Why Austerity does not Work?

With all the protests against austerity in Europe and the push for austerity in USA; one should stop and question as to what austerity is and whether it works or not. Austerity in simple terms is fiscal responsibility to the extent of near stagnation of spending by the government. This is additional spending which includes cutting of posts in government offices and stopping the functioning of offices that the government deems unnecessary (which we all know would be environment related agencies).
When an economy is in recession private investment does not exist. The private institutions would hold off investing when there is no chance for returns to investment. On top of that, they will not have the kind of cash reserve to take that kind of a risk. The only institution that can fill the void that the private institutions have left behind is the government. Therefore the government has to pick up the slack and invest; to drive the economy forward and out of recession.

Comparing two or more countries on the points of microeconomics and macroeconomics is never easy, because the first thing you learn in economics is the fact that each country has its own economic realities and this changes the fiscal and monetary policies that are used. But there is universal agreement on what effects austerity has and when such a policy should be pushed through. Austerity works; only when the economy is in a situation where government spending cuts can be compensated by private investment. So the reality right now is; private spending in none of the European countries can support the drop in government spending and it’s also the same case in USA. The biggest problem for Europe though is that they have no choice but to push through austerity plans because of the one currency issue. The euro as the single currency for countries with different fiscal standings was a big mistake. The countries that could not have borrowed such enormous amounts of money otherwise, started borrowing at low rates and spending without thinking of the consequence. The people have every right to be angry at their governments and they should be mostly angry about joining the euro. Argentina which is a success story on bouncing back from a real deep recession could do so because they could control the exchange rate of their single currency. Only a few of the countries in the Euro Zone are strong enough to support the currency. Unless countries like Germany, France etc. decide to pump in enormous amount of funds to make sure the bug of recession does not spread; austerity is the only way forward. But the people are suffering and it’s going to get worse. When Britain decided not to join the euro, everyone said that they were out of their minds. But in the light of the situation, they made the right call.
In the case of USA, talking about austerity itself should be looked at as a taboo. An economy that is on the cusp of recovery and when its needs more funds to actually push it past the finish line, I am surprised to hear the rubbish talk of spending cuts. USA as a country has one of the lowest borrowing rates in the world because they have the economy prowess to pay back its debt. The US still does not have the required private investments for the government to take up fiscal responsibility. The talk about the debt clock is just scare tactics used by politicians for political gains. The recession was not brought forward by too much government spending alone. Rather it was brought forward by too much investment by private institutions in toxic assets. The private institution borrowed money and invested in asset that really had no returns to investment. They did it to drive up prices to a point where the artificial rise in prices could not be sustained and the debt to rise. It was private greed that caused the recession. When the country’s top economists that includes a Nobel laureate Paul Krugman says that the stimulus was too small and the debt is manageable by US standards, people should listen. Austerity at this point would ruin America’s chances of a smooth recovery and even go as far as pushing it further into a depression and the rest of the world along with it. I hope common sense wins over the political rhetoric.


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