Reviewed by Sep 30, 2020| Updated on
Austerity, in economics, refers to a set of economic policies that the government implements to control public sector debt. Measures of austerity are the government's response to address a high default risk of a huge public debt, or it's the inability to service repayments or debt obligation.
Default risk can rise out-of-control quickly where an individual, company, or country further falls into debt. It includes conditions when lenders charge a higher rate of return for future loans, leaving the borrower incurring huge cost to raise capital.
Austerity occurs when the difference between government receipts and government expenditures reduces. A reduction in government's expenditure doesn't simply equate to austerity measures.
There are three main types of austerity measures. The first is the revenue generation (higher taxes) which often supports more government spending. The goal is to prompt increased growth with spending and be benefitted by taxation.
The second one is the Angela Merkel model that works on raising taxes while cutting non-essential government functions. The third type features lower taxes and lower government spending; this is the desired method of free-market advocates.
The 2008 global economic downturn left many governments exposed to unsustainable spending levels and reduced tax revenues. Several European countries, including the United Kingdom, Spain, and Greece, have adopted austerity as a way to ease their budget concerns.
Austerity became important during the global recession in Europe, where the European Union (EU) members did not have the ability to address rising debts by printing their own currency. As their default risk increased, creditors pressurised certain European countries to check on the spending aggressively.
Although the goal of austerity measures is to bring down government debt, the effectiveness thereof is still debatable. Supporters contend that huge deficits can adversely affect the broader economy and limit tax revenue.
However, opponents state that government programs are the only option to improve a reduced personal consumption seen during a recession. They claim that a strong public sector spending fixes unemployment and, therefore, increases the number of income taxpayers.
Austerity works in contrast to some schools of economic thoughts that have been famous since the Great Depression. In an economic downturn, diminishing private income pulls down the tax revenue of a government. Similarly, in case of an economic boom, a government sees an increased collection of the tax revenue. It is sarcastic that public expenditures, especially unemployment benefits, are required more during a recession than a boom.
An Rs.30.4 trillion budget was presented at the Union Budget for the financial year 2020-21. It provides modest sops for big business and the well-to-do along with increased austerity for the working class.