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

Myth #6: The social welfare state coupled with intractable labor protections are unaffordable, burdensome and discourage growth.

A cadre of economic policy-makers are taking advantage of the democratic deficit arising from the urgency of the economic crisis to push through structural reforms to labor protections, pensions programs, public services and other socially-useful regulations, which they argue are desperately needed to create the conditions for investment, economic growth and employment in economies facing an enduring slump. Growth, they argue, requires a larger private sector, which means to them a smaller public sector. The package of preferred reforms tends to involve a weakening of labor protection laws and collective wage bargaining systems, deep reforms to public pension systems, the privatization of public services and so-called “entitlement” reforms, including slashing legally-sanctified social rights programs such as education, healthcare, social security and other social protections like unemployment insurance. The new conservative government of Spain, for example, coupled historic cuts to social services and infrastructure with reforms to make workers more precarious by making it easier for employers to fire them. In Italy, the ECB instructed the government of its support for the privatization of local water services, just months after a public referendum rejected the idea. The ECB also demanded that the Italian government “design regulatory and fiscal systems better suited to support firms' competitiveness and efficiency of the labour market”—code language for undercutting workers’ rights protections.

Did you know?

There is in fact no solid evidence that gutting labor protections, decreasing worker wages or stripping unemployment guarantees will benefit the broader economy at all, let alone increase the amount of employment in a crunch. Quite the contrary. New empirical evidence from the International Labour Organization—an organization which includes government, labor and business stakeholders—shows that poorly designed reforms to labor regulations in times of crisis actually hurt, rather than help, investment and also impinge upon the quality and quantity of work. Historically, employment protections and union density have consistently decreased across rich countries, according to the OECD, hitting historic lows in the lead-up to the crisis, and driving increased wage inequality. In fact, wages have been dropping for decades prior to the economic crisis, with new evidence from the IMF suggesting that it was precisely the inequality in earnings in the US which fed the financial instability leading to the 2008 crash to the begin with. According to this line of inquiry, stronger wage equality, labor protections and collective bargaining power can stimulate purchasing power and demand, and actually help prevent future financial crises, suggesting precisely the opposite of this erroneous myth. As preeminent labor economist Richard Freeman writes, “The best summary of the data—what we really know—is that labor institutions reduce earnings inequality but that they have no clear relation to other aggregate outcomes, such as unemployment.” Further, poorer individuals and those who earn their income from their labor have a higher marginal propensity to spend the money they earn than richer households and those who earn their income from investment capital. As a result, rising income and wage inequality reduces aggregate demand quite severely and thus constrains economic dynamism and inclusive growth significantly, according to experts.

The case for a smaller public sector, in the meantime, is by no means self-evident. Many of the countries which have weathered the storm of the economic crisis, and consistently rank at the top of human development indicators—places like Sweden, Denmark, France, and increasingly Brazil—have some of the largest public sectors.

Human rights responses

As human rights enshrined in international law, governments have duties to respect, protect and fulfill the rights to a decent wage, clean and healthy working conditions, to associate and strike, as well as other fundamental social rights which form the foundation of the modern social welfare system, independent of their effects on economic competitiveness in a global economy. As the UN Committee on Economic, Social and Cultural Rights—the main body to interpret what economic and social rights norms and principles mean in changing times—made explicitly clear this year, any austerity measures or other crisis-response policies which do not respect the following human rights criteria can be determined, in essence, unlawful. First, any policy that may impede the progressive realization of economic, social and cultural rights must be temporary and limited to the period of crisis. Second, the policy must be necessary and proportionate, in that not adopting it would put human rights at even greater risk. Third, the policy must not be discriminatory in effect and must comprise all possible measures, including tax measures, to support the social transfers needed to mitigate inequalities that can grow in times of crisis and ensure the protection of most vulnerable groups. And lastly, the policy must identify and protect the minimum core content of the rights enshrined in the International Covenant on Economic Social and Cultural Rights at all times.

Hasty, imprudent attacks on core economic and social rights protections like decent wages, collective bargaining, and social protection in a time of economic crisis may very well adversely affect low- and middle-income households for a long period ahead. As such, and especially considering the existence of financing alternatives to austerity, they are likely  unlawful under the Covenant. They also represent sloppy, ideologically-driven and plain bad economics.

Photograph of man begging in Athens © 2011 Mehran Khalili [www.mehrankhalili.com]. This briefing can be accessed in pdf format here.