The Age of ‘Austerity’

9th May 2012

"Austerity" was named the word of the year by Merriam-Webster in 2010 because of the number of web searches it generated that year – and it's still all over the headlines. And still, many of us don't understand what it is.

Wikipedia defines austerity as: "In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided." Government austerity measures include higher taxes and spending cuts. The aim is to reduce a country's deficit – the amount it spends every year over and above what it earns.

The term "Age of austerity" was popularized by David Cameron in his keynote speech to the Conservative party forum in 2009, when he committed to put an end to what he called years of excessive government spending.

It's not surprising that austerity measures are hugely unpopular with the public, as they typically result in cuts to public services, higher retirement ages and reduced public sector wages and pensions.

But has there actually been much austerity – and what does this mean for investors?

Investors would be wise to keep an eye on those countries rejecting austerity, as this has potential for stock market swings in the near future.

Azad Zangana, European economist at Schroders, says: "A wave of austerity fatigue is sweeping across Europe.

"On the 6th of May, both France and Greece held important elections that have the potential to change the shape of the eurozone, and both returned a very clear message that voters are against austerity.

"In our view, the results of the Greek election raise the probability of our central view that Greece's inability to elect a government that will adhere to the demands of Germany and the Troika will eventually lead to the existing bailout deal collapsing, and Greece being forced out of the euro."

Even so, the most recent news is that austerity in Europe has failed already. To the contrary of what most of us would think this post argues that in most cases in Europe austerity hasn't in fact taken the form of massive spending cuts.

Following years of large spending expansion, Spain, the United Kingdom, France, and Greece-countries widely cited for previously adopting austerity measures-haven't significantly reduced spending since "austerity" supposedly started in 2008.

At National Review, Veronique de Rugy posts a chart suggesting that if you don't adjust for inflation and don't count tax increases, there's only been a bit of budget-cutting.

However, The Washington Post  says: "Some countries have carried out a huge amount of austerity since 2009, trimming spending, hiking taxes, and shrinking their structural deficits considerably: Greece, Portugal, Ireland, and Spain are the leaders in this regard. Others have engaged in just a tiny bit of austerity, like Germany and the Netherlands. And Finland stands out as an outlier, having actually engaged in a bit of fiscal stimulus between 2009 and 2011."

But is there a more apt description?

Michael Heller says on his post that Paul Krugman complained to his son: "The austerity thing was just invented out of thin air and a few dubious historical examples to serve the prejudices of the elite. And now the results are in:  Keynesians have been completely right, Austerians utterly wrong – at vast human cost… Nobody ever admits that they were wrong, and Austerian ideas clearly have an emotional and political appeal that is resilient to any and all evidence."

Another criticism is that austerity stifles growth. "Austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues," the ratings agency Standard & Poor's said when it downgraded France and other eurozone countries earlier this year.

But if austerity isn't really being undertaken as expected – and isn't working, as many say, what else could we call it?

Miheal G Heller comments on Marginal Revolution: "The older word "retrenchment" in the days of Gladstone was a lot better. It's more active and participatory and work oriented. Like digging the trenches or something. And it has the appropriate systemic connotations. "Retrenchment means rationalisation of the functions of the state…" as Schumpeter said…

Meanwhile, TallDave adds: "Exactly, I've been saying for a while it needs to be called solvency. One is either solvent or insolvent. "Austerity" sounds like we've taken the gov't to a Buddhist monastery, where it has taken a vow of poverty, relinquishing all material comforts."

What are the alternatives?

And when it comes to the economic crisis "you'd be forgiven for thinking the menu boils down to "growth or austerity", like a limited choice of "rabbit or fish" in a poor pueblo or kampung restaurant," says Michael Heller on Project Syndicate.

So should we move away from austerity towards growth? Some have argued from the beginning
of the crisis that austerity was not inevitable.

Some say that spending should be targeted at boosting growth. For others it is a question of how savings are made.

Olli Rehn, the EU's commissioner for economic and monetary affairs, says Europe needs to get the balance right between cutting debt and stimulating growth.

"Fiscal consolidation, while necessary, [needs to be] done in a growth-friendly and differentiated way, in order to strike a balance between necessary fiscal consolidation and concerns for growth," he says.

 

More on Mindful Money

Voting against austerity

The great austerity backlash

Does austerity work?

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