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"Severe Austerity Programs will have Catastrophic Consequences"

by Joseph Stiglitz Thursday, Aug. 12, 2010 at 5:28 AM

"Instead of real growth, the financial sector has only promoted phantom growth. The state functions differently than a family. Less should be spent for unproductive purposes like the wars in Afghanistan and Iraq and unconditional bank bailout packages.."


The US and Europe should not be driven by the financial markets and yield to calls to massively cut their state spending. Germany should guard itself from that. Otherwise relapse into recession threatens.

By Joseph Stiglitz

[This article published by the Financial Times of Germany 7/27/2010 is translated from the German on the Internet, http://www.ftd.de/politik/international/:haushaltspolitik-harte-sparprogramme-werden-katastrophale-folgen-haben/50149559.html?mode=print.
Joseph Stiglitz is a professor at Columbia University in New York and winner of the 2001 Nobel Prize for Economics. His articles are available at www.project-syndicate.org.]

Soon we will all say: “We are now all Keynesians.” The financial sector and the ideology of the free market have brought the world to the edge of the abyss. Deregulation turned out to be a terrible mistake. The “innovations” of modern financial management did not lead to higher long-term efficiency, faster growth or greater prosperity for all. Instead they were directed at evading balancing guidelines and avoiding taxes urgently needed to finance public investments in the infrastructure and technology. Instead of real growth, the financial sector has only promoted phantom growth.

The protagonists of this sector have been pompous about creating a dynamic economy and how people should act in case of a recession (which can only be caused by state failure according to the ideology of financial management).


Whenever the economy enters a recession phase, revenues fall and spending rises as with unemployment benefits. Deficits grow. The “deficit hawks” from the financial sector now think the state should concentrate on reducing its deficits by cutting spending. Only that way will trust be restored so investment activity and growth return. However conclusive this argument sounds, the historical facts refute it.

When US president Herbert Hoover tested this prescription, this contributed to changing the 1929 stock market crash into a worldwide economic crisis. Downswings became recessions and recessions became depressions when the International Monetary Fund applied the same formula in East Asia in 1997.

The argumentation is based on a flawed analogy. A private household that has more debts than it can comfortably repay must reduce its spending. But production and revenues decline when a government does this. Unemployment increases and the ability to pay off debts may even decrease. What is true for a family is not true for a country.

In Europe, especially in Germany and in some regions of the US, state deficits and debts increase and the calls for harsher austerity measures become louder. If they are accepted as seems to be the case in many countries, this will have catastrophic consequences given the instability of the recovery. Growth will slow down. Europe and/or America will even slip back into a recession.

The “automatic stabilizers” – falling tax revenues and higher spending that automatically accompany every downswing – cause the bulk of the high deficits and debts, not spending to stimulate the economy. Keynesian economic theory has functioned. Without economic measures and automatic stabilizers, the recession would have been more intensive and longer and unemployment would have risen even higher.


There is a simple Keynesian conception. Firstly, less should be spent for unproductive purposes – for example wars in Afghanistan and Iraq and unconditional bank bailout packages, which do not revive the awarding of credits. Instead the state should concentrate on investments with high returns. Secondly, the spending that promotes justice and efficiency should be increased, for example raising taxes on businesses that do not reinvest their profits and lowering them for those that do reinvest. Taxes on speculative profits and environmentally-encumbering CO2 intensive energy could be increased while decreasing taxes on low wage-earners.

Further measures could be helpful. For example, the state could help banks give credits to small- and medium-size businesses which create the great majority of jobs – or establish new financial institutes that do this instead of supporting big banks that earn their money from derivatives.


The financial markets have created a system that carries out their projects. In the short-term, a small country can be flooded with capital over free and open capital markets only to have to pay high interests afterwards – or be completely cut off from all financing. Under these circumstances, small countries have seemingly no choice. They submit to the austerity-dictates of the financial markets or are punished with withdrawal of financing.

However the financial markets are moody capricious taskmasters. The day after Spain announced its austerity package, its government bonds were downgraded. The problem was not a lack of trust that the Spanish government would not fulfill its promises but the fear that they would fulfill them and so contract. After the markets drive the world into economic chaos, they say to countries like Greece and Spain: You are unlucky whether you reduce your spending or not.

Financial management is a means to an end and not an end-in-itself. Financial management should serve the interests of the rest of society, not the other way around. Restraining the financial markets is not simple but it can and must be done with a mixture of taxes and regulation. In any case, the state should step into the breach. The process of moderating and taming has already begun in the US and Europe. However much must still be done.

Stimulate or Die by Joseph Stiglitz, August 2009

author: Jean-Paul Fitoussi and Joseph Stiglitz
Concepts must be developed against the global demand-deficit. Repairing the financial system is not enough. The economic-political prescriptions of the past - flexible wages and restricted social benefits - would worsen the situation.
to read the 12-page pdf file "WAYS OUT OF THE CRISIS AND BUILDING A MOLRE COHESIVE WORLD," the Chair's Summary by Jean-Paul Fitoussi and Joseph Stiglitz, July 2009, click on


VIDEO: Joseph Stiglitz' "Freefall" on BookTV

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