Austerity or Expansion: A critical question

November 29, 2013 | Posted by bobbysrinivasan << back to blog

Keynes, a brilliant economist of Yesteryears advocated increased government spending during periods of economic slowdown. This according to him should help the economy grow and create jobs which otherwise will have to be supported by the nation’s welfare scheme. The impact of government spending exceeding its revenue will create a budget deficit which needs to be paid when the economy recovered. This theory is not easily accepted these days by the academic community. At times the slowdown is persistent and stays for a longer period of time. This makes some economic scholars question the usefulness of pumping the prime.

Recently many academic articles have appeared in journals glorifying the austerity measure. The question it addresses is ‘how can you keep spending the money you don’t have which ultimately you have to pay?’ The first study was made by Alberto Alesina and Silvia Andagne, which suggested the importance of fiscal austerity. A subsequent study was also made by the economists at the IMF in 2010. This study reworked with better data and concluded that austerity measures are not useful in the long run. Change and improved data simply changed the conclusion.

The second study made by Reinhart and Rogoft concluded that once the government debt reaches 90% of GDP, the economy will flounder and the growth rate will drop rapidly. Subsequent studies made by others falsified this conclusion.

In all it appears that during an economic slowdown in a country, austerity measures will do more harm than good. In today’s world austerity measures have damaged many European economies. Spain for example has an unemployment rate of 26% and youth unemployment of over 50 percent. Ireland has entered into a permanent economic stagnancy. In fact austerity measures have increased Greek indebtness substantially.

Why then is this desire for crippling austerity measures. In fact the reason why mass unemployment exists is not because the country has spent too much in the past but it is spending too little to create jobs.

The conclusion about the relevance of austerity measures is that it is politically motivated and is supported by rich people. A study made by political scientists, Benjamin Page, Larry Bartels and Jason Seawright on the policy preferences of ordinary Americans with those of the very wealthy. The conclusion was that the wealthy would prefer cutting federal spending on health care and social security to reduce the budget deficit. Ordinary Americans preferred to have the spending in those programmes to actually rise.

The final question to be answered is what segment of the population the government is meant to serve, a small fraction of rich people who would like to cut the budget expenses or the ordinary citizen who is counting on the government support in meeting his expenses. In India, our government promises to serve both namely by keeping the subsidy on food and fertilizer and nrega and at the same time promises to bring down the ever increasing deficit. The government is promising to keep the budget deficit at around 4.8% of GDP. Ultimately the winner will be the ordinary people because come national elections, it is one man one vote.

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