Sunday, June 7, 2015

The Economic Consequences Of Austerity

Amartya Sen is a Nobel Prize winning economist and philosopher who teaches at Harvard.  His title for this essay is a play on a book written by Keynes which predicted the economic consequences of the austerity imposed on Germany following its defeat in the first world war.  The victorious states imposed an unworkable punishment on Germany that ruined its economy and much of the European economy in the process.  Sen sees a parallel between the austerity that was forced upon Germany and the decision by European leaders choose it as the weapon of choice following the financial crisis.  Keynes hoped that his book would have enlightened the public about political economy and that future generations would have learned from the economic disaster that was imposed upon Germany, and indirectly on Europe, following the first world war.  Sen has distilled the lessons that we should have learned in this short essay.

The rationale for austerity in in Europe was based upon two objectives: the need to reduce the ratio of public debt to GDP, and the need for structural reforms in many of the European economies.  Sen believes that structural reforms are needed, and desirable, but that it was a mistake to use austerity as the means to force the structural reforms on the struggling economies in Europe.  In the first place, the imposition of austerity has not reduced the ratio of public debt to GDP.  Instead the ratio has increased for obvious reasons.  Public revenues grow when the economy expands and they decline when the economy shrinks.  The decision to cut public spending, at the same time that private spending is declining, causes the economy to contract.  It is impossible to lower the debt to GDP ratio when the economy and tax revenues are declining.  The easiest way to reduce the ratio is to expand the economy and the tax revenues which follow the expansion.  Sen argues that this is what happened during the Clinton Administration in the US.  Clinton inherited a large budget deficit but the economic growth that accompanied the dotcom boom increased tax revenues enough to produce a budget surplus at the end of the Clinton Administration.

Sen also reminds us of the debt to GDP ratios in Britain and the US following the second world war.  They were double the debt the ratios that politicians are alarmed about today.  They were quickly reduced during a period of rapid economic growth.  Moreover, some of the public goods, such as the National Health System in Britain, would not have been established if fear mongering about the public debt would have imposed constraints on the political process.

Sen has observed the political consequences of the austerity that has been imposed upon struggling nations which have been forced to cut public services and to deal with the consequences of high unemployment.  Public support for the major political parties has imploded and antidemocratic forces have taken advantage of the economic malaise.  The premise of democracy is that leaders should debate the issues that might be used to restore economic growth prior to making their decisions.  Bad decisions were forced upon the public, and Europe is in the process of attempting to restore economic growth and political order in an economy that has been damaged by those decisions. History has a way of repeating itself.  That is bound to happen when we don't learn from our mistakes.  We made similar mistakes following the first world war and during the Great Depression.  Our financial leaders continue to compare national economies to household economies and to lecture the public about their mistaken economic assumptions and morality that underlies their belief system.

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