19 June 2012

Michael Spence: Clarity about austerity

For Germans, austerity, in the form of sustained wage and income restraint, was an important part of the growth-orientated reforms that their country completed in 2006. Much time and effort was devoted to ensuring that the considerable burden of restoring flexibility, productivity, and competitiveness was shared equitably across the population.

But, on the receiving end of the message in southern Europe (and across the Atlantic), “austerity” is interpreted largely in fiscal terms – as an excessively rapid and potentially growth-destroying drive to cut deficits faster than the economy can structurally adjust and fill the gap in aggregate demand. In other words, harsh austerity is being viewed largely through a Keynesian lens.

Finding the right balance between excessively rapid and dangerously slow deficit reduction is important, and not all that easy. But that is just one component of rebalancing. Growth is essential to bringing down public debt/GDP ratios, and thus is a key part of fiscal stabilisation. And it is true that the benefits of deficit reduction, if achieved too fast, will be more than offset by the negative effect on growth.

At the same time, to restart an economy’s growth and employment engines, other measures are needed, and vary somewhat across countries, owing to different initial conditions. But they generally include removing rigidities and other barriers to competition in labour, product, and service markets; investment in skills, human capital, and the technology base of the economy; and rebuilding safety nets in ways that promote and support, rather than impede, structural adjustment.

These reforms require the sacrifice of certain kinds of protections, as well as of income and consumption growth. The benefits come in the form of sustainable patterns of growth and employment in the future. Discipline and austerity thus entail inter-temporal and inter-generational choices about the price to be paid now – and how fairly that burden is to be borne – for greater economic opportunity and social stability in the future.

After all, restoring stability and growth is only partly about reviving short-term aggregate demand. It is also about structural reform and rebalancing, which comes at a cost. Achieving a sustainable pattern of growth requires choices that affect not just the level of aggregate demand, but also its composition – for example, investment versus consumption.

Whether one calls this austerity or something else is a matter of semantics. But the confusion that has resulted is anything but harmless. On the contrary, it has become a major impediment to a common understanding of current challenges, and thus to achieving a broad consensus on the right path forward – one with well-defined and differentiated responsibilities – in confronting them.

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