Austerity policies and their theoretical foundations have taken a beating in recent years. The experiences after the 2008 financial crisis confirmed many of the criticisms made against similar programs. Against this backdrop, the present volume offers an attempt to salvage at least some of the pro-austerity arguments made by its authors and others over the years and put them on a new empirical basis.
The authors' main contention is that if public finances get out of balance for whatever reason they will have to be rebalanced and that policymakers and members of the public know this. There are then two ways to balance budgets and pay down debt: raise taxes or cut expenditure. The authors categorize austerity programs between 1981 and 2014 as being expenditure based (EB), tax based (TB), or mixed and compare their impact on growth and debt-to-GDP ratios. Their result is that EB programs are less damaging than TB programs and that the negative impact of the former is very limited, with a 1 percent spending cut resulting only in 0.5 percent reduction of output over a few years. As a result, EB programs are also successful at the aim of reducing the debt-to-GDP ratio that TB programs often miss. The authors suspect that the reason for the different outcomes lies in the different impact on the expectations of economic actors. In particular, investors’ expectations are dampened by tax increases because they foresee that tax increases will lower demand for consumption and investment goods. In contrast, investors see cuts to public expenditure as harbingers of future tax cuts, thus increasing profit expectations. An additional finding, from an analysis of the chances for reelection of governments that apply austerity measures, is that austerity programs do not significantly damage the electoral appeal of governments.
Interestingly, the theoretical argument here is couched in the language of Keynesianism. Expectations of economic players are central and the authors make frequent references to “basic Keynesian models.” However, the conclusions are completely opposed to those of Keynes, who advocated debt-financed public expenditure as a way out of economic crisis. As often in economics, the problem lies in the basic assumptions rather than in the details of the empirical work. In the present case, the authors go wrong at the very first turn when they assume that public debt must be repaid and that economic actors expect this to happen in the future and behave accordingly in the present. If debt is taken out in a currency issued by a collaborative central bank, there is a priori no need to pay it back, and decreasing debt-to-GDP ratios can be achieved without repaying debt. The United States did not pay back its debt after World War II yet still saw steadily declining debt ratios.
However, once you posit that there is no alternative to repaying debt it is sensible to compare and find out which method of repayment has less of a negative impact on expectations and growth. But this perspective avoids the truly relevant question: What would have happened to expectations and growth if instead of austerity, public expenditure had been expanded?
The question that the authors are answering is akin to pondering whether it is preferable for those traveling on a ship that is taking on water to scoop it out with a spoon or a fork. Diligent researchers powered with a sizable research grant can produce an answer to this question and it will likely favor the spoon, but a similar study will not do much to improve the safety of naval travel. Also, if a similar study should fall into the hands of politicians there is a risk that they will claim there is clear scientific evidence that spoons are the preferred safety device in case of a naval emergency and that we can dispense with lifeboats, thus trimming costs and “red tape.” Similar dangers loom large in today's world of economic policymaking where an argument for a small state will always find open ears and listeners who are ready to ignore the pitfalls of the underpinning argument.
The most interesting contribution of the volume can be found in the chapter “Austerity and Elections,” where the authors show that reelection chances of governments that implement austerity are not significantly damaged. The authors may have intended this mainly as a signal to politicians that they can board the austerity bandwagon risk-free, but they also touch on a truly interesting question here: Why, despite all the talk about austerity being imposed on countries from the outside, are virtually all austerity programs self-imposed by democratically elected governments on their own constituents? As the authors themselves point out, the complexity of electoral decisions makes it difficult to gauge the electoral impact of austerity programs, and they certainly do not make sufficient effort to examine factors that may lead to strong growth despite ongoing austerity. Important examples are “frugal” countries such as Germany and Switzerland compensating for weak domestic demand with exorbitant trade surpluses or the devaluation of the pound during the United Kingdom's austerity period.
In the aftermath of the financial crisis, the Financial Times’ Wolfgang Münchau quipped that there are two types of economists in Germany: those who have not read Keynes and those who have not understood him. As this volume shows, the geography of this joke needs to be revised; above all, we need to understand better the political dynamics that lead economists and large parts of the broader public to support economic policies that are damaging their economy's prospects and often their own individual economic situation. The power of hegemonic ideas and the fear to find oneself outside of a professional or societal mainstream may be one of the keys to understanding this paradox.
