Why a Policy of Slashing Spending Will Never Work

by Common Cents

Remember this when organizations say they need to slash spending

Remember this when organizations say they need to slash spending

Listen to almost any newscast about the economy and you'll see grim-faced politicians telling us that we MUST cut government spending - or else.


Their ideas on where to cut, of course, are almost always aimed at reducing government "social" spending, or to reduce government services. "We all have to tighten" our belts, we're told. Or we hear some variations on the theme that the "government can't afford" whatever service that the speaker wants to cut.

People that have have been on the receiving end of austerity policies are trying to fight back. They know that there is something inherently wrong with what they are being told, but don't always articulate the problem well.

Luckily, there are at least some economists that are able to slice through the smoke and clearly articulate what the real problem is - and clearly explain why cutting public spending will never work.

Paul Krugman did exactly that in an Opinion article in the New York Times.

I've quoted the most important point above, but here's a fuller quote that provides more context to Paul Krugman's remarks:


" It’s tempting to argue that the economic failures of recent years prove that economists don’t have the answers. But the truth is actually worse: in reality, standard economics offered good answers, but political leaders — and all too many economists — chose to forget or ignore what they should have known....

For an economy is not like a household. A family can decide to spend less and try to earn more. But in the economy as a whole, spending and earning go together: my spending is your income; your spending is my income. If everyone tries to slash spending at the same time, incomes will fall — and unemployment will soar." (1)




So what's this got to do with the never-ending mantra to reduce spending?

Everything.

If the call to "reduce government payroll" is successful, then all the government accomplishes is to increase the number of unemployed. All those newly unemployed people have far less money to spend.

But the issue isn't just about government either.

When companies aim to "increase productivity" by strong arming their employees into accepting lower wages and reduced benefits, those employees have less money to spend.

And then... surprise!

All those people with less money can only reduce their own spending, or go into debt.
What happens when people reduce their spending?

All the companies that rely on consumer spending to sell their products - get less income. When the pattern of reduced company sales becomes obvious, companies respond with more cuts to payroll, or shut down - creating more unemployment

At the government level. an overall reduction in household incomes (from reduced pay or eliminated jobs) means less income for government coffers.

Then you hear the same people make the same demands to reduce government spending.

... and the cycle continues.

It's time to stop the downward spiral, and learn from our mistakes.


________________

(1) Source: Paul Krugman, "The Big Fail"
NY Times, Opinion Pages, 6 Jan 2013


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