Austerity summary

John Maynard Keynes was an influential 20th-century economist whose work is still considered relevant today. 

According to him, cutting government spending has a multiplier effect on the economy – the initial cut creates an even greater negative impact on gross domestic product (also known as GDP). Meanwhile, raising taxes also causes a slight drop in GDP – because people have less disposable income – but the effect isn’t as pronounced.

Many previous attempts to analyze austerity ran into the same problem: it’s very hard to measure. 

And not only because of the influence of expectation, incentive, and confidence that we discussed in the previous blink. It’s also hard to work out whether a change in a country’s finances was caused by austerity at all. For example, it’s possible that a country’s deficit may decrease simply because of increased growth.

As we’ve already discussed, there are two types of austerity: expenditure-based austerity focuses on reducing government spending while tax-based austerity increases government income. These fundamental differences have very different effects on the economy.

According to the authors, expenditure-based austerity usually has a far milder effect than tax hikes. In some cases, it can even lead to a growth in GDP. 

When the authors constructed their average case, they also looked at the effect of tax-based austerity on GDP per capita. In this model, the initial effect of a tax increase was a notable drop in GDP, and that drop became even greater in later years.

According to the data analysis, tax-based austerity pushes economies into recession for several years. This is an especially striking result when compared to the mild effect of expenditure-based austerity.

All the examples so far have been from the 1980s and 1990s. But nowadays, when people think about austerity, they think of more recent times. After all, the financial crisis of 2008 led to massive austerity programs in the years that followed.

Since then, the debate around austerity has been passionate, and often ideologically motivated. That’s why the authors offer their data analysis as a look at austerity focused on facts – even though these facts are complex and differ widely from one country to the next.

If you’re looking for a surefire way to electoral success, raising taxes and cutting public spending probably isn’t the way to go. Understandably enough, voters like low taxes and well-funded services, which often means that they reward short-term policies without considering the long-term costs.

That’s the conventional wisdom, anyway. But, as the authors suggest, governments can do well at the polls even after austerity measures are introduced.