely far more on government services and have little wealth with which to cushion the blows. The 400 richest Americans own more assets than the poorest 150 million; the bottom 15 percent, some 46 million people, live in households earning less than $22,050 per year. Trying to get the lower end of the income distribution to pay the price of austerity through cuts in public spending is both cruel and mathematically difficult. Those who can pay won’t, while those who can’t pay are being asked to do so.

The second factor is compositional; everybody cannot cut their way to growth at the same time. To put this in the European context, although it makes sense for any one state to reduce its debt, if all states in the currency union, which are one another’s major trading partners, cut their spending simultaneously, the result can only be a contraction of the regional economy as a whole. Proponents of austerity are blind to this danger because they get the relationship between saving and spending backward. They think that public frugality will eventually promote private spending. But someone has to spend for someone else to save, or else the saver will have no income to hold on to. Similarly, for a country to benefit from a reduction in its domestic wages, thus becoming more competitive on costs, there must be another country willing to spend its money on what the first country produces. If all states try to cut or save at once, as is the case in the eurozone today, then no one is left to do the necessary spending to drive growth.

The third factor is logical; the notion that slashing government spending boosts investor confidence does not stand up to scrutiny. As the economist Paul Krugman and others have argued, this claim assumes that consumers anticipate and incorporate all government policy changes into their lifetime budget calculations. When the government signals that it plans to cut its expenditures dramatically, the argument goes, consumers realize that their future tax burdens will decrease. This leads them to spend more today than they would have done without the cuts, thereby ending the recession despite the collapse of the economy going on all around them. The assumption that this behaviour will actually be exhibited by financially illiterate, real-world consumers who are terrified of losing their jobs in the midst of a policy-induced recession is heroic at best and foolish at worst.

Austerity, then, is a dangerous idea, because it ignores the externalities it generates, the impact of one person’s choices on another’s, and the low probability that people will actually behave in the way that the theory requires.

Austerity’s origins lie in a tension within liberal economic thinking about the state. In the second of his Two Treatises on Government, the seventeenth-century English political theorist John Locke accepted the inevitability of inequality stemming from the invention of money and private property. But having done so, he also had to acknowledge the need for a state to police the inequities that the market produces. Any state that could do this effectively, however, would also be strong enough to threaten the property holders it was meant to protect. And so a tension was born in the heart of liberalism: you can’t live with the state, since it might rob you, but you also can’t live without it, since the mob might kill you.

Anyway, the bottom line is that the results of the experiment are now in, and they are consistent: austerity doesn’t work.

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15 thoughts on “The Austerity Delusion

  1. Very interesting and informing POST, Laci. Thanks for putting something
    up for us to comment anew…..

    Let me quote a few words you have written, “…benefit from a reduction in its domestic wages….” My question is will not Obamacare encourage a drop
    in wages?
    caompanies are already taken two measures to lower their cost of the health
    care act. One is to convert workers from full time to part time, and the other
    is just lay them off. Both result in a a reduction of take home pay. Moreover, it appears workers are having to buy more health insurance than
    they need wihich reduces their wage. It seems we have a situation where a
    measure is to help the health of our citizens is harming their existence? It
    appears to be increasing their austerity. Hey! Maybe that is the purpose of
    the legislation, i.e., continue to have money continue its upward flow to
    the wealthy from the middleclass and working classes. Is there little
    wonder that income inequality is rampant?

  2. “…austerity doesn’t work.”

    While it might not work in Greece, Spain, Portugal, Italy, Ireland, or
    France on the Continent or in Britain, it appears to work in Germany.
    PM Merkel is really the architect of Eueopean austerity, and it appears
    that her government is not in jeopardy..

  3. UTF, you are wrong, wrong and wrong again in your assessment of the “success’ of austerity in Germany. It hasn’t worked. The German economy is in real trouble. They, the supposed backbone of the Euro, are actually talking about abandoning it. They have a very high unemployment rate. The relative income of Germans is far behind the average of France. I think you should catch up on what is going on between Hollande and Merkel right now. Germany is being forced to admit that it’s limited version of austerity has not worked. Their unemployment numbers are deceptive, as deceptive as America’s. Why? because they are reporting only the unemployed workers still receiving assistance, before it rund out, just like the USA. Yes, the German industrial base is still rolling along, but it is suffering from the same disease as France…The industries get bailed out and then take their factories out of the country to find cheaper labor….I will get real numbers for you later in my next post. Merkel is in real trouble politically in Germany.

  4. The following is an August 2012 review of the German economy provided by
    the BBC

    “German economic strength: The secrets of successBy Richard Anderson

    Business reporter, BBC News

    The German education system is much more geared to vocational training than many of its economic competitors

    Imagine a country whose inhabitants work fewer hours than almost any others, whose workforce is not particularly productive and whose children spend less time at school than most of its neighbours.

    Hardly a recipe for economic success, you might think.

    But the country described above is none other than Germany, Europe’s industrial powerhouse and the world’s second largest exporter; a country whose economy has single-handedly stopped the eurozone falling back into recession and the only nation rich enough to save the euro.

    When you consider that only the Dutch work fewer hours among the 34 members of the OECD, that German children spend 25% less time in the classroom than their Italian counterparts, and that there are six more productive economies in Europe alone, these facts appear all the more remarkable.

  5. Unemployment for France, taken from Current French Economy 2013″

    ” Unemployment is one of the major problems faced by the French economy despite its strong economic status. The rate of unemployment in France was estimated as 9.4 %.”

    Germany”s is 6.9%, and the U.S. is 7.5%

    1. There is a problem with US unemployment figures in that quite a few people are left out of the equation since it is calculated by only those who are collecting unemployment compensation. I’m not sure I would agree with the figure being as low as it is usually reported to be. I know that people who have left school and have not found employment are not in the number. Also, it leaves out the people who take marginal employment (e.g., someone who does volunteer work while job seeking, or the person who is underemployed (e.g., MBA or JD) and is working as a barrista.

  6. I am sure that you know, Laci, that I do not favor austerity per se. Obams’s program of austerity is know as sequester. Despite M_R’s opinion to the
    contrary, it was President Obama who suggested this program to the GOP
    in the debt ceiling compromise last yeear. Now, the President is trying to
    blame the GOP for it, and it has to this point bakfired on the Dems. As we
    have just seen, when the rich and powerful demand a special privilege, that is, in the case of sequester of the FAA funds that created long lines at the
    nation’s airports, Congress without any hearings immediately exempted the FAA from the impact of sequester, and to my disgust the President signed the
    emergency bailout of the rich and powerful. He should have vetoed the
    bill and demanded that Congress immediately stop these discretionary
    cuts which fall the heaviest on the middle and working classes. Again, the
    President was great on his rhetoric during the election, but when it fcame
    down to doing something for the wealthy and powerful who does he side

    1. We have both agreed that there isn’t much of a difference between the two US parties. The democrats only pretend to be a popular party.

      IOW, Austerity is working for those who matter: bugger the rest of them.

  7. Sorry that I disappeared in this discussion…I have been on and off line for the last few days due to a huge oak tree which fell on our phone lines and blocked the road. The France Telecom guys had it restored, but it cut out and now we are sort of back on line…they are replacing a few poles as well.
    I would like to point out that Laci’s comments about the hiding of unemployment figures applies to Germany as well. If you look at the charts showing the downturn of the German economy, while unemployment is increasing, it doesn’t seem to co relate to the situation. Why? because, the German system only reports active unemployment compensation as “unemployed”. After the benefits run out, then the status of the long term unemployed becomes welfare. While Germany has a social support infrastructure, long term unemployment is rampant and the benefits are actually much less than the RMI here in France.
    Here’s a very recent PDF documenting the current downturn in the German economy:

    The German economy has actually gone into reverse. They are suffering from the same economic realities in the manufacturing sector as the rest of Europe. They rely on exports and the consumer confidence of the German public. They are trying to control the erosion of the actual manufacturing base in Germany as jobs vanish as the big facties close to relocate in places they think they can cut labor costs.
    For me, the biggest frustration here in France is the apparent disarray of the Hollande government. Hollande is an economist…he taught it at University level. While he is trying to be forceful in convincing Merkel to abandon austerity, there is a lot of mixed messages coming from various government ministers. Austerity, even in it’s mildest forms, has the negative effect of destroying local economies. It creates a ripple effect from the bottom up. In most cases, conservative austerity is policy that is focused on the middle class and believes it can stimulate the economy by favoring the wealthy, the supposed economic engine that drives expansion. This is a simplistic illogical approach and it is being proven over and over again that it is a false illogical lazy assumption. We seem to be doomed to repeating the economic cycles of the last 200 years. We seem dead bent on repeating the same crisises over and over again with slightly different scenarios. The latest bit of idiocy being injected into this melange is from a conservative Harvard economist/historian Niall Ferguson, who claims that Keynes economic theories are basically flawed because “he was gay”…proof? he was married to a ballerina and had no children…. and homosexuals don’t care about the next generation because they are basically selfish and this was the real cause of the financial meltdown we are now experiencing.
    For the record, Ferguson was John McCains economic advisor in the 2008 campaign, but what he said, even though he retracted it (sort of) resounds after he said it…now Paul Krugman is being criticized by the conservative loonies because he is childless and obviously is a selfish bastard who doesn’t care about the next generation.

    1. Professor Ferguson has issued an apology for his remarks:

      During a recent question-and-answer session at a conference in California, I made comments about John Maynard Keynes that were as stupid as they were insensitive.

      I had been asked to comment on Keynes’s famous observation “In the long run we are all dead.” The point I had made in my presentation was that in the long run our children, grandchildren and great-grandchildren are alive, and will have to deal with the consequences of our economic actions.

      But I should not have suggested – in an off-the-cuff response that was not part of my presentation – that Keynes was indifferent to the long run because he had no children, nor that he had no children because he was gay. This was doubly stupid. First, it is obvious that people who do not have children also care about future generations. Second, I had forgotten that Keynes’s wife Lydia miscarried.

      My disagreements with Keynes’s economic philosophy have never had anything to do with his sexual orientation. It is simply false to suggest, as I did, that his approach to economic policy was inspired by any aspect of his personal life. As those who know me and my work are well aware, I detest all prejudice, sexual or otherwise.

      My colleagues, students, and friends – straight and gay – have every right to be disappointed in me, as I am in myself. To them, and to everyone who heard my remarks at the conference or has read them since, I deeply and unreservedly apologize.

      Niall Ferguson”

      Read more:

    1. I’ve been doing a bit of searching around about Ferguson…his methods and his history of making racial and bigoted comments when his logic fails him. He seems to have quite a track record…this was the guy who compared Obama to Felix the Cat, in his word, “One of the best-loved cartoon characters of the 1920s, Felix was not only black. He was also very, very lucky. And that pretty much sums up the 44th president of the U.S.” When called out for the casually baltant racism of his remark, he apologized in pretty much the lame fashion….”Those of you who know me, know I am not a racist” in other words, disregard my previous statement and ask my lawyer to tell you what I really meant to say.
      An extremely dangerous, much too powerful and utterly lame asshole.

      1. btw, his comments on Keynes came after he got bashed by debating Krugman, who was second handedly smeared by the fall out of Fewrguson’s supposed mis statement. No, this man has a method.

  8. Well, thats cool! Now, your back, and you can apply the seat of the pants to
    the seat of the chair and start with the muckraking, lol….

    Might not be able to comment much depending on the situation here. This
    week promises to be a trying one….I must have a trove of sins to make up

    1. …speaking of a trove of sins, I’ve been challenging some fundamentalists on a religious website on the concept of ‘sin.’ It is amazing how terribly convoluted their ‘reasoning’ is on that subject. My head is still spinning even after I’ve downed an entire bottle of Antivert.

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