Duncan’s Economic Blog

Some Thoughts on Austerity

Posted in Uncategorized by duncanseconomicblog on April 8, 2011

Yesterday I noted that the austerity measures in Greece, Portugal and Ireland have had devastating effects on those economies. In each case they reduced growth, pushed up unemployment and ultimately increased the debt burden on the afflicted economy leading to a loss of market confidence.

Given these facts I questioned why Osborne thought he could claim Portugal as a vindication of his policies rather than a star warning.  

Ireland adopted austerity measures in 2008 and was eventually forced into seeking a bailout last year. In the past year, since tougher measures were adopted, Greek growth has collapsed, unemployment has soared and the interest rate on government bonds is consequently much higher.

Tough austerity is a self-defeating strategy.

Several commentators have been quick to point out that Portugal, Ireland and Greece had ‘no choice’ but to adopt these policies. Now whilst there is always a choice*, I fully accept that in each of those cases membership of the Euro, the maturity profile of outstanding debt that needed to be refinanced and loss of confidence from the bond markets forced the government’s hand.

But this doesn’t change the fact that austerity isn’t work and is unlikely to work. As today’s Economist says of Greece:

A year ago the plan forecast that GDP would shrink by 4% in 2010 and 2.5% in 2011. Instead it fell by 4.5% last year and IOBE predicts it will decline by 3.2% in 2011. The unemployment rate has risen from 9% in mid-2009 to 14.2% in the last quarter of 2010, and is expected to average 15.5% this year…

The economy is stuck in a vicious circle. If it stays weak, that will undermine the government’s ability to achieve additional fiscal retrenchment; that in turn will cause further loss of confidence on the part of the markets, which will continue to lock the banks out of funding sources.

The key difference between Britain and the Euro-Periphery is that Britain certainly does have a clear choice – we have the longest debt maturity in the developed world, the markets are prepared to lend to us at near record lows (and have been for over two years – not just since the emergency budget), our debt/GDP ratio is comparatively low. Whatever the scare-mongers say, Britain was nowhere near the brink of bankruptcy.

It may surprise some readers to learn that I can be something of a ‘fiscal hawk’ at times. I’ve argued here before that Labour shouldn’t have been running a structural deficit in 2003-2007 (although not because of ‘over-spending’, in late 2007 (i.e. pre-crash) I managed to annoy some left of centre friends by arguing that closing the US federal deficit was a more important priority in the short run that healthcare reform and I’ve said many times before that I don’t believe fiscal policy holds all the answers to our current problems.

When the economy is performing well and unemployment has been brought down, I’ll fully support tax rises and spending cuts to close whatever bit of the deficit remains.

Now isn’t that time.**

The important priorities now are to kick-start growth, to cut unemployment, to grow real wages and to increase investment. Get that right and the deficit will fall, get it wrong and we risk finding ourselves is a much, much worse position.

I see no evidence that austerity can deliver growth, employment, higher real wages and higher investment. It’s likely to do the opposite. Which makes it all the more strange that the UK has chosen to embark on this dangerous course.

*In all three cases I strongly suspect some form of debt restructuring would have been a better choice and is almost bound to happen anyway.

** For an excellent idea on deficit reduction timetables see this piece by Adam Lent and Tony Dolphin.  Or take a look at the IMF Chief Economist’s ‘10 Commandments for fiscal adjustment’.

8 Responses

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  1. Dave Holden said, on April 9, 2011 at 10:28 am

    “In all three cases I strongly suspect some form of debt restructuring would have been a better choice and is almost bound to happen anyway.”

    Which is what I’ve been saying all along. In the case of Ireland the need for default had less to do with austerity than the obligations they took on of their lousy banks. Krugman of course never points this out but I don’t expect much better from him.

    On the IPPR paper it goes some way to answer the question I put in your other piece on cuts – what’s the magic number? In terms of it’s likelihood to be taken up I think very small. The politics and market ramifications of any change in course is precarious to say the least. What’s important to recognised though is this isn’t a Keynesian solution they are still proposing cuts.

    On our debt obligations I still think your too sanguine. Our national debt is set to reach over 90 percent in 2012, Rogoff and Reinhart estimated that above this point you can expect a 1 percent reduction in GDP – http://www.voxeu.org/index.php?q=node/5395

    Something else that needs to be born in mind is what in our current state even a small increase in interest rates can do :-
    http://www.economist.com/node/18530079?story_id=18530079&CFID=167856751&CFTOKEN=53153080

  2. stephen said, on April 9, 2011 at 12:05 pm

    More power to your elbow Duncan. What is horrifying is that the so-called economic experts at the BBC are unable to air such an argument as it runs counter to the prevailing orthodoxy.

  3. gastro george said, on April 10, 2011 at 3:27 pm

    On our debt obligations I still think your too sanguine.

    [Not aimed at you personally Dave, but] I get increasingly annoyed by the Dickensian tone when people discuss our “debt”.

    People forget that a large part of this “debt” is actually “investment” for our pensions, etc.

    Japan has been running a much higher “debt”, of similar structure, for years with no apparent financial difficulties.

    As Duncan continually points out, as long as the country is producing enough (Japan has the advantage of being a major exporter), then the debt is not a problem.

  4. Luis Enrique said, on April 11, 2011 at 9:20 pm

    stephen I don’t think what the Economist and the chief economist of the IMF says can be described as going against prevailing orthodoxy

  5. […] But the second key point is that Portugal has been experimenting with exactly the same kind of austerity policies that Osborne has introduced in the UK: raising VAT and cutting public sector spending. The Portuguese finance minister also talked up the prospects of ‘export-led growth’ – another Osborne theme. The result has been lower growth, higher unemployment and ultimately a higher deficit – just as happened in Greece and Ireland. […]

  6. Jim said, on April 17, 2011 at 7:28 am

    Suggestion:

    Why not include Bill Mitchell’s blog and Warrne Mosler’s and NewEconomicPerspectives on the blogroll? Seems like you all have lot in common.

  7. Tom Waters said, on April 27, 2011 at 10:34 pm

    I responded to your claim that PIG show that austerity doesn’t work here -http://libertyinreality.wordpress.com/2011/04/08/what-do-portugal-ireland-and-greece-say-about-austerity/

    In short, Portugal didn’t get bailed out because of faltering growth (its economy was growing) because of austerity (in 2009 spending went up by 6% real, in 2010 it went up by 4% real), it went up because they spent too much money.
    Ireland didn’t have a horrendous crash because of cuts, since the huge fall in output almost all came in one quarter – which was the quarter before the austerity measures actually began
    Greece didn’t have their credit rating downgraded because they had cut too much and had reduced growth statistics – Moody’s said that the reason they downgraded them was because they didn’t believe that they would make the cuts they had promised their would! (Incidentally, Moody’s have been vindicated on that front)

    The actual numbers show exactly the opposite of what Duncan claims.

  8. […] But the second key point is that Portugal has been experimenting with exactly the same kind of austerity policies that Osborne has introduced in the UK: raising VAT and cutting public sector spending. The Portuguese finance minister also talked up the prospects of ‘export-led growth’ – another Osborne theme. The result has been lower growth, higher unemployment and ultimately a higher deficit – just as happened in Greece and Ireland. […]


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