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Home Publications Blogs CEPR Blog Austerity, the Path to Prosperity?

Austerity, the Path to Prosperity?

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Written by Alan Barber   
Wednesday, 25 April 2012 16:38

Rep. Paul Ryan sat down with Steve Forbes recently to have a "very serious" conversation about the U.S. economy. The architect of the House budget plan, Ryan stated in the interview that what America needs is “…prosperity, not austerity.” This is an interesting point for Ryan to make since austerity – deficit reduction via decreased government spending --  is exactly what the House budget calls for.

In the name of reducing deficits, Ryan’s budget calls for shrinking domestic discretionary spending – all categories of domestic spending outside of Social Security and health care -- to 3.75 percent of GDP by the year 2050. Since this includes defense spending, the plan has a bit of a problem. Defense currently makes up almost 4.0 percent of domestic spending. Since Rep. Ryan, has been extremely critical of even the minor cuts to the military in President Obama’s budget, it is safe to assume that any cuts to defense spending in his budget would be negligible at best.

Assuming the house budget only made a modest 1 percent cut to defense spending, bringing it to 3 percent of GDP, only about 0.75 percent of GDP would be left for funding the rest of the government (again, excluding Social Security and health care). That means less than one percent of GDP would be left to cover everything from Head Start to roads and bridges to Homeland Security. At the same time, the Ryan budget would slash taxes for the wealthiest while offering little or no relief for millions of low- and middle- income families who rely on many of the very programs being cut.

But of course this is done in the name of future prosperity. The thinking goes along the lines of ‘if we as a nation tighten our collective belt, cut back on spending and relieve ourselves of our debt burden, America’s economic engine will suddenly be reignited.’ Does it matter than we are in the midst of recovering from the deepest recession since the Great Depression? Well, yes, actually.

When a country is experiencing economic weakness, deficit spending is one policy tool that can help boost the economy by spurring demand and saving or creating jobs. In fact, President Obama’s stimulus package was effective in slowing the economy’s free fall in 2009. The stimulus could have been larger --  and thus, even more effective -- but very few economists would argue that the stimulus did not create jobs and help stabilize the economy. Simply put, deficits aren't a problem in a downturn. On the contrary, deficits are a key part of jump-starting a recovery. Calls to reduce deficits by cutting spending and further reducing government revenue during difficult economic times will actually impede recovery.

To underscore that point, the recent experience of the United Kingdom provides a cautionary tale. Britain chose to adopt a series of austerity policies aimed at reducing its deficit out of a concern that bond markets would force them into default. These policies included drastic spending cuts and slashing taxes for the wealthiest Brits (and bear a striking similarity to the Ryan budget). The British government followed the austerity path even though the UK recovery was still on very shaky ground. But as the latest data from Britain’s Office of National Statistics show, these policies did not help the British economy at all. The United Kingdom has just entered its sixth month of economic contraction, in essence sinking into a double-dip recession.

It is safe to assume that similar policies in the United States would also have the effect of prolonging our already sluggish recovery. And with millions of Americans still struggling with under- and un-employment, now is not the time to cut back on programs that provide vital services to children, veterans, and students. Any politicians or policy makers who promise prosperity via deficit reductions and tax cuts beggar the question, prosperity for whom?

Tags: austerity | budget | deficit | economy | spending | stimulus | unemployment

Comments (2)Add Comment
...
written by JSeydl, April 26, 2012 8:45
Problems with the normal adjustment process that needs to occur to support growth during a period of fiscal consolidation were totally predictable in the U.K., too. Households remain deleveraged and therefore cannot increase spending to smooth consumption expenditures. The BoE's policy is near zero, so there's little room for monetary policy to offset the contractionary effects of deficit reduction. And the pound is obviously going to remain strong with all of the capital flowing out of mainland Europe.
This scenrio vs. the Great Depression
written by Theodore Wirth, April 26, 2012 5:59
Think about it. Stimulus spending is even more important as our economy is now more dependent on consumer spending than our export economy was during the Great Depression.

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