FISCAL CONSOLIDATION: CUT SPENDING, SOLVE FISCAL PROBLEMS AND INCREASE INVESTMENT?
By Sheila Block
At the start of the Great Recession of 2008-09, governments increased their role in the economy. A concerted and fairly consistent slate of monetary and fiscal policies was rolled out. Yet, only a few years later governments shifted into reverse gear and balancing budgets became the main policy priority. Every governmental budget has an income (mostly through taxation) and a spending side—it was the latter which was tightened the most. According to those who believe in the merit of austerity, spending cuts are the most effective way to balance budgets in the short run, and to consolidate public finances in the long run. Yet, the negative impacts on individuals and society at large are ignored.
When spending is not questioned, and when it is
Central banks pumped trillions into the economy following the global financial crisis (GFC). As a result, we did not see an extended collapse in financial markets as in the Great Depression of the 1930s. This was accompanied by concerted fiscal policy interventions, which were shown to have a positive impact on the real economy. An example is the American Recovery and Reinvestment Act, which included investments in transportation, environmental protection and other infrastructure as well as increased access to social transfers. There was a return to stability in the financial system and in the real economy. This experience ran counter to the neoliberal narrative of the ineffectiveness of fiscal policy to stabilize the economy. From a macro-economic policy perspective, these government actions proved effective.
As a result of the stimulus program, government debt did go up post-recession: OECD data show increasing debt-to-GDP ratios in EU countries from 2007 to 2010. This is to be expected coming out of a period of economic downturn and increased government spending. The crisis caused rapidly rising debt—not the other way around (see Greg Albo and Thomas Fricke on the cause of the crisis).
Very shortly after these successful government policy interventions, a variation on an old myth in macro-economic policy regained prominence. It has a number of building blocks. The first was that any country that had a large budget deficit was now at risk of experiencing a government debt crisis. Using Greece’s experience as an object lesson, countries coming out of recession with high debt were warned they would lose access to capital markets, which would make it very expensive—almost impossible in some cases—to finance or refinance government debt. The second was that austerity was the solution to this threat of an ensuing debt crisis. Thirdly, the best way to balance the books again was by cutting public spending rather than increasing tax revenues. The final thread in this myth is that these austerity measures would not have a negative impact on economic activity. It was argued that spending cuts would boost the economy, while increasing taxes would increase the deficit—a variation on the debunked ‘Laffer curve’, associated with the Ronald Reagan US presidency, which argued that lowering taxes would have such a stimulating economic effect that this would lead to increased tax revenues.
How convincing are these arguments? First off, a commitment to eurobonds—or similar instruments designed to pool government debt—would have put an end to financial speculation targeting individual countries. Secondly, if coordinated stimulus ended the free fall, recovery could also have been aided by co-ordinated public-sector investment. Thirdly, increased progressive taxation would have contributed to both the budget balance and decreasing income and wealth inequality.
Government debt levels were in fact used to manufacture a crisis in the aftermath of the GFC—and to lever support for harsh and counter-productive austerity programs with real human costs and negative impact on the economy. Greece implemented some of the harshest austerity measures, predominantly driven by spending cuts. They included freezing the salaries of public servants, drastic cuts in minimum wages, massive public-sector layoffs and sharp reductions in the budgets of ministries such as health and labour. Since 2009, Greek pensioners have seen their monthly retirement benefits cut drastically.
Severe fiscal contractions do real damage. Research from the Global Burden of Disease Study in 2016 linked austerity to increased mortality in Greece. Similar effects were identified for the United Kingdom, in research led by King’s College London in 2017. In economic debates on post-crisis austerity, even where the weakness of these policies is recognized, their human toll receives far too little attention. The abstract argument that spending cuts are a better way to balance budgets than tax increases needs to be interrogated with concrete questions: who pays, who benefits and how fair is the distribution of costs and benefits.
Contractionary consolidation—bad for the poor, not good for economic activity either!
The last eight years have proved there is a continued appetite in bond markets for government debt. OECD data show interest rates remain at historic lows. Predictions from mainstream economists that the Greek crisis would spread like wildfire to other national economies never came true.
At the same time, government retrenchment since 2010 has been associated with higher unemployment and slower economic growth—the opposite of the increased confidence and high growth that was promised. Paul Krugman’s research has shown that government austerity usually has this effect and that economic performance worsens with the intensity of austerity programs. IMF research in 2016 concluded that neoliberal austerity had increased inequality, which reduces both the level and sustainability of economic growth. The authors concluded that periods of fiscal consolidation had been followed, on average, by contractions rather than expansions in output and by increased unemployment.
How can we understand the persistence of a policy like austerity? The answer needs to take into account the interests and ideas of the powerful. These interests are not served by an expansion of the role of government in the economy beyond the protection of property. They are served by a smaller role for the state. Rich people do not depend to the same extent on public services as the rest of us. Private security, private health care and private schools are available to affluent citizens. And any increased role for the state is likely to eat into their considerable wealth, through increased taxation or more protective regulation of their business activities.
Increasing taxation on capital gains or new financial transaction taxes designed to temper financial speculation will have very different outcomes than cutbacks in social programs. Fundamentally, the costs of reduction of government debt and deficits are borne by very different social groups with these different approaches. But the paradox of fiscal consolidation is this: reducing public spending and systematic budget constraints hamper both the state and economic activity.