This fear is not based on an academic model or theoretical construct. Instead it is based on facts and data. Simply put, every other country that has implemented an austerity plan over the last two years in the current economic environment has lowered their growth or made a recession worse. Here is the data:
From the FT on June 24:
Much like Spain, Ireland and the UK, the Baltic states were badly hit by the bursting of a credit bubble in 2008 that sent their economies into freefall and their budget deficits soaring.While others cushioned the impact with stimulus spending, the Baltic trio plunged straight into austerity. As a result, they suffered the deepest recessions in the European Union last year, with Latvia’s economy shrinking by 18 per cent.
The region has since stabilised but, for many ordinary people it still feels like a depression. Wages have plummeted while unemployment has rocketed, with more than a fifth of the Latvian labour force out of work.
Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”
Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.
Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.
Now, the Irish are being warned of more pain to come.
Countries that are implementing austerity measures are conceding their plans will lower growth:
U.K. Prime Minister David Cameron’s planned budget cuts increases the chance the economy will slip back into recession, said Geoffrey Dicks, who heads economic forecasting at Britain’s new fiscal watchdog.Responding to questions during a parliamentary hearing in London today, Dicks said measures proposed in the June 22 budget led his office to shave 0.5 percentage points from its growth forecast in the “near term.” His Office for Budget Responsibility predicts an expansion of 1.2 percent in 2010.
See also this article on the UK situation.
And Portugal -- which is also implementing austerity measures -- admits these measures will lower growth:
Austerity measures aimed at bringing down Portugal's towering budget deficit are crucial to regain creditor confidence, Finance Minister Fernando Teixeira dos Santos said Saturday, while also acknowledging that they will slow down economic growth next year.Measures contained in the government's 2011 budget proposal are intended to "not only reduce the deficit, but will also regain the confidence of those who lend to Portugal," Mr. Teixeira dos Santos said at a news conference explaining the proposal, which the minority government late Friday had presented to parliament amid continued uncertainty on its approval.
And the countries that spent massively are growing at strong rates.
China rebounded quickly from the global downturn, powered by a 4 trillion yuan ($586 billion) stimulus and a flood of bank lending. But communist leaders worry about surging home prices and a possible spike in bad loans at state-owned banks. They have imposed curbs on lending and investment, key drivers of growth and demand for raw materials.
So, here is the data. Austerity measures that have been tried and implemented in the current environment have failed. They have led to lower growth and a tremendous amount of pain. Countries that are looking at implementing austerity measures freely admit that these measures -- if implemented -- will lower growth. And the countries that spent massively are growing at strong rates.
Now, the question will be raised, can we afford this spending. I originally looked at this issue on June 18, 2009. I concluded the following:
So -- the overall conclusion is we're going to be pushing the envelope of US finances which is never good. Overall debt/GDP will most surely be at 100% by the end of fiscal 2012. In addition, the interest component of the federal budget will surely increase as well. Now -- is this development fatal? No. But are we adding more stress to the system? Yes. But finally, do we have a choice? That is, is there another viable option right now? No. Fiscal conservatives (who by the way don't exist in the Republcan party's policy implementation arm) will argue to do nothing. But given the precarious nature of the economy right now that is still a recipe for economic suicide.
Let's take a look at the current situation.
Total US debt outstanding currently stands at $13.7 trillion while total GDP is $14.7 trillion, meaning the debt/GDP ratio is at 93.19%. Obviously, this is not good, but it is not fatal either. Additionally, the 10-year Treasury is yielding 2.62%, indicating there isn't a risk premium in the US Treasury market regarding our current situation. Even if interest rates spike 200 basis points -- a tremendous amount over a year -- that means interest rates would be 4.62% -- still an incredibly low level. Hell, even a 300 basis point jump to 5.62% would not be as detrimental as some would argue. In other words, we're still pushing the envelope, but we're not going to kill ourselves by spending money right now.
And the rewards are tremendous. As I have written about before, the long-term benefits of a solid infrastructure program far outweighs the cost. First, there is the immediate impact of lower unemployment and increase consumer spending. Secondly, the long-term impact is truly amazing, as I explained in this article on my hometown, Houston, Texas. Houston is the fourth largest city in the country, and it would not have gotten to that point without its current infrastructure. You can also read about the economic importance of the US highway system in its forty year report. If you really want to see the benefit do a simply financial projection using the current 10 year interest rate. Make sure you include a monetary value for all the benefits such as land that is now developed that wasn't previously developed, new avenues of trade that have opened up, lower cost of transporting goods because there are fewer traffic jams and wrecks caused by poorly repaired streets, the increase in tax a tax base as new communities develop -- you get the idea.
At the macro level, overall growth is incredibly slow -- we're printing GDP growth around 2%. Unemployment is still at 9.6%. Simply put, the economy needs a stimulus right now. $500 - $750 billion of pure infrastructure spending -- that is, spending only on infrastructure -- would help tremendously right now. As I've outlined in far more detail before, this would lower construction unemployment (which comprises a large part of the current unemployment picture), fix a national infrastructure that is in terrible repair and provide the economy with a physical backbone that will help it grow in the future. Remember -- the original highway system was built is the 1950s and it is still paying dividends, meaning the benefits have far outweighed the cost.
In other words, the data indicates this is not the time to engage in austerity measures. Such measures will hurt an already fragile recovery. As previously indicated, this observation is based on plans that have already been implemented and failed. Those countries considering austerity concede it will hurt overall economic growth. And those countries that spent massively are now growing. The picture that is available from the available data is clear as a bell.
However, it will all probably be ignored.
