Saturday, October 27, 2012

A Simple Metaphor to Explain Austerity

I periodically see posts from left leaning economists decrying the ill effects of austerity followed by right leaning posts trying to deny that austerity is really happening because the government is spending more money.

I think a simple metaphor will serve to illustrate what I think is going on here. Imagine you are a church in the midst of the downturn. You have an extensive anti-poverty program that gives meals, retraining, and other services to the poor. Your receipts have fallen due to a great economic downturn. Your obligations have risen because you have an open door policy towards the poor.

To try to keep a balanced budget you engage in austerity measures. You don't replace some of your paid staffers when they leave. You cut down on perks like social outings for congregation members. You choose to forgo a scheduled update of the computer system as well as maintenance on the property. Small staff and volunteer perks are cut, like free lunches for volunteers. To try to meet obligations you pressure parish members for larger donations.

However, because of the growing poverty in your area and your well known open door policy the numbers of those seeking your services leads to ever higher expenses. The cost of providing so many with meals raises the food budget to unheard of levels. More parish members are asking for help with medical expenses, matching donations becomes a strain on the budget. Costs of job seeking help rise, providing transportation and other services to job seekers becomes a major drain.

On net, despite sharp cut backs in normal operating expenses and investments, the church is left with growing debt. But to any observer the church is obviously engaging in austerity, its parishioners are receiving less in the way of social activities, volunteers get less perks, and the physical infrastructure is visibly decaying. However, continuing to meet other obligations is proving very expensive and is leading to the church spending more on net.

This is essentially what is happening with most governments engaged in austerity. They have not only obligations to taxpayers and creditors but existing obligations promised by their programs. Engaging in austerity means cutting back on discretionary programs (which tend to have some of the largest positive marginal impacts, unfortunately), funds allocated to current employees, and to needed investment activities. A state engaging in this is obviously engaging in austerity. That expenses keep rising due to other obligations does not change this, though if someone believes that a smaller government sector is essential to growth than obviously austerity will seem insufficient. But that a state chooses to keep its obligations to the poor as well as its obligations to the relatively wealthy bondholders does not indicate that real austerity is occurring.* If an organization other than the state engaged in this form of austerity it would be obvious to us that it was, in fact, cutting back. It should be obvious when the state does this as well.**

*It also needs to be noted that increased spending due to obligations to the poor, an aging, sicker population, and unemployment benefits will not have a net stimulative effect since they will at best partially replace lost demand from those previously fully employed. Just replacing the lost demand to keep growth from declining will require expenditure at a level close to what the newly unemployed were earning, to have a net stimulative effect expenditure would have to raise more. Lower growth is consistent with rising deficits and increased state expenditure if the state is not closing the entire lower output gap. The deficit is actually expected to rise quite a bit, since not only is it having to replace the demand loss from those unemployed just to prevent a decline in output but it is also facing lower revenues while doing so.

** This metaphor, can, and probably should, be expanded to criticisms from the right regarding state growth. I read a lot of chatter on the internet regarding how state spending continues to grow despite promises of cuts. If you do any more than scratch the surface, it is readily apparent that discretionary spending has been cut drastically over the past 30 years (in per capita terms) and that state employment has fallen greatly over that period as well (again, in per capita terms). We have obviously been engaging in cuts to the state in the sense that we would understand it for a business or charity (a charity, for instance, that had a growing donor base and growing obligations to programs has obviously engaged in cuts to its organization if it handles this with less staff and fewer facilities, even if more money is passing through it). Now this does not answer the criticisms of those that have problems with those very obligations, as opposed to the state as a distinct organization, but this needs to be recognized as the separate critique it is. The person receiving medical and social security benefits is not a part of the state and reneging on the obligations to this person is as much a default as reneging on promises to bondholders is.

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