Government spending cuts will result in larger budget deficit
- Published: 25 March 2014
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Australia’s Abbott government, like many Western governments, is adopting austerity policies in an attempt to ‘rein in’ its budget deficit. But history tells us that massive cuts to government spending will not achieve the aim of a balanced budget. Rather, the measures will lead to higher unemployment, shrinking government revenue and, inevitably, a growing budget deficit, writes Bill Waters.
26 March 2014
It is said that those who fail to learn from history are bound to repeat it. This applies particularly to naïve politicians who lack training in, and understanding of, modern economic theory as first formulated by John Maynard Keynes to explain the causes of the 1930s Great Depression.
Australia’s Abbott government is about to follow in the failed footsteps of another Coalition government – that of Malcolm Fraser who adopted austerity policies, avowedly to remedy the alleged sins of the “debt-ridden, spendthrift” Whitlam Labor government of 1972-75.
But when Fraser was voted from office in 1983, he bequeathed a budget deficit that was a higher percentage of GDP than the peak figure of the Whitlam years.
Fraser also achieved a unique historical feat, with both the unemployment and inflation rates pushed into double figures by 1983.
Massive government spending cuts inevitably drive unemployment to an intolerable level. The effect of this is then to reduce income tax receipts drastically. Higher taxes on products (like GST) not only reduce consumer spending and fuel unemployment, but also raise the inflation rate.
Let’s not replay the tragic, flawed policies of the Fraser government!
To reiterate: severe cuts in government spending and/or harsh increases in taxation will first drive the level of unemployment upwards and then, in consequence, will start to deplete government revenue significantly.
Such archaic, “pre-Keynesian” policies cannot possibly rein in a budget deficit, particularly as government outlays on unemployment benefits will inevitably have to rise dramatically.
Discredited “pre-Keynesian” economic theory decreed that good “housekeeping” required “budget balance” as first priority.
National governments, almost universally, adopted this flawed perspective during the Great Depression, via cuts in government spending, and increases in taxation. Such policies provided the worst possible scenario by widening, deepening, and prolonging the unemployment crisis of the 1930s.
Paradoxically, government deficits and debts rose rather than fell, owing to the depressive flow-on effects for tax revenues that arise from growing unemployment and falling production.
In his classic work The General Theory of Employment, Interest, and Money (1936), Keynes explained that only government policies that increased (rather than reduced) the levels of production and employment could rein in any budget deficit.
His theories are still the conventional wisdom for university “macroeconomics” courses and are found in all modern textbooks, which pin-point the errors of logic that characterise pre-Keynesian thought.
“Contractionary” policies, which slash government spending, are clearly counter-productive, as witnessed by history and logic.
“Austerity” policies – especially massive cuts to the “welfare state” – will achieve the very opposite of their alleged intent. The budget deficit will rise not fall, while leaving economic and social devastation in its wake.
The ideas of the Abbott government are discredited, outmoded dogmas – engulfed by the tides of history and rational analysis. Ideology must never again transcend economic rationality as occurred in the 1930s, and during the Fraser regime. Or, in the words of the late esteemed economist J.K. Galbraith: ”Dogma must not triumph over thought.”
Galbraith’s classic work The Great Crash, an analysis of the 1930s Depression, confirmed Keynes’ insights and outlook.
Both writers, in their definitive works, concluded that recessions-cum-depressions stem ultimately from a grossly unequal and unfair distribution of income and wealth.
This restricts the consumer spending power of the vast majority of middle and lower income earners, and cuts business sales and revenue. Restricted consumer demand for products will encourage business firms to cut their production and employment.
In short, Keynes, Galbraith (and more recently the eminent economists Robert Reich, Walden Bello, Paul Krugman, and Joseph Stiglitz) have proclaimed that a more equitable distribution of income and wealth is the ultimate prerequisite for achieving high employment and economic stability.
It is customers with their spending power who ultimately provide our workers with their jobs. Business firms simply respond to the dictates of customers, if they wish to make profits or avoid losses.
The proposed “austerity” policies of the Abbott government will dismantle the welfare state and create an even more unequal distribution of income – thus decimating the spending power of most customers (consumers).
Rising unemployment and lower economic activity become inevitable. How can this assist in budget-balancing? Economics is, at the end of the day, so simple!
The Fraser government experience (1975-83) is a case study of the economic truths outlined above. A new government hell-bent on reversing the “over-spending” of the previous Whitlam regime, and committed to “prudent fiscal balance”, started wielding the expenditure axe (see Applied Economics and Australian Business, R. Bennett, 1984).
Gross Domestic Product (which measures the total monetary value of goods and services produced) fell by 4.5% in the period 1981-3; while the inflation rate rose to 11.5% and the unemployment rate to 10.5% by the time the government was voted out.
Predictably, the budget deficit rose rather than fell. The highest full-year Whitlam deficit had been $2.5 Billion; whilst the figure was heading for $9.6 Billion in 1983/4 under Fraser. His hapless Treasurer was one John Howard!
The Abbott government era will be a tragi-comic replay of the calamitous Fraser experiment. As one philosopher famously remarked: “What we learn from history is how little we learn from history.”
Bill Waters holds a Master’s degree in Economics and an Honours degree in Government, both from the University of Sydney. He taught Economics and Government at the University of Sydney, and Politics at the University of New South Wales.
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