A poster promoting the virtues of austerity. But who really benefits? Photo: Flickr Creative Commons
Austerity isn’t working. From the Bundesbank to 11 Downing Street, in Ireland, Spain, Italy, and Greece, expensively educated men in suits are telling the rest of us that we have been living large for too long. Unless we cut government budget deficits, these Jeremiahs warn, inflation will take off, bond yields will skyrocket, business confidence will shatter, and the economy will never recover. Under their influence, we freeze wages, fire civil servants, close libraries, cut pensions. But reducing budget deficits doesn’t seem to be sparking growth. Indeed it is making things worse. Household income actually declined last year and Britain is falling into a double dip recession.
It is counter-intuitive but essential to remember that our current economic travails are caused by lack of demand, nothing else. No supply shock, no hurricane, no earthquake has devastated the planet. Our productive capacity remains pretty much the same as it was before the financial crisis. Only our confidence, or, as Keynes would say, “animal spirits” have collapsed. The solitary reason unemployment remains sky high is that households are paying down debt and firms are sitting on piles of cash. If either group found a reason to be optimistic and opened their wallets, the recession would vanish. In such a situation, with firms and households saving rather than spending, another sector has to pick up the slack. The obvious solution is increased government expenditure, especially on infrastructure and investment. Government deficit spending, targeted say, to education, would make British workers more productive twenty years in the future, while reducing unemployment today. It seems a no-brainer.
Instead, austerity-inspired spending cuts ripple through the economy, further lowering demand, reducing any incentive for private firms to invest, trapping the economy indefinitely below its productive potential. The public, currently tightening its belt, seems pleased by the notion that the government needs to tighten its own, even if well established macroeconomics and recent history teaches otherwise.
Austerity has always been the ideology of creditors. In Latin America in the 1980s, in East Asia in the 1990s, in southern Europe today, banks that had made imprudent loans were able to force governments to cut spending, so as to free up cash to repay debts. Unfortunately, these policies inevitably created massive unemployment and slammed the economy into reverse. Citibank profited from its misguided loans to Argentina, Brazil, and…