Austerity

“Austerity is not the only way forward, and history has shown us that its promises often fail to deliver. What if there's a better way to recover from financial crises?”

1. Austerity Weakens Economies and Burdens the Poor

Austerity, often hailed as a solution to financial troubles, involves cutting public spending to boost an economy's competitiveness and inspire confidence in businesses. While it might work for a single institution, applying it to entire nations has damaging effects. Countries like Greece, Spain, and Portugal offer examples of how national austerity programs have often worsened financial conditions.

When austerity grips an economy, spending by citizens reduces drastically. In turn, businesses falter because they depend on consumer spending to survive. This shrinking economic activity causes a cycle where reduced spending leads to more debt instead of less. Meanwhile, the most vulnerable population groups disproportionately bear the brunt of such measures.

The poor and working class suffer the most because austerity slashes public welfare systems and unemployment benefits, leaving little assistance for those in need. It’s the struggling workers, not the wealthy bankers responsible for financial crises, who feel the immediate, painful consequences.

Examples

• In Greece during the eurozone debt crisis, pensions and wages were reduced significantly under austerity measures.
• Unemployment in Spain spiked after austerity policies were introduced following the 2008 financial crisis.
• Public expenditure cuts in Portugal led to fewer healthcare and educational resources, directly impacting low-income citizens.

2. History Shows Austerity Does Not Work

Reducing national budgets during economic downturns has a history of delivering poor outcomes. This idea of "tightening the belt" to recover ignores historical lessons where similar experiments have failed repeatedly.

Take the 1920s U.S. under Warren Harding; austerity policies contributed to the misery of the Great Depression. Later, under Herbert Hoover, raising taxes in an attempt to balance the federal budget only pushed the economy further into despair. It wasn’t until Franklin Roosevelt abandoned austerity for New Deal investment programs in 1933 that the U.S. began to recover.

Other nations, such as Germany after World War I or Sweden and France in the 1930s, also attempted austerity. These measures deepened their recessions. Recovery in these cases only came after governments reversed austerity measures and focused on building back through public investment and support programs.

Examples

• U.S. unemployment rates during the Great Depression spiked after Hoover's austerity measures but fell once Roosevelt's New Deal expanded spending.
• Post–World War I austerity in Germany created mass discontent, giving rise to extremist politics and economic instability.
• France’s initial recovery during the 1930s came only after abandoning budget cuts and increasing public investments.

3. The Real Cause of the 2008 Crisis Was Not Government Spending

Though many blamed excessive government spending for the 2008 financial crash, the root cause was actually reckless behavior by large banks. U.S. banks relied heavily on "repo markets," short-term financial lending secured with mortgage securities.

As banks bundled mortgage loans into complex securities like CDOs (collateralized debt obligations), they rested their confidence on the assumption that homeowners would continue paying their mortgages. When defaults began, the securities became worthless. This ripple effect triggered chaos, as banks scrambled to cover their losses or avoid halting operations.

Credit default swaps, designed as "insurance" for such securities, worsened the situation when institutions like AIG couldn’t honor their commitments. When this problem spread to Europe, financial systems across nations collapsed under the strain.

Examples

• Lehman Brothers filed for bankruptcy after being unable to manage its toxic asset holdings.
• AIG’s inability to pay credit default claims deepened the crisis as investors panicked.
• European banks, exposed to toxic securities, required massive intervention during the global fallout.

4. Bank Bailouts Drained Nations of Resources

When European nations faced the banking crisis in 2008, they chose to bail out failing banks rather than let them fail. Countries like Spain, Ireland, and Greece funneled their resources into salvaging banks that had grown "too big to fail."

Yet bailing out banks required diverting money away from public services and long-term growth investments. This decision forced these nations into permanent austerity, enduring economic hardship for years to repay the enormous bailout costs.

Faced with this dilemma, countries were left without funds to address existing structural inequalities or prepare for future growth. Instead, ordinary citizens paid the cost of saving banks through higher taxes and reduced benefits.

Examples

• Ireland spent €70 billion bailing out its banks, leading to heavy national debt and public-sector salary cuts.
• Greece imposed brutal budget cuts on its people while attempting to stabilize its financial institutions.
• French taxpayers faced austerity partly due to massive bailouts needed for their top three banks.

5. Ireland's Struggles vs. Iceland’s Recovery

Ireland chose bailouts and austerity, cutting wages and welfare programs while taxing low-income citizens. Despite this, its economic growth lagged, unemployment soared, and its debt-to-GDP ratio ballooned to over 100 percent.

Iceland, facing a worse situation in 2007, took a radically different approach by letting its banks fail. Iceland also raised taxes for the wealthy, protected social programs, and devalued its currency. These measures, contrary to IMF warnings, allowed Iceland to stabilize and resume growth by 2011.

The comparison reveals how directly addressing banking failures can prevent lasting harm to citizens and foster long-term recovery.

Examples

• Iceland’s GDP fell briefly but rebounded to growth rates exceeding 3 percent by 2012.
• Ireland’s unemployment surged from 4.5 percent in 2007 to nearly 15 percent in 2012.
• Iceland implemented capital controls to shelter its economy, while Ireland heavily relied on bailout funds.

6. Letting Banks Fail Protects National Economies

Iceland's recovery offers a strategy for managing bank crises: let failing banks collapse instead of propping them up. Iceland created new banks to handle domestic operations while letting international creditors deal with losses.

This approach avoided saddling taxpayers with massive bailout debt and kept public resources focused on supporting citizens through welfare programs. Iceland’s choice to prioritize its population’s stability over bank profits becomes a compelling lesson for managing future financial crashes.

Examples

• New Icelandic banks were funded with government support equaling 20 percent of Iceland’s GDP.
• Iceland's top earners paid increased taxes while low earners received relief, softening the economic blow on struggling families.
• Global economists praised Iceland’s recovery strategy in hindsight, contrasting it with Irish austerity.

7. Austerity's Limited Evidence of Success

Politicians often use countries like Denmark and Australia to defend austerity. But closer analysis shows success in these countries is unrelated to budget cuts during economic downturns. Denmark’s spending cuts occurred during a period of strong economic growth, not during a recession.

Similarly, when Ireland’s economy grew in the 1980s, it benefitted more from currency devaluation than from austerity itself. Claims that austerity ensures growth misrepresent these examples, misleading policymakers into pursuing harmful strategies.

Examples

• Denmark maintained active social welfare systems while experiencing modest cuts during strong growth cycles.
• Australia avoided cuts to unemployment benefits during their late-twentieth-century fiscal belt-tightening.
• Ireland’s currency devaluation in the 1980s boosted exports, a factor unrelated to austerity policies.

8. Progressive Taxation is a Better Solution

Raising taxes on the wealthiest citizens is a practical, effective way to reduce debt without harming essential public programs. Studies show taxing the rich recoups large revenues while minimally affecting the overall economy.

As seen in Germany’s assessment, imposing a one-time wealth tax on the top earners could restore GDP by up to 9 percent. Taxing the 1 percent in the United States at higher rates offers another opportunity for equitable recovery and reduced dependency on austerity measures.

Examples

• Germany’s proposed 10 percent wealth tax for citizens with over €250,000 in assets.
• U.S. economists Diamond and Saez’s model suggested doubling income tax rates for the super-rich.
• Historical patterns show equitable taxation enabling stable economic recovery post-crisis.

9. The Consequences of Austerity Extend Beyond Economics

Austerity fosters not just economic hardship but also societal and political instability. By slashing social benefits and impoverishing large parts of the population, it often erodes trust in governments and heightens tensions.

Historical examples like Germany after the Treaty of Versailles show how austerity fuels discontent and extremism. Without addressing inequality, the political risks associated with austerity can linger for decades.

Examples

• Germany’s austerity-driven depression set the stage for Hitler’s rise in the 1930s.
• Greece experienced severe protests and unrest during its post-2008 austerity programs.
• Widespread frustration in Spain under austerity policies saw surges in populist movements.

Takeaways

1. Instead of bailing out banks, national responses to financial crisis should protect public services and ordinary citizens.
2. Use progressive wealth taxes to reduce debt and maintain essential investments during economic downturns.
3. Learn from past mistakes: avoid austerity and prioritize policies that stabilize lower-income families and encourage long-term growth.