The UK was initially criticized for its austerity measures, employed at the height of the economic crisis that has slowly subsided now around the world. But some year’s later the UK was then lauded for being prescient. At the time, its economic growth was the fastest of any advanced economy. Things of course moved on – Brexit followed and even though the cloud did not fall in, the countries economic condition has slipped from front of the class to back. But that misses the point of this blog. The UK adopted austerity since that was the right thing to do – to reign in spending and support the natural economic rebalancing of price and supply. Other countries, when faced with economic challenges such as a slow-down or recession reach for the public sector check book.
This approach is known as Keynesian demand-management. The idea is simple, if not well understood as a simple idea from the practices namesake. When there is a shortfall in demand in the economy, the public sector increases spending to help fill the gap. Public spending, like any spending, creates knock-on effects whereby a dollar spent creates more than a dollar in ongoing spending. This simple idea became common thinking and the pain of the 1970s and 1980s were required for governments to learn that this approach has issues. First, Keynes had suggested that such spending should be temporary – since private sector spending was more efficient. However, even though Keynes noted this, it was left off the memo and his name became associated with “spend”, not “spend for a short while only”. As a result, governments spending increases were rarely ever temporary.
Secondly, and as we have seen in spades since the recent period of near-zero interest rates and QE, public sector spending crowds out private sector spending. The entire bond market has been distorted due to massive government intervention and spending. The whole pricing process has been disrupted. This is the same with the economy. As demand-management kicks in it forces normal public sector behavior to change. And so the economy is knocked off kilter even further.
So it was interesting to read some new material from the IMF that demonstrates that austerity is not the bad-boy all the politicians make out. The interesting article is called, Climbing out of Debt, and was published in the March edition of the IMF’s Finance and Development magazine. The actual data shows that countries that exploited tax-based austerity, versus reduced spending austerity, suffered deeper recessions. This is a kind of “devil you know” point in that first one has to prefer austerity over increased spending. Then, once austerity is accepted, one has to make a choice between increasing taxes (keeping public spending as-is) or reduced public spending. That is the key. Well worth reading to defend against the nay-sayers.