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Austerity and the First Law of Holes

published 6 July 2012 updated 6 July 2012
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“If you find yourself in a hole, stop digging.” That’s the popular proverb accredited to former British politician Denis Healy. It’s a graphic way of saying that when you’re in a difficult situation, the first thing you should do is stop making it worse.

When Healy first coined his Law of Holes in 1983 he was talking about the destructive arms race at the time between the United States and the Soviet Union. But his Law unfortunately rings equally true today when it comes to much of what passes for fiscal and economic policy.

A good part of the world’s economy is mired in a deep hole – a recession that began in 2008 following a financial meltdown. History shows us that economic downturns precipitated by a financial crash are deep, brutish and long. Nearly four years on, the economic malaise continues. But instead of thinking about ways to climb out of this hole, it has become fashionable among many politicians to pick up the shovel of austerity and keep digging deeper.

That’s right. The major response to the colossal private sector failure that caused the crisis in the first instance has been to demand public sector austerity in which the most vulnerable – the poor, youth, and the unemployed – pay the biggest cost. If it sounds like madness, it is.

The proponents of austerity – who American economist Paul Krugman helpfully refers to as the “Austerians” – say that large public sector debts are crowding out private sector investment. According to the Austerians, if we can only downsize government, business confidence will be restored, investment will flow, and the world’s economies will bloom again.

You will be forgiven if this reads a bit like a fairy tale. That’s because the truth is public sector deficits emerged as a consequence and not a cause of the recession. Banks were bailed out courtesy of the public purse, unemployed workers had to be paid benefits, tax receipts fell, welfare claims rose and governments needed to inject stimulus spending into the economy in order to prevent a full-scale descent into an economic free fall. As for the crowding argument, the fact is businesses aren’t investing because overall demand for the goods and services they produce remains low, not because government spending has risen.

If we keep following the advice of the Austerians, we’ll just dig ourselves deeper into the hole we’re in. By reducing government spending we’re cutting the jobs, wages and benefits of public sector workers. This is siphoning money out of the economy and has a ripple effect that reduces overall demand. Or as any student of economics should be able to tell you, one person’s spending is another person’s income.

Austerity measures also mean we’re under-spending on high-return social investments like infrastructure, health and education and training. Unfortunately, it is future generations who will pay the heavy price for this in terms of lost productivity and lost opportunities.

The good news is that more and more people now see that austerity isn’t working. More people agree that we should stop digging, but how do we actually get out of the hole?

I’d suggest there are several things we should do. First, we need to boost investment in education and training, public services and infrastructure – particularly green infrastructure. Borrowing rates for most countries remain low, and the returns are high. Sure, this will increase deficits in the short-term, but it will actually help reduce public debt over the long haul because these public investments produce efficiency gains and greater sustainable economic growth.

Secondly, I’ll give a tip of the hat to Austerians and concede that there is some government spending that has a low rate of return and that probably should be reduced. I’m thinking here principally of military spending. Pouring obscene amounts of money into weapons to be used against enemies that don’t exist just doesn’t make sense. Nor does military spending produce as much economic bang for the taxpayer buck compared to other public investments like education and training.

Additionally, many countries desperately need to reform their tax systems. Inequality has risen sharply across large parts of the world, and there’s some good evidence that greater inequality actually produces greater economic instability. A modest increase in taxes on the super-rich, as the French government is now proposing, would generate badly needed revenue to make those social investments we need. And, it would be a small but important step towards dealing with rising inequality.

While we’re at it, we also need to close the myriad tax loopholes and tax avoidance schemes that the super-rich and corporations regularly use. A more coordinated and concerted effort on the part of the international community to shut down tax havens would be a good start.

Finally, we need to honest about the task at hand. The Austerians have one thing right: any exit from the recession will require some pain and suffering. The key question, however, is who should be asked to make the greatest sacrifices? Should it be the unemployed, teachers and students, seniors, the poor? Or the financial institutions that plunked us in this hole in the first place?

Banks never admitted that it was their bad loans, risky and aggressive lending, and ever complex repackaged debt instruments that drove up personal and public debt levels and brought the world economy to the brink. If we are to crawl out of this economic hole, restructuring this debt is key. This likely means banks need to write down the debts of consumers, homeowners and even in some cases governments.

Make no mistake, this will result in a lot of griping from the financial industry. But the alternative is to pick up our shovels and dig deeper.

The opinions expressed in this blog are those of the author and do not necessarily reflect any official policies or positions of Education International.