November 27th, 2012 by Hafiz Noor Shams
Has austerity failed?
In the sense of expansionary fiscal contraction, it has. Expansionary fiscal contraction, in short, suggests that government contraction will immediately expand the private sector. That particular interpretation of fiscal austerity has clearly failed to bear out in countries under crisis. It is like the argument that says reducing taxes will increase government revenue, which is untrue if the economy is on the left side of the Laffer curve.
I do not believe in expansionary fiscal contraction. Other parts of the economy have to grow more than the fiscal contraction caused by austerity if the economy is to expand. In times when taxes go up and public spending goes down, especially in an economy dominated by the public sector, an immediate expansion will be impossible.
But the hypothesized result of expansionary fiscal contraction is a narrow benchmark to measure austerity on. Maybe it is a poetic justice to measure harsh policy harshly.
But the success of austerity can be measured against future growth instead of current growth (or rather current contraction). The idea of austerity is to swallow the bitter pill and get well after that. The point of putting government finance in order is to ensure that the government will not go bankrupt or unable to finance its operations.
Swallowing the bitter pill means the same operations that the government would be unable to finance if it had not switched gears would be cut down to a more reasonable level given the condition of public finance. What makes the cut down bearable is that it usually comes with aids: money for government under severe financial pressure. It means instead of cutting down services drastically under no austerity-no aids condition, the austerity scenario with aids prevents the bankruptcy scenario from happening altogether, with less severe cut.
The cut in public spending in times of recession will be painful and that much is clear. Yet, pointing out that austerity is painful is not enough as a benchmark to say that austerity has failed. There has to be a comparison and the comparison is, how more painful austerity is compared to a scenario of bankruptcy?
There is every reason to believe that the latter scenario (the bankruptcy scenario) will be more painful than the former (austerity). If cutting a significant level of services under the austerity program is painful, imagine a complete collapse of services when the government goes bankrupt. Austerity is the bitter pill to avoid a worse fate.
It is worth stating that austerity is the last option. It is required when countries run out of its economic wits. Despite criticism macroeconomics has suffered in the past few years, I think we still know enough that there are wide options of tools (monetary policy anyone?) before we will be left with severe austerity program.
So, how much pain avoided then should be the benchmark of success for any austerity program. The avoidance of government collapse is another benchmark of success because a collapse is exactly what austerity should aim to prevent.
So, has austerity failed?
When somebody pronounces the failure of austerity, I am almost always wanted to raise my hand and ask, “what is the benchmark of failure?” I suspect those who pronounce the failure believe that pain itself is a failure. If that is the benchmark, then I will disagree with it as I have explained earlier: pain alone is not enough; we need to ask if austerity is more painful than no austerity.
This however does not mean austerity should be done in one shot. There is only so much pain anybody can bear before a society collapses or like in the case of Germany, turns to fascist and other extremists for cure. The point of austerity is to prevent that collapse.
That does not mean austerity should be done in one shot. I prefer an austerity program distributed over time, with a combination of aids, debt relief, low interest rate, long repayment and fiscal reform of government under austerity program.
The alternative to austerity is expanded government spending but in many countries under pressure, they do not have the financial resources to do just that. And there are few countries that are willing to throw money into a blackhole called “helping others” without any fiscal reform associated with a typical austerity program.