Fiscal Austerity: Political Ideology or Economic Necessity

Fiscal austerity typically implies a range of cuts in government spending on state-provided goods or services. This essay will include an in-depth look into how and why Fiscal Austerity, carried out by the Conservative/Liberal Democrat Coalition was about political ideology more than economic necessity. Fiscal Austerity will also be analysed theoretically and through real-world events, to further examine and compare the very apparent differences between political and economic ideology. The main theme underpinning this essay is political ideology vs economic necessity. Due to the nature of the subject, fair discussion on political policy promised and implemented by parties will be included. In addition, this theme is also to be discussed through the observation of both sides regarding the argument. Finally, both sides of the argument will be backed by real-world examples, prevalent in society. The austerity agenda associated with political figures such as George Osborne in the UK and Wolfgang Schauble in Germany will also be discussed – in relation to whether fiscal austerity was an economic necessity or not.

Fiscal austerity can be defined as: a set of policies implemented by the state in order to control public sector debt – also known as the national debt. As stated within the introduction of this essay the issue is political ideology vs economic necessity. Political ideology can be simply defined as an ‘agenda’, policy or set of policies surrounding a specific political and/or economic issue at hand. In another sense, Political Ideology can be seen as a formal system of political thought. Different interpretations and perspectives on social, economic and political issues at hand. To further explore what fiscal austerity means, an example of how and when it is typically used in a real-world scenario. Austerity measures are most likely to be implemented by the state when the national debt is soaring and immediate cuts to spending are required. A prime example is the austerity programme within the United Kingdom. Fiscal Austerity was a policy adopted following the ‘great recession’ of 2008. In this scenario, ‘Fiscal Austerity’ can be best described as a budget deficit reduction programme. “Slashing spending in the face of high unemployment is a mistake. Strong advocates of the fiscal austerity agenda such as George Osborne, come to present a range of arguments. Firstly, austerity advocates argue that cuts to spending would prove beneficial in the form of rising confidence, regarding business organisations and consumers. For the negative aspects surrounding these policies, they argued that the impact on employment and growth would be minuscule. When looking at the perspective of political parties and individuals against the fiscal austerity programme, the outlook is diverse to that of advocates. The People’s Assembly Against Austerity was launched in 2013. The group’s aim was to “push arguments against austerity” that they felt was missing from British politics. Notable members of the group include Lenn McClusky, Tony Benn and Jeremy Corbyn. The group argued that “wages, jobs, conditions and welfare provision come under attack from the government”. Both Monetary Expansion and Fiscal Austerity are part of a toolkit – implemented by the state, when needed. Following the great recession, supply shocks were a common problem within the UK. Supply shocks can impact potential and actual output, which typically has an indirect effect on GDP Growth. A major controversy surrounding the implementation of austerity to, reduce public debt and restore business confidence was social injustice. The national debt was accumulated mostly through, bailouts, adding liquidity and recapitalizing the banking sector. Budget cuts to welfare among many other sectors of the economy were punishing those amongst the poorest in the country. Inadequate levels of spending on public health lead to problems such as child poverty and deaths throughout the country. Continuing on to the topic of benefits and disadvantages of fiscal austerity. Economic recovery is tied with policies pushed forward by Prime Minister Cameron’s conservative party in the coalition with the liberal democrats. An argument presented by Labour stated that “austerity-driven cuts” would be beneficial solely to a “small percentage of wealth Britons”, many residing within the city of London.

The Keynesian school of economics is based off the ideology and policy framework presented by John Maynard Keynes. As explained: Key aspects of Keynesian economic theory are: States can stimulate the economy via increased fiscal spending, especially during economic downturns. The model is as follows: Creating jobs leads to increased consumer demand, as the level of real purchasing power increases and this, therefore, leads to an increase in industry growth. The mechanics explained just now are the initial turning points for a decline in unemployment and an increase in demand. Earlier in modern history, as explained, Keynesian ideologies and models helped prevent the collapse of the capitalist system. The consequential rise of social security, unemployment benefits and an array of other stabilization policies were commonly used after World War 2, following the Keynesian economic school of thought.

The Keynesian argument specifically calls for states to stimulate economic growth via increased fiscal spending, during an ‘economic downturn’. Following this perspective, Keynes believed that creating jobs would lead to an increase in consumer demand. This mechanic displays clearly the effects of increased fiscal spending. An increase in jobs leads to an increase in demand, according to Keynes. This economic school of thought is clearly opposed to the political ideologies presented by the Conservative-Liberal Democrat coalition government. Political ideologies as such (fiscal austerity) can be seen as unfit for real economic necessity. Austerity can be defined as a “political choice” and not a policy toolkit needed with the nature of the economic environment post-2007. It can be argued that substantial tax increases would allow for policies such as austerity to be discarded. Firstly. Tax increases are most likely to bring about a fall in demand due to the overall contraction in disposable income. The fiscal stimulus for the UK may have been an important step towards an increase in GDP Growth, and entry into a boom phase of the business cycle. Boosting during a downturn, increasing unemployment and therefore increasing demand. When government spending as a percentage of GDP grows too high a phenomenon known as ‘Crowding out’ of efficient private sector firms occurs. Many esteemed economists claim that governments holding a lower share of GDP are likely to come out successful, the evidence for claims as such – varies.

In order to assess the economic necessity and whether fiscal policies such as austerity were necessary or if they were part of an agenda of the Conservative-Liberal Democrat coalition government. Friedrich Hayek’s Hayekian perspective being the opposing view to that of John Maynard Keynes. Hayek argues that crises/crashes as a result of bad investments require a period of capital restructuring via debt and equity variation. Secondly, ‘state is not the solution’. Another argument presented by Hayek was that state interference in capital restructuring processes such as the lowering of interest rates would become a problem. Finally, the cornerstone of the Hayekian perspective is favouring a ‘minimal state’. This means low tax, market deregulation and tightening monetary policy. In essence low tax or cuts in tax lead to a boost in demand, due to the increase in disposable income. Tax cuts are also a significant factor in employment as businesses will naturally invest more leading, therefore hiring more employees as part of this investment. Canada is an example of a country successfully implementing fiscal austerity and seeing benefits from these policies. In 1993-1996 period Canada cut their fiscal deficit and, later displayed bold economic growth as opposed to the results shown in Keynesian models. Another example of strong economic growth gained via fiscal austerity was in Latvia which showed strong growth of 5.1% during Q1 2012.

When fairly balancing both benefits and disadvantages of austerity many come to mind. Hayekian economists may argue that increasing tax leads to a stark fall in demand. A simple critique of this, however, is that a ‘liquidity trap’ can occur. As explained by Pettinger, 2012, A liquidity trap is most likely to occur when low or negative interest rates fail to stimulate consumer spending. Consumer’s preference for liquid assets such as cash is greater than the rate at which the overall quantity of money is growing within an economy. “In the post-war period, the macro-economy was managed by changing interest rates and there was no incidence of a liquidity trap (outside Japan). However, in 2008, the global credit crunch caused widespread financial disruption, a fall in the money supply and a serious economic recession. Interest rates in Europe, US and UK all fell to 0.5% - however, the interest rate cuts were very slow to cause economic activity to return to normal. “In the UK, base interest rates were cut from 5% in 2008 to 0.5% in March 2009. Yet, for a considerable time, the economy remained in recession and growth remained weak. This period is a good example of a liquidity trap”. Looking at views against Keynesian ideology. Cutting budget deficits allows a long-term investment confidence platform to be built. Decreasing levels of debt are most likely a crucial factor in attracting private sector Investment. In 2012, “the EU commission produced a report saying that austerity measures are working to reduce budget deficits”.

In conclusion to this essay, the ideologies of both Friedrich Hayek and John Maynard Keynes tie in clearly with the fiscal austerity policies implemented by the lib-con government. Through extensive criticism of both perspectives and ideologies, it is shown clearly that the fiscal austerity agenda was about political ideology more than an economic necessity in the United Kingdom following the financial crisis. Firstly, a vast range of policies was better suited to fixing the many problems posed by the financial crisis in 2008. Expansionary fiscal policy is a prime example. Expansionary fiscal policies are seen to be fairly damaging to an economy with falling demand and increasing national debt. The main benefit posed by such policies, however, is that the private sector is paying debts during the economic downturn. This usually follows up with a decrease in private sector consumption and investment, which in turn – leads to a fall in aggregate demand. Now, if this is followed up by government spending cuts, then an even larger fall in demand is inevitable. As mentioned earlier this can be defined as a ‘liquidity trap’ and the solution for this is the exact opposite of fiscal austerity – expansionary fiscal policy. An increase in government spending.

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