Head to Head: Austerity

 
 

Against austerity

Supporting the anti-austerity side of the debate, Robert Nielsen writes that there is always another option

Whenever someone tells you there are no other options, don’t believe them. There are always other options and when people pretend otherwise it’s usually because they want to shut the debate down. So, when Michael Noonan grimly announces that we have no choice but to implement austerity, we shouldn’t blindly accept this. There is always an alternative.

Let’s take a moment to talk about the numbers. In 2009, the budget deficit was €25 billion, a figure the government declared too high and began introducing austerity. Since then roughly €25 billion has been cut from the budget, mostly in the form of spending cuts but also tax rises.

Surely that would mean that we now have a balanced budget and don’t need to cut anymore, right? Wrong. The deficit is €7 billion this year. How does that add up? Contrary to what the government implies, balancing the budget isn’t as simple as cutting the budget until the deficit shrinks away. You see policies of austerity actually make the economy worse, which in turn makes the deficit worse.

Let me explain why austerity is a false economy. Let’s say the government cuts public sector pay and thinks it has made a saving. What actually happens is that these public sector workers now have less money to spend. So let’s say they decide to spend less money on eating out.

This might sound like being sensibly frugal, but if everyone does it, then local restaurants will go out of business. Now we have more people unemployed, who now have less money to spend and so more businesses go bankrupt and so on. So austerity, far from improving poor economic position puts us into a vicious cycle of economic decline.

Worse still, the budget has not improved. So, although the government is spending less on public sector wages, it is now spending more on unemployment benefits and receiving less on taxes. In this way, budget cuts can actually make the budget deficit larger, not smaller.

For example, the €6 billion in cuts in the 2010 budget merely pushed the economy back into recession and undid most of the proposed savings. This is why austerity is self-defeating; not only does it inflict pain on the most vulnerable members of society, but it fails on its own priority of reducing the deficit. But don’t we have to cut the budget? Isn’t it better to get the pain over and done with?

Actually, no. There are two ways to reduce the national debt. We can either implement austerity in the form of spending cuts and tax rises or we can grow the economy. For example, if the national debt is 100% of GDP and the economy grows by 10%, then the debt has fallen to 90% of GDP.

The crucial point is that austerity policies prevent the economy from growing and only make the recession worse. So imagine if we cut spending by 10%, but the economy contracts by 10%, then we are no better off. We would have suffered the pain in vain.

This is actually how most countries deal with deficits. Developed economies were heavily burdened with debt after the Second World War. At this time, instead of focusing purely on cuts and austerity to reduce the debt, they focused on growing the economy.

By delaying repayment, their economies were able to grow into a stronger position, making the debt far easier to pay. Inflation also wore the debt down so that by the 1970s, although little of the debt had been paid back, the debt was reduced to a low percentage of GDP.

This is the worst recession since the Great Depression, so it seems logical to examine it to find solutions to our current crisis. Back then there were problems over deficits too and many people called for austerity.

However, the countries that recovered fastest were the ones that ignored the calls for austerity and instead launched a stimulus. By spending money, the government was able to give private businesses a boost and put people back to work. Then once the economy had recovered, government could easily pay back the debt.

It is worthwhile to examine how Ireland got out of the high debt doldrums of the 1980s. Little of this debt was paid down, instead the economy grew at such a rate that the debt seemed tiny in comparison. In a growing economy, deficits are not the main concern. If people have jobs and a decent income, then tax revenue will be high and there will be less need for government services. Growth, not austerity, is key.

The emphasis of the three main parties on austerity cuts has been very damaging to the economy. Thanks to austerity, the economy has continued to stagnate and unemployment has remained disgracefully high.

Continuing to cut is preventing the economy from recovering and is keeping us mired in recession. Even if you put aside questions of fairness or sharing the burden equitably, the simple fact is that poorly planned cuts don’t reduce the deficit but can actually increase it. Austerity isn’t working; it is only pushing us back into recession.

 

Rebuttal

Debt is certainly a problem, but so are mass unemployment and a stagnant economy. So it becomes a question of cost. Is it worth the increase in debt to boost the economy into recovery?

If we don’t, the economy will continue to stagnate and the level of household and corporate debt will increase. There is no debt-free option. Until the economy begins to recover, debt will continue to rise.

The line that debt above 77-90% causes damage to the economy is incorrect and the research by Rogoff & Reinhert has refuted this claim. Austerity has never worked and the case of Latin America had more to do with the rising price of raw materials than austerity, which only increased poverty and inequality.

Cutting the deficit is not like offering a sacrifice to the markets in the hopes they will be pleased. The bond markets will lend to us only if they believe we can repay our debts.

Whether or not a country can repay its debts is based primarily on the strength of the economy. So, if we want to get back into the markets, then we need a strong, growing economy. Therefore, if cuts weaken the economy, they are actually delaying our return to the market.

~

In favour of austerity

Arguing in favour of austerity, Elizabeth O’Malley says that these harsh measures are the only choice Ireland has

Back in November 2010 austerity was not a choice. Our government was about to run out of money. The growth only route requires the ability to borrow cheaply enough in order to be reasonably able to pay back your debts. The U.S. was able to do this because they were in a far better position than us financially.

No one but the troika (the International Monetary Fund, EU and European Central Bank) was willing to lend money to us; in return for getting enough money to stay afloat we needed to agree to austerity. How did we get to a position where no one was willing to lend to us?

Our current debt to GDP ratio is 125.1%. To put this in perspective, 77-90% is when an economy starts to get into trouble. Debt becomes a vicious cycle. It turns away foreign direct investment as companies worry that while our corporate tax is low at present, we will have to raise that tax in the future to pay creditors. This deprives Ireland of jobs, infrastructure and tax.

Debt requires our government to focus on short-term returns on investment. This is why we’re focussing on identifying and eliminating waste in the public service instead of, for example, making huge investments in the education sector that would take at least a generation to pay off.

Once your economy accumulates so much debt, there are only two possibilities. The first is to default; to not pay back our debtors or burn the bondholders. This would have been far worse than austerity.

Once a country defaults, it becomes impossible to borrow money. Defaulting also turns away foreign investment, as companies don’t want to settle in a country where financial conditions are unstable.

In Argentina, defaulting led to a lost generation that was marked by huge unemployment, riots, and growth of inequality. National businesses, such as Aerolíneas Argentinas, either came close to bankruptcy or became bankrupt. Those worst affected were the poor. Ireland would have fared far worse, given the open nature of our economy, which relies on trade.

Our other option was to find some way to pay for our debt. Many will argue that we should have grown the economy in order to create more money, but this assumes that we’re a position to borrow money to invest in growth. The fact that we have so much debt scares off investors because they are worried that we wouldn’t be able to pay them back.

Even if we could borrow money, it is not as simple as investing in our economy and getting growth in return. In order to create growth, you first have to provide jobs that don’t divert money from the private sector and therefore shrink another part of the economy. Secondly, it could put people off spending their money if they are afraid that the government will have to increase taxes later, or if it raises interest rates, therefore decreasing demand.

Real growth is impossible while we have huge levels of debt. As long as our debt exists, we are required to raise taxes and cut spending; putting this off only raises our levels of debt, and turns away anyone willing to lend to us. Even if the Troika was willing to lend to us regardless, the larger our debt, the higher our levels of interest and the higher our debt will be pushed up.

Has austerity worked? While our bonds are considered a high-risk investment, we are still performing better than Greece, Italy, Portugal and Spain. The ratings agencies, Moody’s, Fitch and Standard and Poor have upgraded our ratings to ‘stable’ and ‘positive’.

Despite this optimism, they warn that “faltering in Ireland’s commitment to austerity” would have a dire effect on ratings. “Downward pressure would develop on Ireland’s government rating … if the country’s fiscal consolidation process were to falter.”

Economist Dr. David Duffy argues, “The remaining consolidation measures should be introduced as planned. This is because uncertainty remains for domestic and international growth. Even at the end of the consolidation process, the government will still be running a deficit. In addition, there is a continued need to reduce government debt.”

The theory of austerity isn’t new. Lowering debt levels by raising taxes and cutting spending lowered debt levels of Latin American countries during their debt crises of the 1980s, and this sparked massive GDP growth.

Our economy is growing for the third straight year, mostly driven by a growth in exports. Our unemployment levels have fallen from 15.1% to 13.3% in the last year alone, albeit partly due to emigration. Consumer sentiment has risen sharply over the last few months, meaning that there is likely to be an increase in consumer spending. The signs are good; it is just a question of sticking the course to make sure these years of hardship weren’t for nothing.

 

Rebuttal

“Whenever someone tells you there is no other option, don’t believe them.” Whenever the IMF, the Central Bank, the ratings agency and a number of highly esteemed economists tell you there is no option, it is prudent to give them the benefit of the doubt. When the Labour party tells you there is no option, when they have every reason to say otherwise, they must be aware that there is no other option.

The idea that we cut spending by 10% and the economy shrinks by 10% is highly unlikely. The ratio is more likely to be 10:1. Figures like cutting our economy by €25 billion only reduced our deficit to €7 billion fail to take into account that our debt has risen due to the fact that we had to borrow and pay interest.

European countries may have been able to outgrow their debt, but they also had the Marshall Plan providing them with money for such growth. Unfortunately there’s no Marshall Plan this time, no big supply of capital with which to invest in creating growth. In the 1980s we weren’t in as dire a position as we are now, with nowhere near the level of debt. We’re left with what we have, which is a troika demanding austerity.

 

Advertisements