Why austerity and deep cuts are a self-defeating measure


1:47 pm - April 8th 2011

by Duncan Weldon    


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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’.

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About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
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Reader comments


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.

In other news, chemotherapy causes cancer.

2. Duncan Weldon

Tim @1,

You seriously think Irish austerity measures didn’t contribute to higher unemployment, deflation and a collapse in growth? Seriously?

2 – Are you seriously suggesting that Ireland’s economy would be just tickety-boo if only it were running a budget deficit of 40% rather than 35%?

4. Duncan Weldon

If in 2009 thay had launched a stimulus – rather than cuts and tax rises – unemployment would have been lower, growth higher and the deficit smaller than it turned out.

If in 2009 thay had launched a stimulus…

There’d have been an almighty bond crisis and the bailout would have happened that much sooner. Ireland was struggling to auction its debt as it was, and the spread over 10 year bunds was over 400 points.

6. Duncan Weldon

5.

No it wasn’t. 10 yr spread over bunds peaked at 250bp in 2009, then started climbing again throughout 2010.

Did you agree with Guido, Dann Hannan, Iain Dale, etc in 2008/09 that Ireland’s policy of austerity would lead to a ‘quicker recovery than the UK’?

7. AnotherTom

to take this latter line of argument seriously one has to assume that bond investors would have been happy to fund a debt-funded growth package from the Irish government that was also on the hook for the entirety of its banking sector. I don’t think that’s a serious proposition, and spreads would have very likely spiked way earlier and way higher if they had tried it.

8. AnotherTom

you seem to have ignored the one important lesson from the credit crunch duncan

http://www.cashandburn.com/2011/04/puke-point.html

Duncan, as I see it what you are failing to appreciate is how much this is the unraveling of the last decades convergence in yield. Mundell predicted that the eurozone borrowing costs would converge. However, it was all bollocks built on sand and the convergence is reversing and diverging to somewhere around the true risks. I worked in sov. debt markets for years and looking at the eurozone over the last 18 months I would not be buying Portuguese bonds unless they had an EU/ECB guarantee behind them. Without a fiscal transmission mechanism the market woke up to the risk that was always there but it was covered up by the illusion that the eurozone members were all the same. Portugal and Greece are not Germany and their refinancing costs should be much higher. The institutions that buy sovereign debt do not buy sovs to be exposed to risk and there is a lot of liquidity and default risk in the EZ periphery. Buy gilts and one has the credit of the British government standing behind them. Things go ultra pear shaped in the UK and the BoE can always buy them. One will always be paid back in sterling as the government have infinite sterling so in the context of the UK, buying government debt is default risk-free and only subject to inflation risk. Moreover, with the 13 year maturity there is not the roll-over risk that the EZ have with their short-dated debt. None of that applies to the EZ periphery.

Ireland were different to Greece and Portugal and they put themselves in the shit by guaranteeing the banks. Ireland had which they are rapidly losing a young educated workforce and lots of US multinationals who export. So they could and might still manage to earn themselves out of the government fiscal problems. Portugal and Greece can’t earn themselves out of difficulties because their economies are sclerotic and uncompetitive. Austerity probably has made their GDP growth worse but the blow out in yields would have happened anyway. Mr Market will not give them the money without credible institutions standing behind a guarantee. Hence, a bailout which is the credible institutions coming to the rescue.

I really don’t know where you are going with this argument. Yes, Mr Osborne is talking drivel that Portugal provides a salutary lesson for the UK. The two situations are not comparable and he is playing politics to deceive the ignorant. However, it is just not credible to say that the private sector would not have shut out Portugal and Greece if they had not done austerity. They simply can’t afford their current states because they do not earn it so austerity is not just necessary but inevitable.

IIrelands recovery would have been fine had it not done the most abysmally retarded thing I’ve ever seen and said it would stand behind all of the debt of its hopelessly bankrupt banks.

The Irish state itself was fine – till it then pledged its entire annual GDP to bail out its banks.

In the last 30 years there have been numerous examples where austerity has caused a short sharp dip in an economy, allowing it to rebalance and then move ahead with above trend growth. Canada and New Zealand probably the best two examples.

I can’t think of any examples where running 10+% deficits has allowed a country to forge ahead long term. Any.

All that was going to happen if Ballsup got his hand on the chequebook would larger deficits for longer, debt/GDP rising to the growth critical 90% level and long term growth being crushed at the expense of a bit of politically expedient short termism.

You should be thankfull that the UK is well placed enough the austerity can come only at the cost of a bit of short term growth and our debt isn’t going to get out of control (though it is already nasty in repayment terms).

((And before you ramble on about German stimulus; they had a small budget deficit, a well balanced export led economy and had space to play Keynesian for a while. ))

But I suppose you are going to come back with the same monocular Keynesian arguments, effectively saying that growth can only come from more spending, and with that more debt.

Tyler

Rather decent of you to make an argument then rebutt yourself?

In further news, chemotherapy makes the patient even more unwell and there’s no guarantee of a cure!

12. Jonathan Phillips

You can’t live on tick for ever, but there’s no point trying to pay off your debts so fast you end up starving to death. So find the combination of tax increases and spending cuts that will cause least damage to the economy – and society – in the long run.

The Tories’ indiscriminate hacking is intended as much to wreck what’s left of the public sector as it is to cut the deficit, and they don’t much mind if industry is damaged along the way. Or am I just letting my prejudices show?

We’re already starting to see U-turns on cuts as the gov realises they’re too deep.

MOD is being reviewed, and as I understand from some family in the forces, those being told they’re at risk might now not be – or certainly not as many. There are also rumours about Harrier getting a temporary reprieve given 12% of our air force is already deployed on a relatively minor deployment in Libya. Imagine full scale military actions!

Are the government finally realising savage cuts are likely to have the reverse affect? At what point will they finally admit to this ‘Plan B’ ?

Why The U.K. And Europe Can’t Simply Pull A ‘Canada’ To Fix Their Debt Crises

Read more: http://www.businessinsider.com/why-it-will-be-extremely-difficult-for-europe-to-pull-a-canada-can-fix-its-debt-crisis-2010-6#ixzz1IyA45EQO

This is really getting very boring because everyone warned that the Conservatives idiotic plans would fail in one way or the other but the Conservatives or should I say the Evil Party are also Arrogant.

This is truely a deceitful, lying, Evil Coaltion of Misery and to add insult to injury they have embarked on an expensive war to satisfy their need not only to make a name for themselves but also self gratification that they can spread the pain far and wide.

Please deliver us from this Evil and soon.

16. Mike Killingworth

[12] This is the classic conflation of an individual and a State. Hint: States can raise taxes.

That is not to say that they can raise as much money as they like, but certainly in the long term they should borrow as much as their citizens want to lend them. (Anything else is a restraint of trade, a denial of freedom – and one more phrase I can’t come up with right now.)

The way to look at the problem is surely to ask: what determines how much people want to lend to their governments? Well, we buy gilts because we’re risk-averse – we’ll just as happily buy private paper that has the same rating. If, as I suspect, the structural problem is at least partly caused by the fact that savers are so risk-averse that entrepreneurship is restrained*, then the question becomes: what measures can Finance Ministries take to get people like me to move their savings from bonds to equities?

*I’m assuming, along with Osborne, Tim J, and all such happy souls, that new enterprises will be located in the UK, rather than somewhere a long way to the south-east where wages are much much lower and regulation much much less…

I think poor old TimJ got pwned by Mr Weldon up thread.

And all governments would do themselves a huge favour of they put the likes of Richard W and his crowd of vastly Inefficient userers out of a job and stop issuing the debt these buffoons think they can make a “Market” out of.

I don’t know what I am supposed to have done to upset you, Ben. Governments could certainly stop issuing debt securities. However, that would of course mean they only spend what they take in tax receipts. There goes the entire NHS and education budget this year if they did not sell gilts.

Did you agree with Guido, Dann Hannan, Iain Dale, etc in 2008/09 that Ireland’s policy of austerity would lead to a ‘quicker recovery than the UK’?

No, I thought that Ireland, as with Greece, was irredeemably fucked because of its membership of the Euro. That coupled to the unqualified guaranteeing of it’s banking sector’s debt. But I doubt that adding a liquidity crisis to a solvency crisis would have helped matters.

And all governments would do themselves a huge favour of they put the likes of Richard W and his crowd of vastly Inefficient userers out of a job and stop issuing the debt these buffoons think they can make a “Market” out of.

BenM, you’re entire economic worldview is centred on the idea that Governments can borrow their way out of any situation. How do you propose to borrow without debt? Or is this a call for Governments to print their way out of trouble? I have a book recommendation for you:

http://www.amazon.co.uk/When-Money-Dies-Nightmare-Hyper-Inflation/dp/1906964440

19. Richard W

What arrogance.

In the midst of economic depression with ample spare economic capacity Governments don’t need the hangers on in your so-called profession.

They ought to cut out the expensive, wasteful middle men and print the money we need as a society and balls to the debt market and the self appointed sages who act as credit ratings agencies (the very same people who got us in this mess).

@TimJ

BenM, you’re entire economic worldview is centred on the idea that Governments can borrow their way out of any situation.

Not true. I think the government needs to borrow and spend to get itself out of this situation.

When that is done, it needs to completely revamp the UK economy, ensure taxes are progressive and ample enough to cover expenditures, and to regulate properly.

To rewind the economic lunacy of the last 30 years in other words.


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