LONDON, ENGLAND - MAY 05: A volunteer at Wandsworth foodbank prepares food parcels for guests from their stores of donated food, toiletries and other items on May 5, 2017 in London, England. The Trussell Trust, who run the food bank, report that dependency on their service is continuing to rise, with over 1,182,000 three day emergency food supplies given to people in crisis in the past year. 436,000 of these recipients were children. (Photo by Leon Neal/Getty Images)
A volunteer at Wandsworth food bank, London © Getty

After the international backlash against austerity, this is the counterblast. In defending austerity policies, Alberto Alesina, Carlo Favero and Francesco Giavazzi cannot in any way be accused of following fashion. Budgetary orthodoxy has rarely been as unpopular among politicians, whether it is US president Donald Trump’s lack of concern over the deficit-raising effects of his tax cuts or the Italian government’s determination to give itself more fiscal flexibility than EU rules dictate.

In academic circles, too, the direction of travel has been one way in recent months. Former chief economist of the IMF Olivier Blanchard’s presidential address to the American Economic Association argued that the economics profession has over-estimated the cost to society of government debt, and professor Kenneth Rogoff of Harvard University, a vocal advocate of austerity after the financial crisis, recently wrote that it had never been obvious why Britain would want to reduce its debt burden.

This book is timely in offering an alternative view. Its aim is to counter what it calls “the popular anti-austerity argument” that tax increases and spending cuts cause recessions. It will not — and should not — convince all readers of the need for sound budgeting and reduced public spending when deficits get out of control, nor of the popularity of such policies. But it is valuable as a corrective to those economists who are ditching previously held positions on public finances.

The three professors are well known for their views that when countries have amassed unsustainably large budget deficits, the remedy should be less public spending. Alesina, for example, is associated with “expansionary fiscal contraction”, meaning that austerity can increase growth rather than depress the economy.

The big idea here is that when budget deficits need to be reined back, it is much better to do so with spending cuts than tax increases. The tax route, they argue, proves austerity critics right, generates recessions and is often counterproductive. Cutting public spending restores confidence in business that the budget problem will be sorted. It tends to foster investment and economic growth, leading to quick overall recovery.

Austerity. When It Works and When It Doesn't by Alberto Alesina, Carlo Favero and Francesco Giavazzi Published by Princeton University Press
© Princeton University Press

The book’s arguments are based on examining a large number of past episodes of austerity, ranging back to the 1970s, and a new approach to the data. Having been perhaps the most influential economists in the world a decade ago on deficit reduction, the authors’ techniques came under heavy fire after the financial crisis for not sufficiently disentangling correlation from causation. When economies do well, tax revenues rise and public spending falls, so there is a natural correlation between deficit reduction and good economic performance. But causation flows from good economic performance towards lower budget deficits rather than the other way.

In this book, instead of looking for past moments when budget deficits have decreased significantly, the authors have searched the history books using a “narrative approach” for moments governments have explicitly declared an austerity drive.

This is one of the main strengths of the book, but also its greatest weakness. Students of history might find surprising inaccuracies. Take the UK. Its 1990s austerity period included a large component of tax increases and had a very successful outcome, but barely gets a mention. Economic performance after the largely expenditure-driven austerity of the 2010s has been far worse, but this is cited as a key example of success. Statements that the IMF criticised the UK’s austerity plan “harshly” cannot be reconciled with contemporary IMF assessments that the UK government’s plan was “necessary to enhance credibility and ensure fiscal sustainability”.

In the end, the arguments against the critics of austerity are more convincing than the policy prescriptions. Their knee-jerk call for lower public expenditure is justified on the grounds that it distorts economic behaviour less than taxation, but they specifically exclude any consequences of lower spending.

Read this book as an antidote to the calls for governments to give up on fiscal discipline, but do not be fooled by the authors’ claims to be free from their own ideologies.

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