To Spend or Not To Spend: The Austerity vs. Stimulus Debate

Greek unions protest

Public sector austerity has come back to the West in a big way. Governments throughout the European Union are wrestling against striking civil servants, a stagnant private sector, and an entrenched public welfare system to drastically reduce spending. The budget cuts are broad, and they run deep. Under pressure from global financial markets and the European Central Bank to reduce public deficits, Spain, Italy, Portugal, and Greece have issued “austere” budgets for the coming year that simultaneously raise taxes and slash government spending. David Cameron’s new Conservative government has violated its campaign pledge to spare Britain’s generous middle class subsidies in an attempt to close a budget gap that is among the world’s largest, at 11 percent of GDP. Supposedly confirming the wisdom of austerity, the financial press has trumpeted the re-election of Latvia’s center-right government, which passed an IMF-endorsed budget with austerity reductions equal to 6.2 percent of GDP. Prime Minister Valdis Dombrovskis won his “increased mandate” – “an inspiration for his colleagues in the EU” – against a backdrop of 20 percent unemployment and a cumulative economic contraction of 25 percent in 2008 and 2009, the most severe collapse in the world.

Latvian electoral politics notwithstanding, austerity has been a tough sell worldwide. Both the protests that broke out across Europe at the end of September and the general strikes mounted against Socialist governments in Portugal, Spain, and Greece attest to the resistance all governments face in cutting public spending. And opposition has not been confined to the streets. At a G20 summit in Washington DC on April 23, the finance ministers and central bank governors of the world’s 20 largest economies agreed that extraordinary levels of public spending should be maintained until “the recovery is firmly driven by the private sector and becomes more entrenched.” Indeed, Larry Summers, the departing Director of the White House National Economic Council, still argues that the United States must continue its policy of economic stimulus in the form of deficit spending on infrastructure rather than pull back public resources, lest it cede the small gains of the nascent recovery.

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