In Praise of Austerity

Trying to overcome a financial crisis with more debt is ineffective and a scheme of deceit. It would be just another step closer to final bankruptcy. In order to overcome a financial crisis, policies in favor of private business are required. Austerity need not be painful when the contraction of the public sector is accompanied by the expansion of the private sector. This way, the recipe for making austerity work requires to do away with the interventionist burdens and to ignite the entrepreneurial spirit. The challenge for the policymakers is not to quarrel about spending cuts but to determine what must be done in order to make the private sector expand while the public sector shrinks.

Failed Policies

As the Austrian-school economists explained long ago, austerity — and not more spending — is the way out of a depression. A new empirical study of 16 advanced economies has fully confirmed the thesis that austerity works. The research found that the sizable reduction of a country’s deficit and the stabilization of the public debt is the way for the economy to recover and regain economic growth.

Yet the popular belief says that the debt which comes with more deficits would be financed by more tax revenue because government spending “stimulates” the economy. Politicians earn applause with this false thesis. Yet these advocates ignore that the emergence of a debt crisis is in itself the evidence that the so-called fiscal multiplier of public expenditure has not worked as promised. The materialization of a debt crisis means that the wonder drug has failed.

When a debt crisis emerges, governments try to ignore the truth as much as they can. The population anyway does not want to hear that the spending spree should be over. Political candidates gain their job in government as salesmen of apparently free goodies. Consequently, the politicians are inept to elucidate the necessity of less public spending. It runs against the nature of those who live by the government that less and not more governmental activity is the solution.

Even when the public debt crisis has grown into a national emergency, the usual firework of a rhetoric of illusions will not stop. It is much more likely that the tradition of negligence that has brought about the debt crisis will also dominate politics when the debt crisis has arrived. A country can call itself lucky when austerity gets a chance.

A debt crisis shows that now, instead of promoting the state, one must liberate the private sector. When the expansion of private production compensates the contraction in the public sector, the country’s debt burden will fall. Not more public spending finances the debt, as the deficit spenders claim, but to curtail public spending and to make room for the expansion of the private sector will save the economy.

Those who favor more government expenditures in the face of a public debt crisis suggest that the very same strategy that has led to the calamity would also be its solution. Yet how could the debt crisis justify borrowing more when borrowing has been the cause of the debt crisis? The fact of the debt crisis shows that too much debt has been accumulated. In order to overcome the crisis, more savings — not less — are needed.

Austerity Without Remorse

The recovery after World War II in the United States and in Western Europe provides an impressive confirmation of the thesis that spending cuts will stimulate economic activity when they are made in combination with improvements of the investment climate.

The reduction of public spending at that time, when the American war machine had to be reduced, happened in an atmosphere which had become favorable again for private business. While regime uncertainty and the economic policy of President Roosevelt kept the private economy down in favor of the public sector and of government employment during the Great Depression and in the war years, a new period dawned for free enterprise in the United States and the other countries, such as West Germany and Japan, that joined in.

Another instructive example is to contrast the policies of the United Kingdom after the end Napoleonic Wars to those that were adopted after World Wars I and II.

Figure 1

Public Debt of the United Kingdom, 1692-2011



In the wake of the Napoleonic wars at the beginning of the 19th century, British public debt had grown to over two hundred and fifty percent of its gross domestic product. In the century that followed the war, which had ended in 1815, the United Kingdom brought down its debt consistently and experienced its most glorious period of economic prosperity. In contrast, the British economy experienced prolonged periods of economic stagnation both after World War I and World War II.

The economic policies of these periods couldn’t be more different. While in the 19th century, Britain practiced an economic policy molded after the ideals of classical liberalism, the country adopted interventionist policies after World War I and did the same after World War II until the late 1970s. While Britain gained wealth and prosperity in the 19 th century, it earned economic decline and stagnation in the 20th century.

The Next Crisis

In the USA, the debt burden (public debt in percent of the country’s gross domestic product) has been rising since 2008 from 82 percent to 105 percent in 2016. This figure is bound to explode when the next recession hits or interest rates rise. Japan has been mired in debt for more than two decades. In this period, the nation’s debt burden has risen to over 250 percent . Japan provides the most striking example that huge public spending programs and zero-bound interest rate policies are of no avail when the statist system is not replaced by radical free-market reforms.

Whatever the specific circumstances of the next financial crisis will be, it will come together with a crisis of the public debt. In fact, many countries of the world, not only Greece a few years ago or currently Brazil, are in a debt crisis. The United States, Japan, many European countries, – a crisis of public debt looms in almost each of the advanced economies. The crisis has not yet become acute in these countries because the central banks have been buying public debt at an unprecedented pace and implemented extremely low interest rates. Now, these policies are reaching their limit. The next recession will also be the next big debt crisis.

When times are normal and when there is business as usual, investor can regard government bonds as good as currency. Holding bonds is a profitable alternative to savings in currency. Instead of lending one’s money to commercial banks in a savings account, the saver lends his funds to the government. When the bond market is liquid, and the market for bonds is usually one of the most liquid financial market, bonds are a full substitute to currency with the additional advantage of earning interest.

As long as the interest on the bonds compensates the loss due to price inflation, the investor can feel save. Yet what happens when price inflation exceeds expectations? In this case, the calculation that was made when deciding to buy bonds, does no longer hold. The more the newly formed expected inflation rate surpasses the earlier level, the less favorable will it be to keep on holding bonds. Bond investors begin to sell, and new investors will only buy bonds at a higher interest rate. The equivalence of bonds to currency breaks down. Then it turns out that the assurance of the Modern Monetary Theory that the government can spend without regard to its receipt, that “ deficits don’t matter ”, becomes a false promise.

Once, inflationary expectations begin to rise and the projections find their confirmation, the government becomes an ordinary debtor and as such is only as creditworthy as it can make believe being able to honor its debt. The privilege of the state as the issuer of the currency as the nation’s sovereign money comes to an end. This phenomenon is popularly called “loss of confidence”. In economic terms this means that investor do no longer regard government bonds as good as currency.


When will governments recognize that there is no alternative to austerity for a country which has reached its debt limit? When will governments recognize that austerity does not need to be painful when spending cuts are made in combination with an improvement of the economic environment of the private sector? The choice between a cut of government expenditure or an increase of public spending runs down to the choice between accepting a period of adversity or to go on with the illusionary joy ride. In the end, the truth will win anyway. Only a childish attitude would opt for more spending just to make matters worse. However, simply reducing public expenditures is not enough. What needs to be done is to combine spending cuts with a convincing policy of promoting free enterprise without any reservation.

Dr. Antony P. Mueller is a German professor of economics who currently teaches in Brazil. Write an e-mail. See his amazon author page .

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