NEOLIBERAL AUSTERITY DOCTRINE LEADS TO DEEPER CRISIS
By Atila Kilic
[This article published on 11/8/2013 is translated from the German on the Internet, http://blog.arbeit-wirtschaft.at.]
This is the fifth year after the outbreak of the financial crisis. With the collapse of the mammoth US bank Lehman Brothers in September 2008, the underrated weaknesses and dangers of unregulated financial markets came to light. Financial institutes worldwide were in dire straits. The crisis consequences for the real economy were misjudged. Loud voices warned a Great Depression like that of the 1930s threatened.
The banking crisis soon spilled over on the real economy. Businesses were alarmed and banks limited their awarding of credits. However, the horror scenarios of mass unemployment, social unrest and a destructive recession as in the 1930s did not occur in wide parts of the western world. This favorable course of the crisis can be referred back to the stabilizing function of the state that was hardly developed in the 1930s. Unlike that time, a broad consensus exists today on the positive effects of state interventions to stabilize the economic cycle – based on the discoveries from John Maynard Keynes' work "General Theory" (1936) and can finally be read in many economics textbooks like Bofinger (2011) or Zimmermann, Henke and Broer (2009).
A high state share in the economy, developed social states, and readiness to intervene actively and anti-cyclically [1] could prevent falling into a depression. The Institute for Economic Research (WIFO) (2011) emphasized unemployment-, health- and pension-insurance and other social transfers make essential contributions to the success of the so-called automatic stabilizers. The range of state revenue or expenditures opposite to the economic course is varied. In this way, they increase private income in crisis times and effectively stabilize the economic course through the demand-side.
Scandinavian social states like Sweden and Denmark are marked out in crisis conditions compared to southern European and Anglo-Saxon states. Social state benefits go far beyond protecting the socially weak. A high-quality array of public services like kindergartens, all-day schools, nursing homes and home help and services on the communal plane create optimal conditions for economic actors in both crisis- and non-crisis times.
BRIEF CHANGE OF HEART
Finally, the political-economic rethinking that strong demand interventions by the social state have positive effects on the whole economy in crisis times did not last long. Opponents of the social state model seized the chance of the rapidly growing state indebtedness – that was actually caused by enormous capital injections for banks – and accused the expensive social state for the predicament of many European countries. These warnings were accompanied by Reinhart and Rogoff (2010) who saw the reason for the trifling economic growth in high public indebtedness. The threats by rating agencies to downgrade the credit-ratings for government bonds (where gaining money through the financial markets became more expensive) are used to convert a multitude to austerity packages in the eurozone. The implicit assumption that the savings efforts in the public sector would stimulate the private sector to spend more so economic growth would increase was premature.
Several economists admitted the momentous errors of their analysis after the data applied by Reinhart and Rohoff (2010) was made available to the public. [2] The core statement of the two authors Reinhart and Rohoff (2010) – "a high state indebtedness was responsible for the trifling economic growth" – was declared null and void. According to Andrew Watt (2013), the real causality goes in the opposite direction. A trifling economic growth causes a high public indebtedness. In addition, Romer (2011) identified a negative GDP effect of public savings efforts. Higher taxes and lower state spending have a negative effect on total economic production.
Conversely, state spending in crisis times amounting to 1% of the GDP of a country have a positive effect in the short- and medium-terms on economic output far above 1% of the GDP, according to the International Monetary Fund (IMF) (2013), Blanchard and Leigh (2013) and Nakamura and Steinsson (2011). This positive multiplier effect of state spending outweighs the negative multiplier effects of tax increases stressed by conventional wisdom in the economic discussion. In this way, additional state spending in crisis times can be covered by tax hikes without straining the public debt situation and improves the economic outlook. Eggertsson and Krugman (2012) show that anti-cyclical economic policy in crisis times in financing through credits (and a simultaneous growth of state debts) is necessary to avert recessions and stabilize the economic situation.
Enemies of the social state like Agenda Austria insist the state must save more and withdraw from the economy despite the vast number of academic articles on the positive and stabilizing effects of state interventions in crisis times and the negative consequences of an early public austerity policy for market actors.
GREECE IS A GRAPHIC EXAMPLE
The crisis course in Greece (as in Spain, Portugal, Ireland and others) is an illustrative example of the possible consequences of premature savings in the public sector. Austerity in the public sector did not stimulate the economy as assumed but aggravated the already unstable economic reality. The unemployment rate rose within three years from 10% in 2010 to over 25% (and over 55% for persons under 25) (cf. Eurostat). Extensive savings in the social state and in public services like higher mass taxes reduce the available income of private households. Therefore consumer spending, production, and employment fall. At the same time, this leads to a decline in state revenues. Uncertainties spread in the whole population while social unrest in the form of demonstrations and riots has become the daily reality in Greece.
CONCLUSION
The social state impressively proves its important role in the continuing crisis. Alongside the automatic stabilizers, the welfare state ensures stable conditions in crisis times with economic packages that are effective for demand. During crises, the positive effects of anti-cyclical social- and economic policy predominate even when the public indebtedness is high. Nevertheless, the financial crisis has also shown there is still much to do in Austria. The total economic demand must be permanently strengthened particularly in crisis times. Household incomes and the total economic consumption will constantly increase through investments in public housing and development in the range of public services like all-day schools or nursing homes.
Reorganizing the tax structure would bring positive effects for long-term economic growth. Unlike property taxes, taxes on earned income have a much greater negative effect on economic development. Reorganizing the Austrian tax structure is essential since earned income in Austria is taxed more than the European average and property is hardly encumbered, according to the findings of the IMF (in the US, Warren Buffet's secretary pays more taxes than the billionaire!). The high taxation of earned income should be lessened to safeguard long-term economic growth. On the other hand, lowering expenditures does not seem necessary. Whoever wants a well-constructed social state with its stabilizing social and economic effects should be ready to finance this through taxes and fees.
NOTES
1. In this context, anti-cyclical means setting financial- and political-economic measures to counteract the economic course. So the state can stabilize the economy in downturns and curb the economy in times of economic boom. In this way, the economic fluctuations can be smoothed and severe crisis consequences like high unemployment can be prevented.
2. Jeremie Cohen-Setton (2013) offers a clear summary of the economic discussion on the errors in the analysis of Reinhart and Rogoff (2010) in the European blog Bruegel.
