Austerity vs Stimulus

Posted: July 03, 2012

FOR A NUMBER of years, I have been having regular discussions about the world's economic situation with a very close friend. To keep him in proper perspective, I should note that while he is not in the top 1 percent of America's wealthiest, he is certainly in the top 20 percent and possibly 10 percent. He is now retired. Most of our disagreements concern the best way to get out of our economic doldrums.

He is firmly convinced that the only way to restore substantial growth is to have an austerity program with a key provision of sharp cuts in government spending at all levels of government. He is of the opinion that the abuses in our safety-net system are so huge that only cutbacks can solve the problem. He also sees increases in income and estate taxes as short of a Band-Aid. His views are not politically motivated since he is on the left on most social issues.

I firmly disagree with his economic position. It is often difficult to point out the successes and failures of contrary economic policies because there are almost no coincident comparisons. However, in the past few years we do have the ability to see what each of these policies can bring to countries in trouble. Let us consider Ireland and Iceland and what we can learn. The Greek situation is much more complex because of the Euro as common currency with the rest of Europe.

Ireland's austerity program has produced few new jobs, but has cut its deficit. However, the financial community still has little faith in its economy. The interest rates on Irish bonds are in the realm of Greece and Spain. Meanwhile, Iceland, which did not engage in anywhere near the austerity recommended, still has a good bond rating and its safety net is still in place. Its stimulus program has worked.

Let's look a little beyond the recommendations for austerity and stimulus to see what underlies their proponents' thinking. The austerity group claims that reducing the size of government will fix the economy. They also add that reduced taxes on the very wealthy will create new jobs. The stimulus group believes that the Fed has not done as much as it could or should to create more individual spending by expanding the money supply and tackling the mortgage crisis.

Reducing the size of state governments means fewer policemen, firemen, trash collecters, teachers, welfare workers, etc. This will result in less need for taxes, so businesses will have reduced expenses and use the savings to hire more people. Now let's be pragmatic about this. Reducing the expenses of a business does not lead to it hiring more staff. That decision is more related to need, and that is more closely tied to greater demand for products or services. But demand will be severely cut by reductions in the government labor force and reductions in the income of those protected by our reduced safety net.

A stimulus program will make it easier to borrow and to reduce the payments needed on troubled mortgages. The safety net will still be intact and government (and other employees) will not be without jobs or the fear of losing them. And the simultaneous increase in taxes on the very wealthy will help to keep deficits within bounds. Such an increase will also help to reduce the emotional aspects of our wild gap between those at the peak of the wealth pyramid and those at its base.

It makes one wonder if the real aim of those proposing austerity is not getting the economy back on its feet, but using the crisis for other purposes. It has been suggested that the real purpose of their fight is to eliminate, or at least slash, our social programs. Are they trying to create a deficit panic to increase their number of supporters? Is it not highly likely that their motive was never economic, but political? Are they deliberately ignoring the fact that deficits under Reagan (the Right's hero) increased by a higher percentage than we're now experiencing? Remember, during that period, the highest tax bracket was reduced 60 percent! Surpluses and good economic times were inherited from Clinton by Bush in 2001; deficits and near depression were inherited by Obama from Bush in 2009.

Harry S. Gross writes a personal-finance advice column for the Daily News.

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