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The Consequences of Austerity

April 14, 2011

2-minute read

With the federal Tories vowing to enact billions in spending cuts in a bid to eliminate the deficit a year earlier than forecast, it might be a good time to ask what the consequences of all this austerity might have on the Canadian economy.

Thankfully, we have a concrete example of what austerity can do to the recovery of a fragile economy right across the pond. U.K. Prime Minister David Cameron has initiated an aggressive – some would say “draconian” – series of spending cuts since coming to office in May of last year.  Cameron has slashed social spending by over $130 billion dollars, sending tuition rates soaring, cutting benefits to children and seniors and gutting public sector employment by almost half-a-million workers. (More disturbing still is that Cameron has modeled his deficit-slaying approach on Paul Martin’s similarly draconian budgets in the 1990s). Cameron declares that the breadth and impact of the cuts will require “years of pain” and “will affect our whole way of life” as the British Conservatives seek to fundamentally transform the relationship between citizens and the state.

Cameron argues that such deep cuts are necessary to bring deficits under control and restore confidence within the private sector. Implicit in Cameron’s austerity program is that the time for public spending stimulus is over and the private sector is healthy enough to take up the slack and begin investing again.

Except it isn’t. For all the calls by U.K. business leaders to reign in state spending, the result of this punishing austerity has not been a return to growth but a slide back into recession. The U.K. economy actually contracted by half a percentage point in the last quarter of 2010 and OECD projections predict the United Kingdom won’t be able to do better than a mere one percent growth rate in the coming years.

Former Asda supermarket Chief Andy Bond recently admitted that the private sector in the U.K. will not be able to rescue the UK economy: "I don't think the private sector is going to be able to pick up the slack in this climate," Bond said.

As Nobel economist Paul Krugman observes, the British example illustrates the absurdity of the claim that slashing government spending in the face of a depressed economy will help growth rather than hurt it:

So how's that theory looking? Not good. The British economy, which seemed to be recovering earlier in 2010, turned down again in the fourth quarter. Yes, weather was a factor, and, no, you shouldn't read too much into one quarter's numbers. But there's certainly no sign of the surging private-sector confidence that was supposed to offset the direct effects of eliminating half-a-million government jobs. And, as a result, there's no comfort in the British experience for Republican claims that the United States needs spending cuts in the face of mass unemployment.

Canada’s private sector doesn’t appear that much more capable of leading us out of recession. As Jim Stanford notes,

Despite a few signs of life (mostly in the oil and gas industry), overall business investment spending has not bounced back at all. Business capital investment is only 6 percent higher than in the trough of the recession a year ago. Yes, profits shrank during the downturn, but are recovering. And businesses aren’t even re-investing what they get, let alone taking on new debt…The odd result of this private-sector passivity is that non-financial firms have actually saved close to $100 billion since the recession began. That almost perfectly offsets the $100 billion in new debt taken on by our governments over the same period. In other words, governments (and the taxpayers who fund them) are taking on debt to try to restart a sick economy. But for every dollar they put in, private firms take a dollar out – in the form of idle, un-invested cash flow, used to pay down their own debt or (worse yet) speculate in the paper markets.

Hedging our bets on an anemic private sector – even one fat on corporate tax cuts – does not appear to be as safe a bet as conservatives would lead us to believe. If our own conservatives wish to follow the same path as the British, they certainly cannot claim ignorance if we also slide back into recession.

Simon Enoch
Saskatchewan Office
Canadian Centre for Policy Alternatives

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