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Friday, September 23, 2011

Austerity Plans

Today's post is in response to a question from Jay S., submitted via facebook.  Jay asks: "how do you feel about Austerity Measures?"  Well Jay, I feel like this:

All of us know a guy who tends to spend more whenever he makes more.  The moment he gets himself a good paying gig, he goes out and gets a new TV, a better computer, and starts buying all his lunches take out.

Inevitably, our friend winds up just as broke as he was before the new job, and as a result, suddenly becomes dissatisfied with the money he makes.  “I gotta find another job!” he’ll say, “the scratch I’m making now just isn’t cutting it.”  If only he’d be more aware of the it he’s trying to cut…

Well, governments can be the same way.  Governments like to keep their expenditures and income right around the same level (“government income” is just fancy talk for the revenue collected from taxes).  As far as I know, there’s no rainy day fund jar on top of the fridge at the Treasury Department, or a "take a penny, leave a penny" tray at the Federal Reserve.  Governments don't collect money just for the sake of collecting it. 

So what happens when a government DOES have a rainy day?  If a government's debts and deficits are starting to get out of hand (like in the US), if government financial problems are affecting the private economy (like Ireland), or if they go just plain flat broke (like Greece)?  

In these circumstances, governments often call for something called an “Austerity Plan.”

Austerity plans are pretty straight-forward.  The process works like this:
               Step 1.  Increase government income.  I.e. raise taxes.
               Step 2.  Decrease government spending.  I.e. cut government activity and service.

                It’s similar to the advice we’d give our friend who is spending his pay at the same speed he's receiving it.  "Make more and spend less."  Have a 'cushion.'   

                Raising taxes is the governmental equivalent of finding better paying work; its just their way of upping their income. 

                And what does a decrease in government spending look like?  It looks like a government doing less of the things that government does.  It might lay off some of its employees.  Roads, communications satellites and electric power grids that were going to be built this year might be put off until later.  Research can be deferred, pensions squeezed or social safety nets limited in scope and scale. 

They may cut entire programs, or just trim a little bit here and there.  It all depends on the size, strategy and duration of the plan.

                The goal is to get the government in control of some extra cash that they can use at their discretion, to pay off debt, to buy up assets, fund a short-term projects or stimulus…the exact usage will be dictated by the particular economic issue that particular government is trying to beat.

                Keep in mind, the size of the surplus the government is trying to engineer through their austerity plan is not entirely determined by the size of the problem being addressed. 

For example, in the up coming year the US will likely run a deficit of about $1.5 trillion dollars.  If Congress decides to enact austerity measures this year, this doesn’t necessarily mean that they will raise $1.5 trillion in new taxes, or that they’ll drop $1.5 trillion worth of public programs and expenditures. 

They may only try to free up and extra $500 billion, or $50 million, or $5 thousand!  Austerity plans are often used just to take the edge of a situation, and typically only run for a few years at a time (by definition, really.  If they were permanent, than they wouldn’t be “austerity” any more, they’d just be “what the taxes and public spending are now,” right?). 

Here's a real world example: just a few days ago, Obama suggested to Congress a plan for mild austerity.  (Side note: in the US, the executive branch - the President - can only make requests when it comes to financing, budgeting or taxation.  The legislature - Congress - has total control in all things financial.  From watching the commentators on the news, I get the vibe most people don't really internalize that.  The only connection the "Bush" tax-cuts and the "Obama" debt crisis really have to those men is that they were the president when those things came into being). 

Anyway, Obama's recommendation was for $500 billion to be cut from Medicare and Medicaid, $1 trillion from the military, and $1.5 trillion added in new taxes (mostly from corporations and wealthy individuals), parsed out over a period of ten years.  

There's an added bonus in there too.  The plan is projected to help us avoid almost $500 billion in interest payments, since the government won't have to borrow as much otherwise anticipated.     

So if austerity plans are such great financial tools, why don't governments make use of them all the time?  Because they have one huge hang-up:  they are wildly unpopular politically, and incredibly hard to enact. 

Why?  Because for the people in a country undergoing an austerity plan, it will always “feel like” they are just getting LESS from their government for MORE.

Think about it.  Let’s say I create an austerity plan for the upcoming year where government services and spending remains totally unchanged.  But I raise taxes.  What will happen?

The tax payers will say (quite correctly): “Hey, last year we were getting the same services and benefits, but it cost so much less!  The price we pay per service has gone up!  What’s with this price hike in the services we consume?”  They’re going to feel gypped.

Ok, so I’ll come up with an alternative plan.  In this one, taxes stay the same.  But government spending (and therefore, programing and service) decreases.  What will be the reaction from the crowd?

“Hey, this is what we paid last year, but back then we got so much more!  The cost we pay per service has gone up!  What’s with this price hike in the services we consume?”  They’re going to feel gypped.

Think about it another way.  Say I run a shop where I sell 12 inch subs for $5 each.  If I were to:
a) raise the price of a 12 inch sub to $10 or
b) keep the price $5, but reduce the sandwiches’ size to 6 inches,
in either situation, from the perspective of my customers, the subs will have doubled in price!

                So good luck on your reelection bid after passing that austerity plan!  Sure, it might be great for the economy.  But the economy doesn’t vote.  Austerity plans usually just wind up in a government’s “last resort” pile.

                Over the last few years, Greece enacted series of SEVERE austerity plans.  They raised sales, excise and income taxes, upped the price of fuel, laid off or cut the salaries for government employees, restricted eligibility for unemployment and other welfare programs, closed down public housing and increased many people's retirement age.  This year alone, Greece will attempt to raise $100 billion through austerity, a number which is about a third of their annual GDP.  Their ultimate goal is to cut their national debt five-fold by 2015 or 2016.   

It’s a great deal for Greece’s future, but a rotten one for Greece’s present.  We all saw on the news the protests in Athens.  They got pretty ugly pretty quick.  

         The Greek plan was really drastic (as to be expected, I suppose, given their situation), and it all has come about quite suddenly.  There wasn't a lot of time for debate over how austerity would unfold.  I think that gave the whole affair an extra air of desperation that left the Greek people feeling powerless, and put them into a bit of panic, pushing everyone over the edge.  Big changes coming on fast are never easy.   

At the same time I was watching the protests in Greece on the news, I remember seeing an interview with the prominent development economist William Rhodes where he used the term “heroic” to describe the action’s of Greece’s leaders and their support for austerity measures. 

Even though these plans might very well help save their country's economy in the longer run, the careers of many Greek politicians will end over their support for austerity.  Of all the words used by Greek protesters to describe their leaders, I doubt “heroic” was a common one.  Than again, what do I know, I can't read any of those placards...   

Remember that friend we started with, the guy who spends all the money he earns?  Well, it’s easy for us to judge his habits, and dismiss him for being foolish with his money, sure. 

But if someone were to point out the flaws in our own financial behavior, we'd probably struggle to try to change them.  Even doctors hate the taste of medicine.  The most confounding thing about austerity plans is that they'll always be one of those "easier said than done" ideas.  

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