Are there limits to austerity measures?

Last week, EU leaders agreed on a balanced-budget rule and to resolve sovereign debt problems.

However, the summit was also supposed to focus on creating jobs and growth. How they will manage to realize those contradicting targets together is unknown. They are, of course, aware that austerity measures are unpopular but also necessary to realize the first target and that there are technical, political and social limits for the implementation of austerity measures.

There is a famous folk tale in Turkey. Our well-known Nasreddin Hodja once had an obese donkey during a time in which hunger became a serious problem for the family budget. The hodja thought that if he fed the donkey less each day, it might get accustomed to eating nothing at all. Naturally, the donkey finally died and the hodja said it died just before learning how to live on nothing. The moral of the story? It is necessary to ensure that countries facing harsh austerity measures must not share the same fate as the donkey.

Austerity measures simply mean cutting government expenditures and raising taxes in order to control budget deficit and public debts. The implementation necessitates the cutting of wages and salaries in the public sector, the trimming of social aid programs, the raising of taxes and the imposition of new ones. These are good for restoring macro-economic balances, but not so good for individuals and, in the end, may also not be good for the economy in spite of the goals at the outset.

The reason is obvious. When unhappy individuals begin to cut their expenditures because of these measures, economic activity also begins to slow down and tax revenues stay below targets. This is a big dilemma for all governments which implement austerity measures now. 

The United Kingdom’s public debt reached a record level in December, mainly because of weakened tax receipts. Many countries in Europe will surely face the same problem. This is the biggest technical difficulty of implementing austerity measures. The other important problem is the probability of a recession caused by weakened total demand which might spread first all over Europe and then jump to other parts of the world. 

There are also social and political problems. In other words, there must be social and political limits on implementing austerity measures. In every Western country, politicians have begun to talk about the ever-growing gap between the living conditions of the rich and poor parts of their society.

This might seem like a populist approach, especially in countries such as the United States, Germany and France, which have elections this year. However, it does not mean that unjust income distribution is not a serious social and - ultimately - political problem. The recent upheavals in some Western cities must not be forgotten.

In all Western democracies, it is a very difficult task for governments to decide what level of austerity measures might be tolerated by the people. Naturally, it is a big mistake and also very dangerous to use the trial and error method. But then how can politicians decide upon the exact time to stop the implementation, at least temporarily? Unfortunately, there is no rational way of doing that. It is generally fruitless to explain to people that ending austerity measures will be more harmful than the present troubles and difficulties.

Everybody knows that to establish sound budget equilibrium and to pay back debt on time, a reasonable growth is also necessary beyond austerity measures. For reasonable growth, reasonable domestic and foreign demand is also needed. But it is obvious that austerity measures weaken domestic demand. As export markets are the countries which are struggling with the same problems, reasonable foreign demand is also out of question. Who, then, will solve this superficially simple but politically very complex problem and how will they do it?

The U.S. administration seems to be solving this problem by talking much about the double deficits (budget and current account) but paying less attention to taming them, especially in an election year. There is no foreign pressure on the administration, unlike most European governments, and there is also no domestic political pressure, since presidential candidates prefer to fight each other on matters other than deficits, macro-economic balances, debts and the like. Unfortunately, European governments have no such luxury.