Austerity: good or bad?

One of the big issues globally, and more specifically in the UK before the General Election in 34 days time, is austerity. Is it good or bad? Should we impose it or not? Personally, I believe that budget deficits are too high and need to be reduced, especially in the UK where the deficit is at £91 billion, with Cameron having reduced it by a third in his five years in power. However, in this post I will hope to assess the pros and cons of austerity, and leave you, the reader, to make your own judgement.

Firstly, if you cut the budget deficits by austerity, it will give investors greater confidence in your country, as it shows that you have a greater degree of control over your expenditures and revenue, and bringing them closer together means that the private sector will also have greater confidence with which to invest in your country, which is very good for the country as a whole, and the civilians too by virtue of more employment.

There’s also the issue of morality. Why should people spend money that they just don’t have? Some would argue that one should only spend money when they have it, and borrowing more money and increasing the deficit day by day just isn’t right, in moral terms.  One could argue that one of the only ways to cut the deficit is by austerity, and until the deficit is cut to 0, the government has no right to spend money when they are already in hundreds of billions of pounds of debt.

An argument commonly propagated against austerity is that it will hinder economic growth. However, one just has to look at countries such as Canada, where, in the 1990’s, they cut fiscal deficit but still maintained relatively strong economic growth. This means that austerity is not a sure fire guarantee to hinder economic growth – it can be imposed without doing so.

However, some could say that countries who have imposed austerity have not necessarily benefitted economically from it. Countries such as Estonia, Latvia and Ireland still have a lower GDP than when austerity was imposed, and as such, one could argue that the same thing could, possibly, happen to Britain as well. Although some stories such as Canada’s seem relatively bulletproof, one could say that that was 20 years ago and we live in a different time to then.

Finally, there is no rock solid evidence that cutting government spending increases investor confidence. One could say that when the coalition came into power and announced spending cuts of £81 billion, then consumer confidence dropped to record low levels. As such, one can only hypothetically state that austerity would increase consumer confidence, and would only be plugging an unsubstantiated opinion.

Thanks for reading! Stay tuned for my next blog post.

9 Comments Add yours

  1. simplysellside says:

    Whaddup – so the most important aspect of this post hinges on this notion of ‘Confidence’. This question of whether fiscal retrenchment is necessary to promote confidence is now largely settled. See:

    https://fsaraceno.wordpress.com/2015/03/25/the-confidence-witch/

    One paper does not a proof make, but the fact that the IMF and the ECB have publicly retracted their unconditional pro austerity stances on the grounds that confidence is not a significant consideration should give you pause for thought.

    There is a really significant misconception in your post about the nature of money as well. You say “Why should people spend money that they just don’t have?” Well, the government owns the printing press. They can have as much money as they like. They institutionally constrain themselves, not permitting themselves access, but this could easily enough be reversed. Simple moral intuitions that might serve you or I well do not apply to sovereign governments, because where for us money is just money, for a government, money is an instrument of policy.

    Please keep writing and responding to comments and criticism. There can never be too many voices in the dialogue!

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    1. Thank you so much for your comment! When I said “people shouldn’t spend money that they don;t have”, I was simply applying basic ethics to the situation to give an argument for austerity – people should not spend money they don’t have, be it a TNC such as Pepsi or a simple 14 year old such as myself. Regardless of the scale, it is my belief that the basic premise should remain, and regardless of what money means to an entity, they need to only use it if they have it, as should they for any commodity, in my opinion.

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      1. simplysellside says:

        I’d encourage you to think about why it is that people shouldn’t ‘spend money they don’t have’. Consider that:

        – money is created by banks lending
        – most people who own houses also have mortgages
        – most people informally borrow and lend with friends as a matter of course

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      2. Steve says:

        In reply to simplysellside, with government spending there is a much more moral dimension than individual household budgets. Why? Simply because when a government borrows, it often borrows for long terms, which may mean that government spending today increases the debt for the next generation (or the next government). Usually, individuals will pay off borrowing (for a mortgage) in their lifetime, or the asset could be sold to pay off the debt.

        The household equivalent is an individual dying in significant debt, and passing those debts onto their spouse or children!

        However, even this isn’t really a fair comparison; today we have a debt of £1.5 trillion, or between 80-90% of GDP. The overall debt figure is the highest figure ever recorded for the UK, but the debt as a proportion of GDP is about average for the past 300 years! (debt as a proportion of GDP is a more useful figure, as it gives and indication of affordability of debt to a country). Economic growth means that debt incurred today does not have the same impact on future generations; similarly inflation in the economy also lowers the real value of debt… Finally, population growth means that the debt incurred today is “spread” between more people!

        This appears to be a perfect situation; growth tomorrow means that borrowing today has little impact. The household equivalent might be the “permanent income hypothesis”, meaning that an individual may borrow today for consumption, with the expectation of higher wages in the future!

        However, if growth becomes stagnant, and inflation becomes deflationary, even whilst running a fiscal surplus, the affordability of debt goes down!

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  2. Steve says:

    The problem with comparing Canada with the UK, say, is that Canada (along with the U.S. Post WW2, and Belgium in the 90s) had the ability to use looser monetary policy to stimulate growth. Austerity, on its own, is likely to stifle growth; for example the (independent) OBR estimated that the first 2 years of fiscal austerity in the UK lowered economic growth by about 1% per annum. This is likely to have reduced GDP (today) by between 50 and £80bn.

    The great cost to not following austerity is the confidence of those buying bonds; if confidence is lost, the interest rates go through the roof (see for instance Greece). Fiscal stimuli can help to maintain confidence, as these will (likely) improve growth, and give the market confidence. However, fiscal stimuli are never certain!

    Many have argued that temporary fiscal stimuli are of no use for stimulating long term growth due to Ricardian equivalence, but this is likely a fallacious argument!

    Liked by 1 person

    1. Thanks for your interest and the comment – I completely agree with your first point! 🙂

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    2. simplysellside says:

      The notion that government debt is like regular debt is mistaken. Best to aggregate the government and the central bank in one consolidated government budget – which then leads you to understand that:

      Spending => Putting purchasing power into the economy
      Taxation => Removing purchasing power from the economy
      Debt issuance => Temporarily removing purchasing power from the economy

      It’s a bit of a wrench to think of it like this, but it helps.

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  3. Jono says:

    Hi Shrey. I think its fantastic that a 14 year old is engaging with ideas many 40 year olds disregard as too complicated. Some of your articles are far more insightful than many I’ve read from proffessional journalists, so well done and keep it up!
    I think there is another factor that is missing from both your great article and the excellent comments below, and that is timing. Canada went into recession (small by today’s standards) in the early 90s, but began growing again by 1992. After 3-4 strong years of growth it then balanced the budget. The coalition in the UK, by comparison, brought in quite severe cuts, very quickly and almost immediately after the largest recession in living memory. This hurt growth (which reduces the debt burden), and helped cause the double dip recession, and resulting in the coalition massively reducing the rate and severity of the cuts they had planned (the original ‘long term’ economic plan failed and was scrapped in other words). Some of Vince Cable’s speeches are a brilliant source for understanding the ideology of the coalition, and how it changed around 2012.
    Secondly with regards to confidence, as has been eluded to above, the UK has its own currency and its own printing press, which means we can never ‘run out’ of money with which to repay our debt, providing it is denominated in pound sterling, so the risk of default is very low, and the central bank can control interest rates by buying and selling bonds, so the interest rate is being manipulated by government anyway and not freely floating in a free market of external buyers. Despite the media and politicians continually doing so, it is a complete fallacy to compare the UK to a country like Greece, because Greece does not have its own national currency, does not have its own printing press and so really can run out of money with which to pay back its debts (which are denominated in Euros). Interest rates on Greek bonds sky rocketed when investors realised that the ECB was not any normal central bank, and would not necessarily bail them out.
    Thirdly with regards to surpluses. Though many think countries should all aim to run budget surplusses, it is important to remember what this actually means. Surplus involves the government taking more money out of the economy through taxation than it puts in through spending. This is useful if the economy is overheating, and allows for greater flexibility when it cools down, but it is not realistically a sustainable or sensible position to hold in the long run, unless perhaps you’re an economy like Norway that is highly reliant on highly valuable finite commodities, and a low population. Prices in Norway are already very high in spite of the constant surplusses.
    Just some things to keep in mind. Keep up the good work, and if you want to learn more about what simplysellside is talking about, I suggest visiting the site of Positive Money. Also if you want to learn more detail about economists views on the coalitions past 5 years and previous 13 years of Labour government, I’d recommend checking out http://www.coalitioneconomics.org/. Good Luck!

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    1. Thanks a lot for this overview! I really appreciate things like this that help me learn more and more each day 🙂

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