Rationale and Success of Austerity Programs in Greece and UK

‘Growth in a Time of Debt’ is the name of the working paper that Carmen M. Reinhart together with Kenneth S. Rogoff published in May of 2010. Back in 2010 it is important to notice that the governments of the USA and Europe, were pursuing Keynesian programs that had been launched after the financial crisis that took place on 2008. Keynesians believe that aggregate demand does not necessarily equal the productive capacity of the economy. Instead, it is influenced by a host of factors and sometimes behaves erratically, affecting all parts of a sustainable economy, such as the production, the employment and the inflation (Lee H. Dymond, 2015). By taking the risk to follow these programs the government created a big debate. M. Reinhart and S. Rogoff doubted that the program that supported further borrowing procedures, in order to support governmental spending tax cuts, will have success. Both sides agreed that reliable information of countries collected since the Second World War, showed that higher debt to gross domestic product (GDP) rations are associated with lower levels of GDP growth. Furthermore, M. Reinhart and S. Rogoff argued that there is not anything new in the Amherst paper and they created a theory. The theory said that there is a level of indebtedness at which growth rises positive or turns negative. M. Reinhart supports that the relationship between government debt and real GDP growth is weak for debt to GDP rations below a threshold of 90 percent of GDP (Carmen M. Reinhart, 2010). The two economists, identified after some new research that the threshold as a debt to GDP ratio of 90 percent and they added that if the debt rises above that level, then the average growth rate was negative 0.1 percent. This research caught the attention of the Amherst economists.

The Amherst economists gave their answer to what M. Reinhart and S. Rogoff published. More specifically, Thomas Herndon, Michael Ash and Robert Pollin, the three Amherst economists, did their own research. They supported that countries with debt to GDP rations below 30 percent, grew at an annual rate of 4.2 percent. Countries with debt to GDP rations between 30 – 60 percent grew at an annual rate of 3.2 percent. After M. Reinhart and S. Rogoff doubted with their theory what the Amherst’s publication announced, the Amherst economists tried to see if they had made any mistakes. In detail, they did a new study by using updated data and they found out that the average growth in countries with debt to GDP ratio of 90 percent or more, is positive 2.2. Also, in countries with debt ratios of 60 – 90 percent was less than 3.2, but it was not negative as M. Reinhart and S. Rogoff supported. All in all, the Amherst economists believed that there is not statistically distinguished, whether in categories of 30 – 60 percent, 60 – 90 percent and 90 – 120 percent, there is a difference in the average GDP growth.

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At that time, there was a lot of confusion between the economists of the countries and the financial crisis made the governments decide to use a program called austerity to solve the problem. They used this program hoping that, by reducing government spending and increasing taxes, they will reduce their budget deficit and the general unstable economy. The economy of the countries, especially in Greece, were weak, and these programs, that austerity brought in every weak economy, often lead to further falls in aggregate demand, rise in debt to GDP rations, higher unemployment and generally lower economic growth. It was expected that austerity will not affect everyone in society, but it would affect the lower paid, because they would have to cover higher wages. Also, spending cuts will lead to lower inflations and the fall in aggregate demand will lead to lower inflationary pressures. Moreover, there have been attempts to improve competitiveness through lower inflation and cause lower growth and unemployment for some years. If the government reduces a country’s pubic wages, it will cause downward pressure on wages and reduced underlying inflationary pressure. However, if austerity measures, create lower economic growth, it will also cause governmental fall in cyclical tax revenues.

Greece was one of the most affected countries by this crisis. In 2010 the country was bankrupt and bailed out by the European Central Bank twice, since the banks of Greece could not support the country anymore. Greece suffered from this issue because when the country entered the eurozone and changed the currency to the euro, people started spending without saving or investing. Also, at that time the banks were allowing people to take loans without a strict limit. For the banks, loans were products that needed to be sold in order to earn more money. However, people ended up with great loans that they could not pay back accordingly and this situation led to cash flow collapse. As government revenue increased because of the global boom that took place before 2008, the government was led into a false sense of security, cut taxes and increased investment in order to support the rise of the country’s growth. In March 2012 Greece had “the largest restricting of government debt in history, lenders and banks wiped 105bn euros off Greece’s debt burden” (BBC News, 2012). This made Greece’s sovereign debt aim, to reduce it from 160 percent of GDP to 120 percent GDP, this with an increase in new property tax and the cut of civil servant workers (BBC News, 2012). This program by EU came into criticism as it was only making the situation in Greece worse. It led to unemployment from 10.5 percent in Q1 2010 to 26 percent in January 2015 (Trading Economics, 2015). The government of Greece also reversed some of the previous austerity measures, including cuts to pensions and public sector salaries. The inclusion of its sovereign bonds in the European Central Bank’s quantitative easing scheme also helped (E-Kathimerini, 2018). Greece has a low exporting rate and together with unemployment the program leads to a large budget deficit. After these years the Prime Minister of Greece ended up writing in his account: “We are all ready for the battle against austerity and neoliberalism, for a progressive Europe of social justice and labor. For a Europe of many” (To Vima, 2019). Greece still faces a crisis although the austerity program started years ago.

The United Kingdom at that time had 205 percent debt, due to investing programs by the government. In general, the austerity program in the UK, as the Chancellor says, is tackling Britain’s large budget deficit through a mix of spending cuts and tax increases. But the main debate is, whether these policies will stop people from spending their money or not (The Guardian, 2013). In this case if the austerity programs together with Brexit creates insecurities to people. Then they will not invest or spend money and the cash flow will face big inefficiency. For the UK austerity, is a project that focuses on transferring wealth from the poorest to the richest. More specifically, the typical British worker is still earning less after inflation that he or she was before the banking crash and the UK billionaires have nearly quadrupled since 2009 (The Guardian, 2016). The austerity program leads the country to hand over a lot of what is still owned by the British public to the wealthiest. At the Whitehall, ministers plan to sell a big part of the Channel 4 and also the public part of the national air traffic control (The Guardian, 2016). The government had putted a lot of public holdings such as collapsed banks and the Royal Mint, under the control of government organization called the UK Government Investments. So, the UK followed the program of austerity by trying to sell all public firms and make them private. An example is also that it privatized the Royal Mail. This made some government funds and enabled the Prime Minister to reduce the budget deficit Britain was running at that time. The Chancellor of the Exchequer had pledged extra cash for the NHS in his 2018 budget in addition to an earlier than planned income tax cut for 32 million Britons, as he hailed the ‘end of austerity’ (Express, 2018). Also, after seven years of austerity the Chancellor said “there is light in the tunnel” for Britain’s public finances, with debt about to fall as proportion of GDP (Financial Times, 2018). However, in order to use this program in a country, the country should have a strong exporting market, because the debt will continue to decrease despite the privatizing of public firms.

In general, if in a country the governmental spending is well used, then it could create aggregate demand and more investments. More specifically, if the government creates an environment in which people and companies would invest, then it could lead to a more successful economy. Referring to the Keynesian perspective, the companies produce output only if they expect to sell it and the availability of the means for the production, determines the potential GDP of the country. Also, real GDP which is the sold goods and services, depends on how much demand exists in the economy of the country. Furthermore, a new demand in the country’s circular flow of income could be described as a multiplier effect. Extra income leads to more spending., so more goods and services will be sold and create more income to the sellers. So, it creates a circle of a healthy economy where people produce, buy and spend.

In conclusion, the austerity program is questionable and it has created a lot of debates. More specifically, after 2010 together with the world’s economic crisis, the UK and Greece faced a period of insecurity and an unstable economy. This situation led to a lot of stress between the countries of the eurozone and the world’s governments. Greece’s government discussed the case of Grexit and the UK’s the case of Brexit, which shows that the euro and the austerity program is still inefficient. For both countries the privatization of public heritage, gave a great amount of money to the government, but in the long run it created more problems. In an economy that is stable, cash flow is required. By giving the privilege to the rich and causing the middle class to fall and the lower class to suffer from high taxes and unemployment, is questionable if the investments of the high class will be enough for changing the economy of a country.

References

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