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Fiscal Fallacies: 8 Myths about the 'Age of Austerity'

Myth #1: Governments caused the crisis through runaway public spending.

Governments, according to this pervasive myth, are at fault for the economic collapse because of their profligate overspending which led to unwieldy deficits, the crowding out of private sector initiatives and thus widespread economic malaise. In the EU context, some argue, it was the fiscal indulgence of the so-called “Profligate Five” Ireland, Greece, Spain, Portugal and Italy which drew down the whole regional economy. Government overspending being the diagnosis, deep cuts to public expenditure—“slimming the State”—is considered the obvious cure. So goes the conventional analysis of EU economic policy-making, as most recently captured by the EU Treaty on Stability, Coordination and Governance adopted by 25 EU States in February. This Treaty obliges all signatory States to enshrine a permanently balanced budget, or face exclusion from future crisis financing from the European Stability Mechanism. The ceiling for annual structural deficits, set at 0.5 per cent of GDP, can only be raised in a severe economic downturn or other “exceptional circumstances” to be defined by the European Court of Justice in Luxembourg, which would also have the new right to fine governments whose deficits rise above that deficit ceiling.

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In fact, in contrast to this popular myth, in most cases today’s high public deficits do not stem from overspending. None of the 12 eurozone members in the eight years before the crisis, for example, were in any significant debt, except Greece. Two of the hardest hit countries—Ireland and Spain— in fact had budget surpluses, in stronger fiscal positions than France, Germany and Austria. Existing debt in most crisis-affected countries, in contrast to the myth, came as a direct result of the 1) bank bailouts to rescue the private financial sector from bankruptcy, 2) crisis-induced reductions in revenue collection, and to a lesser degree, 3) necessary economic stimulus programs, some of which paid for themselves through benefits to the larger economy. The existing deficits on the whole are symptoms of crisis, in other words,  not the cause.

Going deeper and beyond these symptoms of the crisis, then, what were the structural and root causes of the 2008 financial crisis? Although the origins of the 2008 financial crisis are myriad, two underlying structural causes are broadly cited. First, successive waves of de-regulation of financial activities is widely agreed to have been a major contributing factor. By gutting the previous set of post-Great Depression rules of transparency, anti-fraud, basic exchange-based and other macro-prudential regulations needed to prevent systemic financial crisis, and failing to ensure systems of meaningful accountability, governments in many regions opened the door for an aggregation of individual abuses which eventually contributed to a systemic melt-down.

A second broadly-cited cause of the financial crisis was in full play in the lead up to the 2008 meltdown: growing income and wealth inequality. The story reads like a perfect storm. In the three decades preceding the crisis, the top 1 per cent of income earners in the US—the epicenter of the 2008 financial crisis—doubled their share of national income to almost 16 per cent—the highest level of inequality of wealth distribution since 1929 before the Great Crash. As top income earners reaped increasing gains from economic growth, relatively little of their wealth went to creating demand for goods and services, but instead was funneled into de/under-regulated, high-risk, shaky investments such as derivatives. Low- and middle-income households who faced decreasing purchasing power over the same period, meanwhile, had to either limit their purchases (“belt-tightening for people who cannot afford belts” in Jeffrey Sachs’ apt adage), or go deeper into debt. For those with credit available, especially in their homes, the solution was a no-brainer. Household debt levels skyrocketed, doubling in the 1980s to over 100 per cent of GDP before the crisis broke.

This combination of skyrocketing household debt on the one hand, and ever-riskier and un-supervised investments on the other created a toxic cocktail that we are all still struggling to recover from. It was the combination of this rapid accumulation of capital at the top, and the simultaneous explosion of debt at the bottom, which generated a level of intense financial fragility and risk not seen since the Great Depression. This was a key impetus to the financial crisis as soon as debts became unsustainable and debt defaults began, according to International Monetary Fund researchers and the UN Commission of Experts on Reforms of the International Monetary and Financial System led by Nobel prize winning economist, Joseph Stiglitz.

Yet, the fiscal austerity policies adopted in many countries today wrongly see deficits as the biggest short-term problem, rather than financial regulatory failures, epic levels of inequality and anemic demand for goods and services—the ultimate pillar of growing employment and revenue generation. The slashing of public expenditure in healthcare, education, social protection and job programs required by these policies is making ordinary people pay disproportionately for a budget crisis they had no hand in creating. An austerity-driven, double-dip recession is now all but upon the European Union—an austerity trap expected to spawn ever-higher unemployment, fewer revenues for governments, and justification for further cutbacks in social services precisely when they are most needed, with ramifications across the globe.

Human rights responses

A human rights-centered alternative to austerity-driven recession would move beyond simply treating the symptoms of the enduring financial and economic crisis to address some of the structural causes—chief among them, financial de-regulation and income inequality. Governmentss duties to protect human rights through adequate financial regulation, on the one hand, and to fulfill human rights through more expansionary and more equitable fiscal and monetary policies to combat income inequality and stimulate decent work in times of crisis, on the other, are essential now more than ever.

Photograph of protesters on Wall Street courtesy of Tom Giebel. This briefing can be accessed in pdf format here.