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Does austerity work?

C.S. SUNDARESAN
**The perspective suggested for the postponement of measures to reduce fiscal deficits until the recovery is firmly entrenched. The counterview by the proponents of austerity has been that high fiscal deficits threaten to crowd out private spending and undermine market confidence.
RACTICALLY there are two ways to live. One is to earn more and spend more and the other is to earn less and spend less. The ones who followed the first for
long will find it difficult to get into the second, for obvious reasons. The capitalist way of life is perhaps meant to prefer the former as it envisages stimulation while the latter is gradualist. Therefore, the interpretations of austerity in the contemporary world have been viewed with much suspicion and vary-
ing levels of confirmation by the proponents and opponents respectively.
It is, however, true that austerity is prescribed for economic recovery from global recession currently faced by world economies in varying degrees. The basic Keynesian perspective is that fiscal retrenchment in a context of recession will only deepen the downturn arising out of the negative multiplier effect of falling effective demand and the likely > reduction in investments. Hence, 2 the perspective suggested for the w postponement of measures to 5
reduce fiscal deficits until the g
recovery is firmly entrenched. The § counterview by the proponents of austerity has been that high fiscal deficits threaten to crowd out private spending and undermine market confidence. Fiscal consolidation, therefore, is potentially expansionary in nature with increased expectations of declining future tax, interest rates and currency values and thereby a boost in the confidence level of investors, which will eventually stimulate growth by enhanced
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consumption, investment and exports.
Financial crisis and markets:
There is a common notion that financial crises indicate the inefficiency of the markets and the capitalist system, which not only have market implications but development impacts too. In his 2011 Hicks lecture, Prof.Angas Deaton (of Princeton University) has analysed the welfare effects of the financial crises since 2008, particularly for the American people. The unemployment rate of the American economy has risen from 4.8% in 2008 to 10.6% in January 2010, causing a 4.7% drop in disposable personal incomes.
Simultaneously, the desperate right wing coalition composed of rich households, large corporations and conservative political parties advocated for the elimination of deficits through severe reduction in all government welfare spending which either supports the poor and middle class or the critical social sectors like education and health. Almost similar austerity measures were adopted by the EU governments as well. In essence, the adoption of austerity programmes across the world evolved into a situation where the economies started sinking in deeper recessions or depressions, raising serious doubts about the scope of austerity in overcoming economic crises.
Prof. J.Crotty of the University of Massachusetts has established three main elements on the scope and options of austerity in a financial crisis. One, the current austerity war has historical roots and the costs of depression led to powerful political move-
ments in the US and EU demanding an end to the uncontrolled capitalism that had caused much devastation and hence its replacement with new economic systems designed to meet the needs of the people. The western models of economic development evolved from these movements have variants of social democracy, democratic capitalism, regulated capitalism or a mixed economy approach.
Two, the current government debt crisis is the outcome of right wing economic policies which deteriorated economic performance and generated large budget deficits. Rising deficit creates pressure on financial markets and compels governments to act towards easing the crisis. Cut in spending on productive investments in turn will shrink the social safety net. Third, the slow growth and radical regulation of financial market potentially will go into a vicious cycle, which is unlikely to attack the root cause of deficit crises, and end up in resurgence.
The straight question is, therefore, does austerity work in a recession situation? If not, how does it avoid the burden of fiscal deficit for the future generations? The neo-liberal view is that government deficits are damaging given the fact that they impose fiscal burden on the future generations. At the same time, if governments borrow to finance the deficits, it will end up in crowding out of private investments and accelerate the interest rate, which will further retard the scope for investment.
King et.al, (2012) observe that austerity is less effective if one views it from a historical perspective. Further, the depression can be caused by the austerity measures. For
instance, there is evidence (Taylor, et.al, 2012) that over the last 50 years in the US fiscal expansion has repeatedly resulted in higher economic growth, especially during recessions. The opponents of austerity argue that fiscal retrenchment will only deepen and extend the recession. Accordingly, the efforts to reduce the deficit should be postponed until the recovery is fully underway because it is only then that such efforts can succeed. This happens because the multiplier effects of additional government spending works when the economy is operating below the capacity.
Austerity and LDCs: The scope of austerity in pulling the developing countries out of recession has been denied by economists as well as organisations. Joseph Stiglitz and Paul Krugman have prescribed that nations in the grip of economic recession
with high unemployment levels need to keep away from austerity drives. The neo-liberal policies aimed at reducing the role of state in economic growth and development and bringing in the markets to arbitrate growth and development met with high levels of inefficiency in much of the developing world. International funding for development in less developed countries comes with a series of austerity driven controls and commitments. These are mainly in the domains of less government spending, reduced consumption expenditures, and removal of financial regulations to name a few. The impact of these controls is reflected on wages (reduced value of labour), volatile capital flows and the resultant slowdown in economic growth and social welfare. It is perhaps time for countries to review the returns of their austerity drive for economic growth and social well-being.
The writer holds the Ford Foundation Chair in AKRSP India and the Visiting Professor in the school of rural management at KIIT University. Views expressed are personal.