If you are a regular reader of the economics sections in the newspaper or are at all interested in the economics world to follow all the news related to it, you must have heard the term austerity quite often. This term is used in reference to the policies that the government implements to tackle its public debt and it more commonly takes place when the public debt is very high. Over the years austerity has received its fair share of criticism from the general public as well as economists. However, the concept is considered to be useful by the government in restoring the nation’s economic health. To know why this term has so much importance in the world of economics and why it has faced so much criticism, we need to have a brief yet detailed look at the basic concepts behind this term and see how it works.
What is Austerity?
Austerity is a term that refers to a set of economic policies which have been implemented by a government in order to control the public sector debt. This step is usually taken by the governments when their public sector debt is way too high and there is more risk of a default or inability to pay off the debt and satisfy the obligations. Given this possibility of default, the government puts the austerity measures in place.
In simple terms, you can say that austerity is used as a tool to bring back financial health to the government and to maintain the stable economy of a nation. As the risk of default, or default risk as it is popularly and more commonly known can spiral out of control quite quickly, the country slips further into debt and the lenders can charge a higher rate of return for future loans, which makes it even more difficult for the borrower to raise the needed capital and pay off the past debts.
Primarily, there are three main types of austerity measures, which include revenue generation or higher taxes to fund spending, raising taxes while cutting non essential government functions, and lower taxes and lower government spending.
The concept of austerity is controversial and according to many economic experts, the national outcomes that are gained from the austerity measures can cause more damage than good. This is why austerity is a debated topic with many suggesting that these measures should not be used at all. However, many large nations like the United States, Greece, and Spain have all introduced austerity measures at the time of economic uncertainty.
When talking about austerity, it is important to know that there is also a recent austerity measure which was implemented in India. A budget of 30.4 trillion rupees was presented at the Union Budget for the financial year of 2020-21. This has provided modest sops for the big businesses and the well to do individuals, while at the same time increasing the austerity measures for the working class.
How does Austerity work?
Whenever a government experiences financial instability it is as a result of their debts outweighing the amount of revenue received by them. This results in large budget deficits. The debt level of the government generally increases with an increase in the spendings by the government. As a result, the chances of default and inability to pay off the debt increase. This is why the lenders or creditors start to demand higher returns on any future loans in order to avoid the risk of default. The government faces the responsibility of paying off the debt and satisfying the obligations towards the creditors. In an effort to do so the government needs to implement certain measures.
This is when austerity measures are introduced. The need to implement austerity measures only occurs when the government spends too much or takes on too much debt. As discussed above, the government needs to consider implementing austerity measures when it owes more money to the lenders than the revenues that it receives. The aim of the government in doing so is to maintain the financial stability of the nation and to maintain a confident economy while also restoring the balance in the government budgets.
The implementation of austerity measures is an indication that the government is willing to take some action to repay the overbearing debt. This may encourage the lenders to lower the rate of interest applied on the debt. But this comes with certain conditions.
The global economic downturn in the year 2008 left many governments exposed to unsustainable spending levels and reduced tax revenues. Many European countries, including the United Kingdom, Spain, and Greece opted to adopt austerity measures as a way to ease out the budget concerns and to pay off the debts.
During the global recession in Europe, austerity became an important measure. This was when the European Union members did not have the ability to address the rising debts by printing their own currency. This led to an increase in their default risk, as a result of which many European countries were forced by the creditors to check on their spendings.
Types of Austerity
Now that we have seen the basic concepts behind the term austerity and know how it works in an economy, let us go through the types of austerity. There are three main types of austerity measures, which are listed as follows:
General revenue generation through higher taxes This method supports more government spending and works with a goal to stimulate growth with spending and capturing benefits through taxation.
The Angela Merkel Model This measure is named after the German Chancellor Angela Merkel and it focuses on raising taxes while cutting non essential government functions.
Lower taxes and lower government spending This measure of austerity is preferred by the free-market advocates.
Criticisms and Debates over the Austerity measures
Although austerity measures are considered to improve the financial health of a nation, the effectiveness of these measures is still debated. Many expert economists believe that there are many risks associated with the austerity measures and it can cause more damage to the economy. Many believe that cutting government spendings will lead to large-scale unemployment which is bad for the nation’s long term economic health and growth. Austerity also runs contradictory to certain schools of economic thought that have become prominent since the great depression. This is why the concept is often debated.
Risks Associated with Austerity
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.
Recent Austerity Measure in India
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.
