Austerity – For And Against

It’s a word that politicians love to hate and as much as the current government is telling us that the measures they are taking don’t amount to austerity, by definition, they do. And as other commentators have noted, New Zealand has elected a government of austerity, so let’s weigh up the pros and cons.

Proponents argue that austerity is a necessity when a country faces unsustainable levels of debt. By reducing spending and increasing taxes, the deficit is lowered and debt to GDP is reduced, both of which are important for long-term economic growth. The interesting difference with our government is that it is proposing to reduce taxes, not increase them.

Austerity measures are seen as a rather blunt instrument to encourage market confidence. This could lead to lower borrowing costs and potentially stimulate investment. But, in the case of New Zealand, a lot of the economy is dependent on government agencies and the immigration settings are so tight that investment from outside can be very difficult.

In some cases, where structural reforms are married to austerity measures you can increase the economy's efficiency. Things like public service reform, for example. But we are not doing that either. This government is not reformist. It is a repeat of the previous time National was in power without the reformation aspects.

These are all thin pros for austerity. What I think we see here is a populist movement more than anything else, where arbitrary cuts to spending are made with no wrap-around reformation or strategy for growth. Which leads us to the negative aspects of austerity.

The economy suffers. Particularly if you implement austerity measures during periods of weak economic growth because it can cause a recession or make it worse if one is underway. Everyone spends less, there is higher unemployment and an increased brain drain.

The social impact can be high. Austerity always affects frontline staff despite politicians telling you it won’t. That means cuts to social services, education, benefits, policing, and healthcare. All of that can be particularly damaging for vulnerable populations.

There is some evidence to suggest that austerity can increase inequality. The weight of austerity tends to fall on lower-income households that rely on government services and benefits.

Austerity can create a false economy and undermine long-term economic growth by cutting investment in infrastructure, education, and other critical areas. Kicking the can down the road simply shifts those costs into the future while creating high risk to existing services needing investment.

Empirical evidence on austerity measures is mixed and hotly debated. What is generally agreed is that it is only effective when coupled with policies that support economic growth and reformation. Austerity for the sake of saving money without those is almost always doomed to failure. At the peak end of austerity in failure mode comes social unrest.

Now, before I go on, I want to acknowledge again that there is wasteful spending in government. There is no doubt. Priorities have also been reset.

All of you will have a pothole story that underlines the complexities of wasteful spending. In my neighbourhood, over the last two years, a pothole grew to a reasonable size, and we put a road cone in it. Then about six months ago as I drove home, I saw a near kilometre of road cones and signs littering the street. As I turned the corner, I spotted seven different kinds of vehicles and probably fourteen workers. Some of whom were working. They were there for a week and left a gravelled stretch about fifty metres long, with all of the road cones still in attendance.

Time went by and cars and trucks tore up the road and then last week all the men and vehicles returned, stayed a week, and then left the gravel section and disappeared. It must be costing a fortune to fix this pothole and it speaks to a lack of oversight, accountability, and frankly, a contract that must be just printing money for a private company.

Back to austerity. What happens if we flip the story, what happens if the government spends more during a recession?

It can create a multiplier effect. Increasing spending pumps money into the economy and business grows. It allows for more investment and further growth. In a recession, it brings idle resources back into work. It stimulates demand which induces growth.

In a recession investing in infrastructure and other areas such as research and development creates the opportunity for economic growth in the future while creating jobs in the short term.

But again, all of that only works if you have the right policy wrap-around and a plan.

In the case of New Zealand, we don’t have the other usual advantage that a recession usually creates, lower interest rates. Lower interest rates would allow the government to borrow while not ending up in a poor debt position.

And of course, increased spending leads to increased inflation in some circumstances, however, we could do a lot better to control this. Government spending tends to create inflation in a “full” economy where there are idle resources or capacity. Rather than output increasing, prices increase. We are not in a full economy. There is increasing idle resources and capacity in the economy.

If you were going to spend more then you need to target the sectors that are the idlest with the most capacity that are likely to generate the most productivity and economic return. That means less risk of inflation.

When you have three CEOs running the country it is almost impossible to create a joint economic plan. Instead, what you get is what we are seeing, arbitrary targets that are not only affecting people but also services. Right now, agencies are generally culling low-tier staff to save their management roles. And we are starting to see the culling of some larger, necessary, infrastructure projects.

Globally, we are seeing the economy starting to pick up again post-COVID. A more measured “wait and see” approach could have been advantageous. If it got to a point where they needed to save money, they could, if the economy started to power back up, then it wouldn’t be necessary.

Wholesale austerity measures without wrap-around planning and policy will be a failure, in my opinion. The government needs reformation, otherwise, this whole thing will simply swing in the other direction when the government changes again.

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