How Effective Are Austerity Measures?

How Effective Are Austerity Measures?

How and Why They Were Employed in Greece, Greece, and Europe

Government spending must be reduced, tax revenues must be increased, or both. These severe measures are implemented to reduce budget imbalances and prevent a debt disaster.

Unless they are compelled to do so by bondholders or other lenders, governments are unlikely to implement austerity measures. These actions resemble fiscal policy that is contractionary. They impede economic expansion. Due to this, it is significantly more challenging to generate the necessary funds to pay down sovereign debt.

  • Government initiatives must change as a result of austerity measures. They, for instance, restrict the conditions of unemployment benefits.
  • Increase the minimum age for receiving retirement and health benefits.
  • Reduce the pay, benefits, and working hours of government employees.
  • Cut back on the poor’s programs.

Tax reforms are another aspect of austerity measures. For instance, they increase income taxes, focusing in particular on the wealthiest.

  • Target tax evasion and fraud.
  • Privatize state-run corporations. These sectors are seen as essential to the interests of the state. They consist of telecommunications, transportation, and utilities. Selling them will generate income for debt repayment.
  • tax on value added being raised.

Other austerity measures reduce regulations to lower business costs. They require governments to:

  • Eliminate some of the safeguards against unfair terminations.
  • Reduce or do away with the minimum wage.
  • Hours worked should be extended.

All of these adjustments might not be part of austerity measures. Depending on the state of the nation.

Key Takeaways

  • Government policies known as austerity measures aim to reduce debt by increasing taxes or reducing spending.
  • Countries with high debt-to-GDP ratios implement these policies.
  • Austerity tactics work best when the economy is growing since a larger base of tax payers is present.
  • Low income individuals are most affected by austerity measures because social safety nets are harmed by spending reductions.

Why Countries Agree to Austerity Measures

To prevent a sovereign debt catastrophe, nations impose austerity measures. At that point, creditors start to worry that the nation would miss its debt payment deadline. When the debt-to-gross domestic product ratio exceeds 77 percent, it happens. According to a World Bank study, that is the turning moment. It was shown that slower economic growth occurs when the debt-to-GDP ratio is above 77 percent for an extended period of time. Every percentage point of debt above this mark reduces economic growth by 1.7% for the nation.

64 percent represents the breaking point for emerging market nations. A greater debt-to-GDP ratio will cause growth to stall by 2% annually. Then, in order to make up for the increased risk, creditors began to demand higher interest rates.

Higher interest rates make refinancing the nation’s debt more expensive. It eventually comes to the realization that it cannot continue to roll over debt. It then seeks for new loans from other nations or the International Monetary Fund. These new lenders want austerity measures in exchange for bailouts. Simply put, they don’t want to finance ongoing expenditure and unmanageable debt.

Measures of austerity help the borrowing nation’s budget management regain its credibility. The suggested reforms boost productivity and encourage a more robust private sector. For instance, focusing on tax evaders increases income while assisting people who do pay their taxes. Foreign knowledge is brought in when state-owned enterprises are privatized. Additionally, it promotes taking chances and grows the sector as a whole. By increasing their cost, a VAT or value-added tax discourages exports. This safeguards regional businesses, enabling them to expand and boost the local economy.

Examples 

Greece - During the Greek debt crisis in 2014, the European Union implemented austerity measures. Tax reform was a goal of Greece’s austerity measures. Greece was compelled by its lenders to restructure its tax collecting department in order to crack down on evaders. For audits, the agency specifically targeted 1,700 high-net-worth and independent individuals. Additionally, it set managers’ performance goals and decreased the number of offices.

Other specific measures required Greece to:

  • 150,000 fewer people work for the government as a whole.
  • Reduce the pay of governmental employees by 17%.
  • Pension benefits beyond 1,200 euros per month should be reduced by 20–40%.
  • Increase the price of property by 3–16 euros per square meter.
  • Take away the subsidy for heating oil.

By 2014, the Greek government committed to selling off 35 billion euros’ worth of state-owned property. Additionally, it pledged to divest 50 billion euros’ worth of additional assets by 2015. More information on this is provided in the IMF Memorandum.

Layoffs, tax increases, and benefit cuts restricted economic expansion. Greece had one of the highest debt-to-GDP ratios in the world by 2012, standing at 175 percent. Greece’s recession was marked by a 25% unemployment rate, anarchic politics, and a fragile banking sector.

European Union - The eurozone’s crisis was caused by the Greek debt crisis. Numerous banks in Europe had made investments in Greek companies and national debt. Other nations had also overspent, including Italy, Portugal, and Ireland. They profited from low interest rates since they were Eurozone members. These nations were heavily damaged by the financial crisis of 2008. They required bailouts as a result to avoid defaulting on their national debt.

Italy - Silvio Berlusconi, Italy’s prime minister, raised health insurance costs in 2011. He also reduced family tax breaks, affluent people’s pensions, and subsidies to local governments. He was defeated in the election. His successor, Mario Monti, increased taxes on the wealthiest, increased pension eligibility ages, and pursued tax evaders.

Ireland -The government reduced employee salaries by 5% in 2011. It closed police stations, cut back on welfare and child payments.

Portugal - For senior government employees, salaries were reduced by 5%. It boosted taxes on the wealthiest and hiked the VAT by 1%. Defense and infrastructure spending were reduced. In turn, privatization grew.

Spain - The wealthiest paid more in taxes in Spain. Additionally, cigarette taxes were raised by 28%.

United Kingdom - The U.K. raised the retirement age from 65 to 66 by 2020, slashed budgets by 19 percent, and terminated 490,000 government employment. It decreased child benefits and the pensioners’ income tax exemption.

France - Tax loopholes were closed by the government. It stopped using economic stimulus programs. Taxes on businesses and the rich were raised as a result.

Germany - Parental subsidies were slashed by the German government. It increased nuclear power taxes and removed 10,000 government positions.

United States - Although they were never referred to as “austerity measures,” plans to lower the national debt of the United States gained prominence in 2011. The U.S. debt crisis was caused by a deadlock on these austerity measures. Tax rises and spending reductions became a problem. When Congress declined to pass the budget for Fiscal Year 2011 in April 2011, the government nearly came to an end. Through an agreement on small spending cuts, calamity was avoided.

By refusing to raise the debt ceiling in July, Congress threatened to let the United States go into default. When the two parties decided to create a bipartisan panel to look into the issue, tragedy was once again avoided. If nothing was resolved, Congress also enforced a budget sequestration. The so-called “fiscal cliff” scenario would result in tax increases and a required budget cut of 10%. It was settled by a last-minute compromise in Congress. Sequestration was postponed, wealthier taxpayers’ taxes were increased, and a 2 percent payroll tax benefit was allowed to expire.

Why Austerity Measures Rarely Work

Austerity measures, despite their best intentions, deepen debt and impede economic progress. According to a report published by the IMF in 2012, the austerity measures implemented by the eurozone may have delayed economic development and made the debt crisis worse. However, the EU defended the actions. They allegedly restored people’s faith in how nations are run. For instance, Italy’s budget cuts put investors at ease, leading them to accept a lower return on their risk. Bond yields for Italy decreased. The nation discovered that it was simpler to renew its current debt.

Everything about austerity measures is timing. A nation that is fighting to recover from a recession is not in a favorable position. Government spending cuts and job cuts will slow economic expansion and raise unemployment. An key part of GDP is the government itself. Similarly, increasing corporate taxes while businesses are having trouble can only result in further job losses. Raising income taxes will reduce consumer spending by taking money out of their pockets.

When the economy is in the business cycle’s boom stage, austerity measures are most effective. Spending reductions will prevent a bubble by reducing growth to a manageable 2 percent to 3 percent rate. In addition, it will reassure holders of public debt that the government is accountable with its finances.

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