Austerity: we are not all in it together

By Michael Kitson, Ron Martin, and Peter Tyler

Europe has a Greek tragedy; the US is grappling with a Tea Party; and in the UK we have the economic consequences of austerity.   The focus is budget deficits, public expenditure cuts and being ‘all in it together’.  But, of course, we are not all in it together.   The impact of austerity is very unequal:  the whole mess was started by the financial sector driven by avarice and hiding behind the convenient veil of ‘free markets’; but the burden is being felt by the poor, the unemployed and the destitute.  And the inequality is being felt in different parts of the UK, Europe and the USA.

The origins of the crisis can be traced back to the 1980s and the deregulation of financial markets. This led to an explosion in household debt driven by a perfect storm of asset price inflation in housing and stock markets; cheap goods from China and elsewhere in the Far East; and a glut of savings, in China, Japan, and the oil exporters.  The global financial system, unleashed from regulation, developed ever more ‘creative’ ways of making money.  During this period, many of the advanced countries had increasing structural trade deficits, whereas other countries (China, Japan and the oil exporters) had structural surpluses.  Simply, the former were continually spending more than they earned whereas the latter were continually earning more than they spent.  This is only sustainable if the deficit nations can borrow or sell assets.  And this is what happened.  The global financial system developed increasingly innovative ways to recycle resources from surplus countries to fund the consumption habit in deficit countries; and also novel ways to transfer the ownership of assets (land, property and businesses) from consumers in deficit countries to savers in surplus countries.  But a debt-driven consumption boom is dependent on debtors repaying their debt. Once it became apparent that this was not going to be the case, the foundations of the global financial system – built on speculation, leverage and confidence – became increasingly vulnerable to collapse. As Keynes had observed in 1936 “when the capital development of a country becomes the by-product of a casino, the job is likely to be ill done”.

And when the casino went bust it was the public sector that stepped in to rescue the banks and to stop economies going into freefall.  The rise in Government expenditure and budget deficits was necessary and vital.  But now Governments almost everywhere have embarked, or are embarking on, programmes of major cuts and reductions in public spending on a scale not seen for decades.  At both central and local government levels, support for public services, investment in public infrastructures, and expenditure on welfare have all been targeted for major cuts and retrenchment. A new discourse of ‘rebalancing’ the economy has taken hold in government circles, of reducing the size of the state in favour of the private market.  Reducing the scale of national debt is regarded as fundamental to restore the fiscal integrity of states and prevent default, to appease the financial markets and stave off threats from the bond markets, and to restart economic growth.  The mantra is one of ‘renewing prosperity through austerity’.  Some prominent critics have questioned this strategy, arguing that making major and rapid cuts in government budgets may merely prolong economic recession rather than stimulate recovery.  Governments should spend their way out of the recession, and worry about budget deficits later: growth would in fact help to bring deficits down.

It is important to recognise that the negative economic effects that have resulted from the move from boom to bust have not been felt equally across the population of the economies affected. Some people in some places have suffered disproportionately more than others.  This has been particularly the case as the effects of the financial crisis have taken hold but also reflects the impact of austerity measures to reduce debt.

In the early days of the financial crisis attention in Europe focused on what the consequences would be for employment in financial services.  It was thought that there might be a significant impact on the traditionally prosperous parts of the European economies where many of these jobs are concentrated.  However, it is now clear that the effect of the lending paralysis that afflicted the banking system as the crisis developed has severely hit employment in industry and many traditional service sectors. Housing and property market related sectors have also been particularly badly affected since it was permissive lending to these sectors by the financial sector that was partly responsible for the crisis in the first place.   The diversity of experience across the regions of Europe since the onset of the Crisis represents a significant set-back to one of the most central goals of the Union, namely to reduce regional variations in inequality and opportunity. In the United States the recession has also had a highly differentiated spatial impact. The sub-prime mortgage crisis, which triggered the banking crisis and thence the recession, was not itself a US-wide phenomenon, but was concentrated in particular states, such as Florida, Nevada, California, Michigan and New Jersey, and it has been these same states that have witnessed the main impact of the recession.

In the current stage of austerity it is cuts in public expenditure that are having an unequal impact. In the UK, it is the low income households of working age that have the most to lose from the Government’s policies. The geographical impact of reductions in public expenditure suggests that many parts of Britain that have historically been the most economically depressed, and which have suffered the most from the recession, are particularly exposed to reductions in job opportunities in the public sector.

Arguably, cuts in government expenditure are bearing the brunt of the austerity agenda not because of fiscal expediency – but because governments and politicians in many countries are pursuing a long-run agenda to reduce the role of the state in the economy. But this will be difficult and painful.  The share of government in the economy has increased in all OECD countries since the Second World War – primarily because of increases in expenditure on education, health and social protection.   There are powerful economic drivers that have led to increases in expenditure on health and education:  as countries become richer, citizens want better education and to live longer and healthier lives; and they are services that can be often be supplied more efficiently by the state than by the private sector.   For both economic and political reasons it will be very difficult to make major permanent cuts in expenditure on health and education. This suggests that the burden of fiscal retrenchment will fall on social protection.  It will be the poor, the unemployed and the sick who are feeling the pain. We are not all in it together.

Michael Kitson, Ron Martin, and Peter Tyler are all Editors for the Cambridge Journal of Regions, Economy and Society and all members of the University of Cambridge.  Michael Kitson is Lecturer in Global Macroeconomics at the Judge Business School, University of Cambridge, Research  Associate of the Centre for Business Research and Fellow of St Catharine’s College, Cambridge.  Ron Martin is Professor of Economic Geography in the Department of Geography, a Research Associate of the Centre for Business Research  and President and Professorial Fellow of St Catharine’s College, Cambridge.  Peter Tyler is an Urban and Regional Economist and Professor at the Department of Land Economy.  He is also the Director of Studies in Land Economy and a Fellow at St Catharine’s College. You can read their editorial for the Austerity issue of the Cambridge Journal of Regions, Economy and Society in full and for free here. OUPblog also has related posts by Julie MacLeavy and Vassilis Monastiriotis.