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Whatsapp People hold inflatable scissors as they take part in a march and rally in central London on July 10, 2014, as more than one million public sector workers went on strike in Britain over pay and spending cuts by the government imposed as part of its austerity programme, trade unions said.

In the 2014 federal Budget, Treasurer Joe Hockey pledged to cut government spending to pay down the nation’s public debt. Yanis Varoufakis is a Greek-Australian political economist and author, currently working on his latest book, Europe Unhinged: The next phase of the global crisis. Here, he writes that similar strategies have crippled economies around the world, and argues that in an environment of flagging economic activity, fiscal austerity fails by its own criteria.

Six years after the great financial crisis of 2008, Australia is opting for fiscal austerity.

Australia was the only industrialised nation not to have suffered significantly from the GFC, partly because it stimulated its economy in 2008/9 and shunned austerity post-2010, precisely at the time the United Kingdom and the eurozone were embracing austerity with moral enthusiasm.

Like all other economic variables, government spending can fall as well as rise. Thus, a reduction in government spending does not, per se, constitute fiscal austerity. However, any plan to reduce government spending, over a decade, below its long-term average is the definition of fiscal austerity.

quote Can Australia expect accelerating demand from China, or elsewhere, in the next decade? While high hopes are wholly legitimate, it is foolhardy to confuse a wish for a realistic expectation.

Australia now has such a plan firmly in place. In his last federal Budget, Joe Hockey, Australia’s federal treasurer, set himself an ambitious target: not only will he reduce government spending by 1.1 per cent of national income before 2025, but he will also endeavour to push spending below its 30 year average level. All in the hope of driving the Budget into surplus and, therefore, paying down the nation’s public debt.

While at the level of the household, or the enterprise, reducing debt through spending cuts resonates nicely with prudence, the international macroeconomic experience with fiscal austerity suggests that the Australian government’s economic policies may prove deeply injudicious.

Put boldly, in an environment of flagging economic activity, like the one Australia dwells in presently, austerity fails by its own criteria.

Can Mr Hockey’s austerity deliver?

For austerity to work, one of the following two conditions must hold.

One is that a nation’s trading partners are growing fast. That is how Canada’s austerity succeeded in the mid-1990s. The reduction of public sector expenditure was replaced by private sector spending as net exports rose on the back of the rapidly growing American economy next door. Similarly, Scandinavia’s and Germany’s 1990s austerity drives were underpinned by accelerating (credit-led) demand in the rest of the eurozone as well as in America. Can Australia expect accelerating demand from China, or elsewhere, in the next decade? While high hopes are wholly legitimate, it is foolhardy to confuse a wish for a realistic expectation.

The second scenario under which austerity may work is if fiscal austerity coincides with the creation of large bubbles within the private sector; for example, in the housing market or finance. But is this prospect desirable today? Even if, say, a crisis in China’s shadow banking system were to cause an influx of middle class Chinese property investors (driving Sydney house prices through the roof and triggering a real estate bubble), how confident could the government be that a bubble of that sort would not end up in a combination of tears and negative equity that brings on an early 1990s-like recession and a Budget deficit blowout?

In short, for austerity to succeed in Australia, Chinese resource demand remains the key. Alas, during the ‘good times’ it is frightfully hard to maintain a sense of how temporary their gifts are. During Australia’s resource boom, investment rose from less than two per cent of national income to a remarkable eight per cent in 2012/3, from around $14 billion to more than $100 billion annually in nominal terms. The result was a bifurcation: while almost 200,000 jobs were directly created by the resources sector, many manufacturing jobs were irretrievably lost as the Australian dollar skyrocketed.

Today, with Chinese growth flagging and Europe buffeted by deflationary headwinds, mining companies are expected to drop their investment rate from seven per cent to no more than 2.5 per cent, causing growth to lose much of its momentum. Meanwhile, the rest of the economy, battered as it remains following the Australian dollar’s frenetic rise over several years, seems unwilling to bounce back and compensate for activity lost in the mining sector. And all that before the federal government’s austerity drive takes its toll.

With these thoughts in mind, it is difficult to see how Mr Hockey’s plans can come to fruition. Indeed, a quick look at the United Kingdom, and the more problematic eurozone, suggests that Australia’s recent austerity stance will produce larger deficits even if it reduces government spending.

Lessons from Europe’s dalliance with austerity

There can be little doubt that austerity has a tendency to undermine itself.

In 2010 the UK’s newly elected coalition government led by Prime Minster David Cameron decided that cutting the Budget deficit was the national priority.

Precisely as the Abbott-Hockey government has argued, the British government claimed large government expenditure led to large deficits; large deficits would crowd out private investment; debt had already been on the rise (and had to be subdued); and, unless the deficit was brought down, the nation faced the deadly threat of increased interest rates that would put it on an unsustainable fiscal path.

The British opted for fiscal austerity in the 2010 Budget, setting an annual net borrowing target for the next two years of no more than £322 billion. However, in its June 2013 Budget, the actual sum exceeded £535 billion. Why? Because the spending cuts slowed the economy right down, aborted the nascent recovery of 2009/10, and reduced the government’s tax take by more than anticipated.

Things were far worse on the other side of the Channel. In the eurozone, the states lacked their own central banks and were at the mercy of a European Central Bank that was itself prohibited from the type of monetary easing which had, at least, prevented a credit crunch in the UK. In that environment, the more the European governments cut, the larger their public debt ended up being, as a percentage of national income.

For further evidence of the brittleness of austerity’s intellectual foundation, consider what happened to the interest rates the money markets charged European governments when their debt increased: nothing! Had the UK government not argued, as Mr Hockey does today, that a deficit and debt overshoot would exact a terrible price in terms of higher interest rates? Nothing of the sort transpired in Britain. Interest rates remained at historic lows. Even in eurozone nations whose debts rose exponentially (Greece, Italy, Spain) as a result of efforts to curtail them, interest rates are now remarkably low.

The reason is that for nations with their own central banks andfloating currencies like the UK and Australia, long-term interest rates are determined by the expected future short-term interest rates which, in turn, depend on expectations regarding the overall state of the economy, not the government’s budget. Similarly for the eurozone countries, once the European Central Bank had signalled (as it did in the summer of 2012) that it would not let the common currency fragment, government interest rates fell to the floor, reflecting the markets’ low growth (and, thus, low short-term interest rate) expectations.

Some may protest, asking: ‘But, has British austerity not been vindicated most recently, with growth steaming ahead over the past year or so? Might it not be that the medicine simply needed more time to perform its miracle?’

All that happened in the UK was that the government abandoned austerity about 18 months ago, while the Bank of England substantially cranked up its ‘quantitative easing’ program of flooding the flagging economy with liquidity (which, incidentally, caused a nightmare bubble in London’s real estate market).

In short, the wrong diagnosis is leading governments to adopt the wrong prescription: a cure (austerity) that is worse than the disease (deficit).

It is argued that public debt is too high and has to be cut. In neither the British nor the Australian case is this so. When the GFC struck, net public debt was close to its historic lows both in the UK and in Australia. Even today, after public finances have absorbed the shock of the GFC, public debt in these two countries is at the low end of its historic range and scarcely a genuine cause of concern.

London has already discovered, the hard way, that trying to reduce public debt through austerity is a bit of a boomerang. Canberra is in for a similar lesson unless China and the world economy take off in a manner that would surprise us all.

The only hope left is that Canberra’s policy makers will prove faster learners than their British and European counterparts, who negligently waited for four long, lost years before quietly ditching austerity.

Why this penchant for austerity?

The intellectually curious cannot, at this juncture, fail to ask: if austerity is a foregone disaster, why is it so popular amongst conservative governments? The answer lies not so much in the austerity measures that they adopt but, rather, in those which they shun.

For instance, if the Australian government wanted to slash the federal deficit, why did it not think of culling the factor price-distorting fuel subsidy to miners and farmers, which costs Canberra $7.5 billion annually? How about the private health insurance subsidy that could have saved the government $7 billion every year, some of which could be spent on public hospitals without any net loss to health care provision? Why abolish the $5 billion carbon tax? Indeed, why keep the Howard government’s tax cuts, which were responsible for the increase in public debt as a result of the faulty assumption that corporate and capital gains taxes would pay for them ad infinitum?

The obvious answer is that austerity was never about tackling public debt. It was not even a political campaign to end the ‘culture of entitlement’. In the UK, in the eurozone, and now in Australia, austerity is, and always was, a thinly disguised campaign of invoking fiscal prudence and public virtues in order to indulge private vices and redistribute entitlements at the expense of the majority.