Austerity Measures of European Governments - Essay Example

Austerity Measures of European Governments Following the Euro zone sovereign debt crisis where the European governments were not able to pay their debts, the European governments started to impose austerity measures. Austerity measures used by the European governments include reduction in government spending and increase taxation. Austerity refers to the policies that governments use to reduce their budget deficits (Blyth 2013). In Europe, the methods used by the governments to reduce deficits after the sovereign debt crisis were reduced government spending and increased taxation. This essay argues that the austerity measures were used on creditors, the government, companies and citizens of the European countries. As a result, it caused several problems which it was intended to resolve. With political motivations, governments of the Euro zone have developed austerity measures to demonstrate their discipline to their creditors and credit rating agencies. The governments essentially targeted government spending to reduce their budget deficits because they were directly affected by the sovereign debt crisis which made their budget deficits relative to GDP to soar significantly (Traynor and Katie Allen 2010). Therefore, the austerity measures were focused on the government, although it had significant effects on all sectors of the economy in the affected countries. Increase of taxes as part of the austerity measures is also intended for the citizens, businesses and companies of those countries. In this case, the people and businesses in the country were made to pay for the government deficit. This increased the problems of the Euro zone rather than reducing or solving them. In 2010-2011 when the austerity measures were used, all European countries except Germany experienced an increased in public debt to GDP ratio. For instance, the public debt of Greece increased from 143% in 2010 to 165% in 2011 (Eurostat 2013). This indicates that as the budget deficits declined, the GDP growth was not sufficient to support the rising ratio of debt-to- GDP. The reason why austerity measures failed in the Euro zone is because the problems of sovereign debt crisis after the 2008 financial crisis were not caused by policy choices. Following the 2008 crisis, private sector retrenchment occurred and capital account surpluses increased. However, the austerity measures did not target these sectors. Instead, it aimed at the government; hence becoming counterproductive (Blyth 2013). The three financial balances in any economy are: government fiscal balance, foreign financial capital (Capital account), and private financial account. The sum of these three accounts should always be zero. In Europe, there is a capital account surplus because the countries import capital to fund their trade deficit. Similarly, the private sector account is always in surplus because business investments are less than household savings (Blyth 2013). Therefore, there should always be a government deficit to make the three to add to zero. The austerity measures which intend to reduce the budget deficit using reduced government spending is therefore likely to cause imbalance between the public and private sector; hence causing numerous economic and social problems to the affected Euro zone members. One of the worst problems caused by Austerity measures is the macroeconomic problem of unemployment. According to Eurostat (2013), the Eurozone unemployment reached the highest record of 12.1% in 2013. This is because reduced government spending reduced the investment of various sectors in the country. Unemployment has then led to safety net spending and significantly reduced tax revenues for the government. As a result, the austerity measures are offset by the resulting unemployment problem. Austerity measures have also led to reduced GDP in the affected countries. This is because government spending increases GDP, and when the government cuts on spending the GDP declines. In problematic situations like the current Euro zone crisis, consumers and businesses are unable or unwilling to spend (Paul 2013). Therefore, the government should increase its short-term deficit spending in order to stimulate growth in GDP. However, instead of doing that European countries attempted to reduce the deficit by cutting on spending; hence causing a reduction in GDP growth. The European Austerity measures also reduce growth in the economies through crowding out effect. The crowding out effect refers to the extent to which budget deficits are offset by private sector spending. According macroeconomic theories, an increase in government deficit through government spending and reduced taxation increases aggregate demand in the economy which stimulates growth and employment (Paul 2013). However, this depends on the level of interest rates in each country. When the government borrows to finance an increased budget deficit, interest rates in the country rise. This leads to crowding out or reduction of private investment; hence causing reduced growth and increased unemployment. Similarly, reduced government spending to reduce budget deficit, crowding out occurs leading to reduced growth and increased unemployment. In the Euro zone crisis, the reduction of government spending plays a similar role of causing a crowding out effect. Because governments of European countries have implemented austerity measures by reducing government spending and increasing taxation, the interest rates of the countries have risen. This has led to crowding out of private investors, causing unemployment and reduced growth in the economies (Blyth 2013. If the governments had allowed the deficits to increase, higher demand would be achieved and that would increase output and employment; hence increasing income which cause crowding in. Posen (2013) suggests that the austerity measures of European nations caused problems by causing loans to go bad – that is, unavoidable due to rising interest rates. He also claims that the austerity measures caused the public deficits to worsen. Indeed, the economic policies implemented by the countries were not determined by the markets but decided by political agents. While the problems of economic crisis affected the private sector financing, the government developed fiscal policies which affect the government and public sector financing. As a result, interest rates increased and the private sector could no longer afford loans. This led to reduced investments, reduced growth and increased unemployment. Johnson (2014) similarly argued that European austerity measures caused by the deficit reduction lengthened the great depression rather than solving it. He suggests that the depression has lasted longer than the great depression of 1930s because it worsens the economic problems by causing unemployment, human misery and poverty. Furthermore, it also causes less revenue that leads to further deficits rather than reducing the deficits. Therefore, Johnson (2014) contends that austerity measures make deficits to become worse and hurt people. In conclusion, it is clear that the austerity measures of European countries have caused problems of reduced GDP, increased unemployment and increased deficits due to rising interest rates caused by the fiscal austerity measures. As the austerity measures reduce money supply in the economy, they cause interest rates to increase. This has led to unaffordable loans and caused the crowding out of private investors. As a result, investment and growth have declined as unemployment increases. References Blyth, Mark. 2013. Austerity: The History of a Dangerous Idea. New York: Oxford University Press. Eurostat. 2013. Euro Area Unemployment Rate at 12.1%. Eurostat Press Office. Johnson, David. 2014. “Austerity has made Europe’s Depression Longer than in the 1930s.” Common Dreams, http://www.commondreams.org/views/2014/08/24/austerity-has-made- europes-depression-longer-1930s. Paul, Krugman. 2013. “How the Case for Austerity Has Crumbled.” New York Times. http://www.nytimes.com/2012/04/16/opinion/krugman-europes-economic- suicide.html?_r=0. Posen, Adam. 2013. “Austerity Has Made Europe's Real Problem Worse.” U.S. News. http://www.usnews.com/debate-club/is-europe-right-to-abandon-austerity/austerity-has- made-europes-real-problem-worse. Traynor, Ian and Katie Allen. 2010. Austerity Europe: who faces the cuts? London: Guardian News. Read More