In order to understand why austerity is a flawed strategy for dealing with our crisis, we first we have to establish a baseline. If your economy is doing well and you determine to reduce your government deficit or even generate a surplus and pay down government debt, this is not austerity. This is simply thoughtful and deliberate fiscal policy. Austerity occurs when you are in trouble. When your debt levels have become dangerously high and, indeed, unsustainable. Austerity is a strategy that argues that a reduction in government spending is the appropriate response to a debt/deficit crisis.
In very narrow circumstances, this recipe can work. But in general (and specifically within the current United States) it will not. The Keynesians are wrong about many things, but one thing they are right about is that a reduction in aggregate demand will lead to an economic contraction. This will, in turn, lead to a decrease in tax revenues which leads you right back to a debt criis – but with your economy in even worse shape (see Greece, Spain).
Reduction in government spending is a reduction in aggregate demand. This will lead to an economic contraction unless that reduction in aggregate demand is balanced elsewhere: either in private sector spending or by virtue of exports. Export growth is a sometimes successful path. Devaluation of the currency (i.e, reducing local wages) will decrease imports and can make exports more competitive. In a narrow context, a local economy can use this strategy to juice aggregate demand in the face of government austerity and keep the economy flowing while reducing their debt burden. But this only works in a narrow context: by definition every dollar of increased exports means someone somewhere else has had an increased dollar of increased imports. In the current global economic context, who will increase imports to balance out an American effort to increase exports? Europe? Hardly – in fact everyone in Europe is trying to juice their own exports. Japan? Not remotely plausible. China? Maybe, over time. But for the next decade, at least, China is and will remain an export economy. Everyone can’t be a net exporter and an American effort to do so will simply lead to a collapse elsewhere – which will (at the very least) dry up export demand.
Of course, private enterprise can, in principle, be enhanced even in periods of decreasing government spending (largely through deregulation and privatization). However, in reality, the kinds of social capital to really drive private sector expansion take time. They are precisely the sorts of things that are hard to grow in a debt/deficit crisis. Instead, as we are seeing throughout the global economy today, the natural and rational response of private enterprise to a debt crisis is to be careful. Both consumer and corporate spending declines or, if it grows, grows hesitantly and not quickly to replace demand contributions from the public sector. One look at the American economy over the past five years is illustrative. In spite of extraordinary *stimulus* both in terms of magnitude and duration, the private sector has been able to maintain only the most tepid growth. Take away that stimulus and, in fact, reverse it and we will almost certainly see a contraction of both private and public spending. In other words a Depression. Try paying off government debts in a Depression!
Of course all of this is dramatically exacerbated by the dynamics of debt money. Because our current monetary system is based on the supply of debt, any effort to pay down debt (public or private) will decrease the money supply. In general, a contracting money supply will lead to a contracting economy – even in the private sector is growing vigorously. A classic deflationary spiral. The only way to avoid this would be for the private sector to not only grow adequately to counteract decreases in government spending, it would also have to do so while taking on enough debt to counterbalance government debt reduction.
In other words: another bubble. But, looking around, there are no more bubbles to be had. Interest rates have been at zero for two years and, still, the private sector is wary of debt. Moreover, do we really want to try to inflate another bubble. Isn’t it time that we recognized that stimulus economics is deeply unhealthy and can only lead to a deeper disaster down the road. Isn’t it time that we stop kicking our problems down the road to our children and grandchildren? It is time to get serious and recognize that a monetary reset and jubilee are the only responsible way of dealing with our problems.