The Austerity question

To spend or not to spend?

British Conservative leader and now Prime Minister, David Cameron, proclaimed the “Age of Austerity” in 2009. Miriam-Webster dubbed it the word of the year in 2010. Europe grappled mightily with austerity through 2011. And by 2013, our Labor Government, in a tip of the hat to austerity, has promised to balance the budget.

But now, in little ‘ole 2012, we are starting to see some of the results of all this austerity. And those results are not great.

First, let’s back up and take a stab at a definition. Austerity, as an economic policy, aims to cut government deficits by reducing spending, services and benefits.

With our economy doing pretty well, government cuts have been relatively painless. But in countries like Greece and Spain and Italy and Ireland … well, we’re talking strikes, mass protest, civil disobedience and disaffection.

The belief in Europe is that if governments slash spending and balance their budgets they can bolster private-sector confidence and hence confidence in a European government’s ability to pay its debts.

Counter to this thinking is the traditional economic wisdom that during a recession governments should stimulate the economy with extra spending, even if they must borrow to do so. Think GFC stimuli by Obama, Rudd and Chinese Politburo.

Sure, the thinking goes, balanced budgets in the long term will reduce interest rates (encouraging growth) and lead to smaller debt repayments allowing tax cuts, which also increase growth. But austerity in the short term lowers income and raises unemployment because all that stimulating government spending is removed from the economy.

The thinking continues that a weaker economy generates less tax revenue, which offsets the initial savings benefit from the austerity. Therefore, austerity in times of recession can actually make it harder to balance the budget, not easier.

But the austerity crowd, including much of Europe’s policy elite and many in the U.S., is unbowed. It insists that “expansionary austerity” is the key because confidence is the key. Some have even urged Obama to “do a Cameron”, meaning implement strict, British-style austerity.

So, how’s austerity going? To borrow a phrase from Nobel Prize winning economist Paul Krugman, has the “confidence fairy” materialized?

Not so, according to British think tank, the National Institute of Economic and Social Research. These pointy heads took changes in real GDP since this recession began, and compared it to past recessions. The results were alarming.

It seems Britain grew faster during the Great Depression than it is now. Four years into the Depression, Britain had recovered to its previous GDP peak. Four years into this recession, Britain isn’t even close to recovering its lost ground.

Meanwhile, recent employment figures in the U.S. have been surprisingly good. So perhaps it’s lucky for Obama he didn’t “do a Cameron”?