Austerity refers to the governmental measures taken whose debt is so immense that the default risk and the government’s lack of ability to make payments against its debt becomes a possibility. The bad debt conditions of the government make it impossible to get more funds on lower rates. Thus, the lenders charge higher rates because of the greater risk of default. The 2008 global economic downturn left many governments with unsustainable levels of spending due to the reduced revenues collected from tax revenues. In Europe, during the crisis, many countries including Greece, United Kingdom, and Spain tilted towards austerity measures as they could not print euro currency or raise capital enough to cover its debts.
Broadly, the Austerity measures can include revenue generation through higher taxes, cutting government spending, and another measure can be the lower spending and lower tax rises. The lowering of the government spending cannot be blindly termed as an austerity measure. The austerity measures are taken when the expenditures and receipts gap of the governments is reduced as a result of the reduction in government spending.
Economists are divided on the effect of tax policy on the government fiscal budget deficits. Some believe that cutting taxes will lead to increased economic activity leading to increased revenues. Whereas, others believe that the increase in taxes increases the tax revenues more rapidly. It has been implemented by many governments. Greece, for example, imposed increased value-added taxes of 23% in the year 2010 along with increasing income taxes on the upper-income holders.
Another measure undertaken is that of lowering the spending of the governments. It can be considered as one good measure. However, it is to be noted that there are many more important and crucial spending which also come under fire through this measure. The grants, wealth redistribution, health benefits, pensions, employee’s salaries, subsidies and foreign aids; these all are also governmental spending. The cuts and reduction in these spending directly affect the lower and middle class of a country, increasing the uneven wealth distribution. Thus, the critiques of austerity criticize the measure of government spending by showing that it affects the lower and middle class more; hence increasing the uneven wealth distribution.
The measure of austerity, which can be enacted by governments, can be enforced in following ways:
- Without rising of the salaries by the governments, cutting is done.
- The reduced hiring of government employees, and increased layoffs.
- Reduced governmental services.
- Cuts in pensions.
- Lower interest on government securities
- Reduced spending on public programs which were planned like construction, infrastructure plans or health or social welfare programs.
- Increment in all taxes, VAT, property, income and sales taxes
- Increase or reduction in the money supply by the Federal Reserve
These measures are not the only one; the governments may create new ways to enforce austerity. However, the underlying processes would remain the same.
THE KEYNESIAN SCHOOL OF THOUGHT
The British economist John Maynard Keynes believed that the governments are responsible for increasing their spending at the time of economic downturn for compensating the declining private demand. He argues that the demand has to be increased and stabilized with the government for increasing employment and the spending power of the people.
Keynesian economics is built upon this school of thought. This theory advocates that the increased expenditures of the government and the cut in taxes stimulate a pro-economic environment and it can consequently increase demand, pulling the economy out of the recession.
Keynes wrote his book while witnessing the Great Depression. He was highly critical of the measures taken by the British government at that time. The government then cuts its spending and raised taxes for balancing its books. He argued that this cannot increase spending by people and will not stimulate demand and thus consequently will not cause the economic recession to end.
The theories above discuss the relationship between the money, economic policies, and inflation. It is known that the relationship between the money supply and inflation is directly proportional as with changes in money supply, the higher money supply gives rise to higher inflation.
Researchers have resolved that fiscal policy and supply-side phenomenon alone cannot cause inflation. The rate of money growth has to be associated with any of the factors for increased inflation. As per the scholars, the budget deficit is one of the many causes which lead to inflationary monetary policies. Monetizing of the debt, printing money, and increased money creation for compensation of the deficit can cause increased inflation.
Due to the economic crisis, and increased inflation, governments, tend to tilt towards implementing austerity measures for getting results quickly. The neoclassical rationale given in support of the phenomenon of austerity is explained in the next section.
THE NEOCLASSICAL RATIONALE FOR AUSTERITY
The supporters of Austerity propel it as an idea to pull the economy out of the crisis. It is true that the idea of austerity has failed in history and present, but it remains. It is due to the reason that it is an “idea” which is dangerous. Theorists believe that the idea of Austerity has survived because of the misrepresentation of the facts.
The idea of austerity is propelled by its believers for the aim of economic stability. It is done to build the business confidence. It is quite logical indeed. The simple logic based on economics gives strength to the basis of austerity. The neoclassical rationale behind the austerity shows that the debt cannot be compensated by the “auto referentiality” of the debt. It can only be compensated by another debt. These ideas are very tempting.
The neo-liberal theory focuses on the supply-side of the economy. It means, they focus more on how the savings lead to investments, leading to employment, increasing wages, and consequently demand, which in turn raises the profits that can be invested again in the firms. The economic theory is evidently much more and much less than an instruction sheet. It is more as it is important in the world; however, it is less, as it is not an exact reflection of the world because of the reason that it is in economic language.
With the failure of the Keynesian instruction sheet, this showed that at any given rate of employment a rate of inflation is present. The failure because of the choosing of the policy-makers of the trade-off between unemployment and inflation rather than inflation and employment caused it a serious blow. It gave rise to the introduction of a new instruction sheet introduced by the neoliberals or neoclassical economics. It gave the rationale by showing that individuals were smart processors of information. This theory persisted that the behavior of the financial markets is dependent on the behavior of the individuals such as firms, investors, and funds. It was dependent on the rationale that the behavior of the aggregates depends on the behavior of the individuals with whom they are made up. The theory of new liberals is more realistic and applicable as compared to other theories (Mishkin 677).
The neoliberal rationale argued that through the Keynesian sheet individuals must be seen as being misled by the government, because if they had seen the policies, the individuals would change their decisions, canceling the effects of the government policies. This theory suggested that error-prone individuals would get eliminated from the market. It will cause the market to share the same model of an economy. It will cause the individuals to converge their expectations and a stable equilibrium in the economy will be self-promoted.
CRITICS IN BLYTH’S BOOK
These ideas mentioned above of the Efficient Market Hypothesis and also from the rational expectations theory does not entail the role of the state. And the only role that the state plays as per these theories is “doing nothing.” And if the state played any role, as per these theories, this will be only unstable the equilibrium.
These theories were rather liked by finance, as it gave them the authority to do whatever they liked. As per this theory, the finance other than deliberate fraud and insider trading cannot do anything wrong. According to Blyth, if one thinks that markets are run in this way, then it must follow that the risk is calculated, traceable, and is held by the investors who know what they are doing. Here, as per the author, the only problem which arises is how come one avoids any moral hazards. The problem with this new theory presented is that by seeing only the equilibrium arising out of the decisions taken by the super smart individuals, it bluntly ignored the possibility of arising of a crisis other than moral hazard. It disregards the fact that the instruments and individuals which were only intended to see the world as a better place can make the world a better place.
The flaw is based on the fallacies of composition. As per the author, the neoclassical insistence on basing everything on the basis that if you make the individual parts safe, the whole aggregate will get safe as well. But as it turns out, the whole is different from the sum of the parts, and the interaction of the parts has caused the results far away from expectations (Blyth 37).
It is also argued by the analysts that governments seeking refuge in austerity measures forget that there is always another way present. It is a difficult way forward, but it is the right way. Governments cannot get a default. They can always print more money (Allen). They can always enjoy over drafting protection (CarneyY). Thus, their cries about raising debt ceilings and having no ability to stay current are baseless.
CONCLUSION
The neoclassical theorist’s rationale behind austerity lies, on the basis that all the individuals are smart-thinking individuals who make informed decisions. This is based on the assumption that all these individuals cannot make decisions which would be bad for the market. Thus, by making the individuals safe, theorists believe, the whole system can be made safe as well. Thus, all individuals acting wisely would always cause the market to stabilize bringing it to the state of equilibrium. However, as per the author Blyth, the sum of the behavior of the parts is not equal to the whole aggregate. He argues that the austerity measures only create increased unevenness in wealth distribution and does not bring success in pulling the economy from recession.
Work Cited
Allen, Patrick. “No Chance of Default, US Can Print Money: Greenspan.” CNBC. CNBC, 7 August 2011. Web.14 February 2018. https://www.cnbc.com/id/44051683?__source=sharebar|email&par=sharebar.
Blyth, Mark. Austerity: The History of a Dangerous Idea. New York: Oxford University Press, 2013.
CarneyY, John. “The U.S. Government Cannot Ever Run Out of Money.” The Atlantic. The Atlantic, 27 July 2011. Web. 14 February 2018. https://www.theatlantic.com/business/archive/2011/07/the-us-government-cannot-ever-run-out-of-money/242622/.
Mishkin, Frederic S. “Money and Inflation (Chapter 27).” The Economics of Money, Banking and Financial Markets. Pearson Addison-Wesley, 2004.
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