I’ve been reading Austerity: When It Works and When it Doesn’t by Alberto Alesina, Carlo Favero and Francesco Giavazzi. It’s a book that won’t be popular with some people.
While accepting that fiscal austerity reduces aggregate demand, the authors argue, strongly, that the negative output costs are smaller in the case of expenditure reductions than tax increases, and so that expenditure reductions are also more effective in reducing debt to GDP ratios. They also suggest that austerity can in some circumstances be expansionary. They dismiss claims that fiscal multipliers are larger during economic downturns. And also the claim that voters do not always punish austerity when it comes to election time. The authors dismiss some other often-heard arguments for restraining austerity programmes. For example, they suggest that some European countries had over-invested in unnecessary infrastructure so low interest rates post-2008 were not a good reason to invest more public money in long-term projects. They argue for means testing areas of public expenditure such as free or subsidised higher education.
The book is based on data for 16 advanced economies from 1970, with a chapter focusing on post-2008 and 2012 Europe. Its findings conflict with those of other macroeconomists, including Olivier Blanchard for instance. There are two big gaps – clearly acknowledged. One is contemporaneous income distribution, the other the intergenerational equity issues. This is about aggregate macroeconomics, output growth and debt-GDP ratios.
As the conclusion notes, the questions addressed by the book are intertwined with another: did European countries overdo austerity after the financial crisis? The argument here is that austerity measures were insurance against sovereign debt and further banking crises, and even with hindsight it is impossible to know whether the degree of austerity was just right or too much to avert this potentially disastrous outcome. However, it is clear that the output cost of austerity was lower in the cases of expenditure cuts than tax increases.
This is very much not my area of expertise and – as I so often seem to say – history is over-determined so it is never going to be possible to resolve the causality questions posed by macroeconomic events. The evidence presented here that if you have to do fiscal austerity for cyclical reasons, do it through spending cuts seems persuasive in terms of the aggregate GDP effect. The book doesn’t address, and so doesn’t begin to answer, the question about the effect of actual austerity measures on the social fabric and political events. It seems fair to include these in the assessment.
Nevertheless, the authors appeal to the counterfactual question to justify their argument: “We find it remarkable that those who opposed any form of austerity seem to be so sure that everything would have worked out, with more government spending and more debt in countries such as Italy, Ireland, Spain and Portugal.” Less certainty, more humility, in this area would be welcome – but unlikely. I suspect this book will reignite the controversy it claims to seek to defuse.