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Posts Tagged ‘GDP’

Austerity – Alt-med of Economics

Posted by Don McLenaghen on June 4, 2012

The very social fabric of society is currently under assault by the forces of economic minimalism. What it means to be a member of a society is radically changing in the direction of extreme libertarian types that believe a society is only a collection of individuals, the government that governs least is best and that personal responsibility means others should feel NO expectation to help their fellow human.

The latest salvo in this assault is “austerity measures” that MUST be passed to avert economic disaster…the Shock Doctrine manifest. Okay, pretty stirring stuff, can I defend this claim….what light can the skeptic tool box shed on this issue. First, we need to define our terms, then seek empiric evidence to support/defuse these claims and lately is there any “test cases” that can be used as data points for analysis.

What is austerity?

Simply put, austerity is the reduction of government spending…well, not really. It is an irony that many governments’ budgets are increasing but this is not due to “social spending” or stimulus spending ; it is due to debt maintenance and financial bailout. Most of this money is leaving the countries in question exacerbating the local economic recessions.

There are three poster children for austerity – Ireland, Spain and the UK. Most people think of Greece or the USA for austerity but these are rather new to the game (Greece) or incomplete (US military spending).

So, let’s check the budgets for Ireland specifically, this was the first to stumble economically and the harshest to follow (with little internal dissent) the “austerity cure”:

Ireland 2008 2009 2010 2011 2012
Total Expenditures 57.722 60.127 54.753 59.160 61.471
Total Capital Investment 11.089 14.609 7.406 10.169 10.249
Debt Servicing 1.939 2.664 4,807 4,904 7.,488
Net Spending 44.694 42.854 42,540 44,087 43.734
Adjust $ (2008) 44.,694 41.,996 40,855 41,494 40.338
The Austerity
0 -2.698 -3.839
All values in billions of Euros. Sourced from the Government of Ireland Department of Finance

2011 also included €7 billion recapitalization of the banking sector…i.e. bank bailouts…after an emergency bailout of over €4 billion in 2009 and another €7 billion in 2010. The bailout money is important because when we talk about austerity, we mean specifically cuts in government spending on society…the bailouts (although arguably necessary) largely went to foreign debt holders or to maintain the liquidity of the institutions. Although the expenses of the state increased these were offset by equal or greater losses in the economy in general.

Austerity in Ireland meant €6 billion in cuts in 2011, including a quadrupling of student fees, reduction in child benefit, EI, welfare, 4% cut in student grants, reductions in public employee benefits and pay, and an increase in the VAT.

The UK spending followed the same trend: £697 billion (2010), £710 billion (2011), and £683 billion (2012).

Okay so first myth, that governments have not ‘tried’ austerity because some budgets are still growing; dismissed. So, what about the second myth that ‘austerity’ is needed to recover the economy; that painful cuts in government spending will stimulate the private sector and revive their economies?

Well there are two metrics we can use to judge this: GDP and unemployment

IMF GDP (Billion US$) GDP % (Constant Prices) Unemployment
2010 2011 2012 2010 2011 2012 2010 2011 2012








































1: In 2010 the Conservatives took power and moved towards austerity measures2: Canada is added as a non-austerity comparison

On the one hand, GDP seems to have recovered but what is GDP? And what does it say about the measure if it does not reflect itself in the employment rate?

This points to a major disconnect in our economy and why austerity, however some economists may insist it is necessary, is ultimately bad for our global economy now. NOW is important and often missed in many discussions about deficit. Why deficits? Well, those who promote austerity do so because they blame rising debt and government deficits for the financial crisis. There is plenty of academic work that shows the cause of the current ‘financial crisis’ has nothing (or at least little) to do with debt and everything to do with under regulated global juggernaut financial institutional gambling (sources below).

That said, debt is not an issue to be ignored indefinably. When in economic boom times we should run fiscal surpluses and pay off the debt…IN TIMES OF BOOM, not Ka-BOOM! In the past we had been promised in good times tax reductions (predominantly for the corporate class) while still maintaining necessary and desired social services. That was society’s failure (or as some more realists believe the result of lobbying and media propaganda by one class for its own benefit). When good times return, the debt should be paid down or eliminated. If debt is such the bane some claim, how has Japan managed to have a robust society and functioning economy for the past twenty years with a debt-to-GDP ratio of over 220%? Greece is barely over 140% and that is supposed to mean automatic economic apocalypse.

But we are not in good times. EVERYONE is cutting back. Tax reductions now (almost exclusively for the corporate class) have not stimulated spending but saving instead. The public is too unsure about the future (largely thanks to political fear mongering about debt and austerity) and put off large purchases for fear of job loss, pension loss or just reduction in pay/hours. The corporations are not spending because there is no demand. If people do not spend, they corporations have no one to sell to. Even in those industries were growth is possible, the corporations are just as nervous of the future as the masses and are saving “war chest” in case of future losses and moments of opportunity to acquire less prudent companies.

For a capitalist economy to function we must have both supply and DEMAND. If the people are not demanding; if the corporations are not demanding; it falls upon governments to stimulate the economy out of recession/depression. This means increasing debt. If government put money into the economy, be it directly through spending or indirectly via hiring, there will be more demand in the economy. This will, if capitalistic logic is valid, cause corporations to supply this new demand resulting in more growth. This leads to inevitable recovery provided enough stimulus is spent. The aborted recovery in the USA shows what too little cannot do. Once the economy is running of all pistons then comes the “adult” moment where we forgo immediate pleasures of tax cuts but instead take the tax win falls and removing the accumulated debt.

So, claim this is simply spending today and leaving the bill to future generations. Well, that is true in one sense; in the future we will have the capacity to pay the debt. It is also true that we are investing today so that future generations will have greater prosperity. That what is spent now will give them the extra needed to pay later. Lacking stimulus now, what we give our children is not a financial debt but a societal one…an economy in ruins; a social contract in tatters; a people in poverty who wished they had the money to pay for today.

As a skeptic we can look to the past. In every economy that experienced depression/recession; the only cure was stimulus. In most cases governments were the source of this spending and only in rare cases has this failed and those times under conditions not likely to be repeated (Weimar Germany). The empirical evidence shows that austerity in the past has failed (Hoover in the 1930s) and it is doing little better today (Ireland). So, that leads to the question why are so many politicians are moving forward with austerity?

“By the way, I think you’ve just given me confirmation of something that people like me tend to say [about those who promote austerity], which is, actually none of this is at all about fiscal responsibility. It’s all about exploiting the current situation to pursue an ideological goal of a smaller state. We could argue whether the British State is too large but Sweden which is weathering this very well with a much larger state presence than [the UK]…that’s suggesting you’re not actually sincere. That it’s not really the budget deficits that concern you but you looking for a way to exploit this definite situation to pursue an agenda” Paul Krugman on Newsnight, 30 May 2012


Austerity falls out of fashion


The Austerity Agenda

Austerity is Not About Policy, But Ideology

Austerity Plans Are Based on the Wrong Diagnosis of the Wrong Problem

The Macroeconomic and Distributional Effects of Fiscal Austerity

Britain’s austerity drive as ‘deeply destructive’

Austerity Defenses

Amid EU Austerity Backlash

Greek “Bailout” is a Bank Bailout

Expansionary Austerity

Austerity isn’t working: There is an alternative

Anti-austerity movements gaining momentum across Europe

The “Austerity Myth”

Irish Budget 2011 – Key Points

EU austerity drive country by country

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A taxing issue

Posted by Don McLenaghen on November 17, 2010

In the shadow of the elections victories of the Tea Party in the US election and the recent announcement of our own Campbell government here in BC to both cut income taxes while implementing a user fee for hospital stays, I thought it would be educational to take a sceptical look at taxes and in particular tax breaks.

Taxes have been a widely used tool by governments to punish ‘sin’ (in the form of alcohol and tobacco taxes) and to promote investment (in the form of tax holidays or credits like the capital gains tax). I am not going to get too partisan here. There are valid arguments on all sides about what are appropriate taxes and at what level those taxes should be – that is a discussion for a different day and perhaps a different show. What I would like to investigate here are two things: first that cutting taxes increases tax revenue (this was called Voodoo economics by G. Bush Sr., trickle-down economics by others but economist refer to this broadly as supply-side economics) and second that tax cuts are always good.

I shall address the former first. For those of us who had access to an US media source (or those who can remember any recent political campaign) every politician was promising to cut taxes; when asked how they would pay for these tax cuts, they would either respond by saying tax cuts cost nothing or they said they will reduce spending…when asked what spending, they would say something like “that fat in the system” or “improved efficiencies” – IE they would not cut anything. For example they often say they will cut “ear-marks’, but this only accounts for $3 billion out of a budget of $3.6+ trillion (with a deficit of $1.7 trillion)…or 0.08% of budget (0.17%  of deficit).

It seems popular among voters across the political spectrum. However, the recent dual announcements of our local government show the reality of the situation. Campbell announces a popular across the board tax cut of 15%. This applies to rich and poor alike (although not equally, but again that’s a different show*). This equates to a loss of over half a billion dollars a year. That is money the government will not have to provide services…like hospital beds. The government also recently announced a user fee on hospital rooms amounting to over $200 a week. Who is going to make up for the loss in tax revenues? The sick.

Environics Poll 2007

Now don’t get me wrong, maybe we are all happy with that, but most people when asked the question do they want to cut public spending (especially healthcare), they say no…in fact it is one of the few areas people show an innate socialist tendency.

Just to put the two into perspective, the median family will save about $350 a year in taxes.  The average hospital stay for an individual is 3-10 days (depending largely on age)…that’s a fee cost of $87 to $290 (and for those of you who say “well most people will not be in hospital that long” just remember that makes the fee even more onerous because it WILL effect most those who are suffering most and likely least like to afford it).

Okay, my math may be a little dodgy (mainly due to the lack of accurate numbers for ‘average hospital’ stay or the myriad of different income/fee/taxes an individual will pay) but the point should still be obvious. The hospital fee was not to pay for the tax cut but add in the added cost of medical insurance premiums[1], camping fees[2], transit fees[3], licence fees[4], tuition[5] and so on you will get there. (for those of us old enough, we remember when ‘user fee’ was a dirty word and the fees that did exist were token…not any more).

Cost of Bush's tax cuts

The point I am getting at, is if we want social services we have to pay for them as a society. That means when someone yells “tax cuts” remember they are also saying “cut services”. Maybe something you are comfortable with…maybe not but that is the reality of it. I was going to go on to talk about the wisdom of providing robust social services but that would be straying perhaps outside the bound of a sceptic podcast so we shall stop here and address the second point.

Many have claimed, largely Republicans and Monetarists, that cutting taxes increases tax revenue. On the surface this sounds paradoxical; however there is a shred of logic to be found. The idea, goes that if you cut taxes, those who have more money will invest in the economy, the economy grows, from this larger tax base you collect more absolute dollars even though the rate is lower. The idea works in reverse as well; increasing the tax rate will cause a contraction of the economy and a reduction in absolute dollars.

Often the example of the Reagan Revolution is used to prove this point…i.e. that it works in practice. However this is a flawed claim. As many modern economists have shown[6], including noble prize winner Paul Klugmen, the Reagan tax cuts did not improve the US economy and actually made government finances worse.

It is true the US economy grew fast from 1983-89 however this is in contrast to the miasma of the severe recession of 81-2. Capitalist markets are cyclical, and this was not an unusual recovery. Private savings, something supply-side economics assumes from the masses to provide the capital for investment, continues to decline throughout the decade (7.8->4.8%). Meaning, the money for the recovery, as it was, came from spending savings and increasing personal debt. Finally, this trend is echoed in the US budget; when Reagan came to office the US debt as a % of GDP was 32.5%, when Bush Sr. left it was 66.1%. Clinton, who raised taxes, brought the rate down to 56.4%. The same happened in Canada, when we increased taxes in the 90’s and went from the ‘basket-case’ nation to arguably the country with the most stable finances.

Lastly, the multiplier effect. Not all tax cuts are equal. Tax cuts cost money; those who claim that it is not should ‘not’ collect their next pay-check and see if it costs them money. So, the current desire of governments everywhere is stimulus. When the government (or anyone really) spends money it has what is called, a multiplier effect on the economy; that is for every “Y” dollars spent it generates Y*x (or Y’) in the economy. So, if I give you a dollar and you burn it, which generates no activity in the economy, in fact it removes the dollar from circulation so has a negative multiplier effect. Now most people will spend it or ‘invest’ it (be it real investments or just in your bank account) and they have a positive effect; that is they generate more than a dollars worth of economic activity. The best way to think about this is if you spend the dollar, the merchant sells more, can now hire a new employee, and we will in turn make more dollars and spend them; the new employee generates the new value. An economist could spin a better story, but I think you get the gist of it – the one dollar generates more than a dollar of economic activity.

Relative stimulus effect

Having given the background, how do tax cuts fair as stimulus[7]? In general, every dollar of tax cuts generates $1.30 of economic activity compared to a dollar spent on increasing UI benefits would generate $1.62 or increasing food stamps generates $1.74. There is also the issue of WHO to give the cut to. Lower income people spend (out of necessity) every penny they make so a cut in their taxes (thanks to HST we ALL pay taxes even the poorest) will generate the most activity but they latterly also have the least money (the bottom 50% of household control about 3% of Canadian wealth). As you move to the other extreme, the very wealthy often ‘invest’ most of their tax cuts (earning more than they need), so less activity generated but because they make more money a big bang (the top 10% own around 58.2% of the nation’s wealth[8] in the USA its 1% owning 35%). However, in a global world, it is most likely their investments will be ‘trans-national’ or outside ‘our’ economy and thus lost completely to the system – complete fizzle.

Society, of course, is not only extremes but a lopsided slope of ‘everything-in-between’ (note percentages of wealth ownership mentioned earlier) otherwise it would be easy to define tax policy; the trick is to determine both purpose (stimulate consumption, promote manufacturing, decrease inflation) and effectiveness. History has given us lessons to learn from and one a sceptical economist should be able to apply.

<From Episode #88 of Radio Free Thinker>

[1]British Columbia Medical Services Plan Premium Increase Notice
[2]BC April fee increases
[4]BC Gov 2010 fee increase
[5]BC Gov tuition increases
[6]Supply-Side Economics Debunked – TYT
[7] Recovery Ac
[8] Inequality in Canada

* By this i mean 15% of $100k = $18k while 15% of roughly the median income, $50k = $7.5k. So, the tax applies the same but the benefit is very unequal.

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