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.