This may seem like a bold claim, perhaps too bold even for critics of austerity, but if you give me a chance I can provide what I think is a sound argument for it.
I will take ‘austerity’ to mean a systematic policy aimed at reduction of the deficit. One thing to keep in mind is that I am going to invoke no laws of nature, no physics or geological plate-tectonics, no models of human nature or culture and no philosophical ideas of value. Everything I will talk about is based on basic principals of finance and is all derivable from observations of how our financial systems actually work and that they make sense mathematically (that is that the equation 1 – 1 = 0 holds true).
There are a few ideas that I need to establish to piece together my argument:
Closed financial systems add up to zero. The balances of a closed financial system, denominated in any one currency, must add up to zero. One entity’s liability is another’s asset.
The UK’s money system is a financially closed system. Our economy is split into three parts: the government sector, the domestic private sector and the rest-of-the-world sector. The UK currency balances of these three sectors always and can only add up to zero.
The UK Treasury is the only thing that issues Pounds Sterling. I think most people would accept this but at the same time somehow forget it’s a reality. Perhaps we believe it’s too simple to think this is all there is to it, but this is all there is to it. We all pay our taxes with pounds issued by the treasury. We, as a group, got those pounds when the public sector bought something. This is just a simple matter of fact.
For the non-government sector to run a surplus the government sector must run a deficit. This is simply an extension of the above point. The government constantly takes money out of the non-government sector through taxation (and other non-discretionary charges, like fines and duties) and injects money into the non-government sector through government spending. If the government ‘balances it’s books’ then no new money is being injected into the non-government sector. In this case the non-government sector on the whole cannot save; it has to run a surplus in order to save. This also means that any saving done by any firm or individual must come at the cost of at least one other firm or individual making an equivalent loss.
The government can refuse to issue enough currency to finance the non-government sector’s surplus. When the government issues more currency than it taxes the excess gathers in the non-government sector. This is collectively called saving. Investment is also financed by savings in the sense that the money you invest had to have been saved first. In a budget-balanced utopia if a firm is to invest in new activity it must either deplete it’s own savings or get money gained by some other firm or individual making a loss. That loss would have to be funded, ultimately, with money that that person or firm had saved, depleting their savings, or by them taking a profit cut reducing their flow of savings. Long story short: in this situation all investment is simply consuming savings. Investment, obviously, stops when the savings run out. You should also note that those savings would be made up of currency issued by a government deficit in the past, so this fiscally balanced economy is only investing because of left over’s from a time when it wasn’t fiscally balanced.
New jobs require investment. For a group of unemployed people to get jobs (without those jobs to be funded by losses elsewhere) the government must run a deficit.
Individuals and firms have varying power over their own savings. This is a side point but it is worth keeping in mind. As stated a balanced budget means that the non-government sector as a whole cannot be gaining money and therefor cannot be saving, but individuals and firms within non-government sector are free to create a situation in which they can individually save at the expense of others. And doing so will be beneficial for the same reasons saving is ever beneficial. Further, some firms and people are positioned, by virtue of distribution of control, to effectively resist reduction of their own saving. The flip side of this is that some individuals and firms will be powerless to resist running a loss and/or spending their own savings. This all means that in a balanced budget world any particular unemployment target can only be sustained under very weird and unimaginable circumstances. Firstly, unemployment can only be reduced so far as other people are willing to reduce their own savings (which they got from a historic deficit). The government would have to hope that people will sacrifice their savings to fund other peoples jobs. As mentioned, some people will resist and continue to save. Every pound saved is a pound that can’t be used to finance a new job. Secondly, even if everyone was ultra-generous and always willing to sacrifice their savings to achieve higher employment, those savings would necessarily be finite, once spent there can be no further new investment, growth would have to stop. Any particular level of employment, full or otherwise, would require that neither population nor economic activity grow, so everyone would have to agree to that too. It should be obvious that this would also be in incredibly brittle economy because no-one would have any savings. A small natural disaster, like the recent floods, would be devastating.
Austerity is the refusal to meet the non-government sector’s demand for new money. The non-government sector demands enough money to pay it’s government bills (tax, fines, duties etc.) and to finance it’s saving (from which it can invest). Trying to push the government budget to balance is the systematic attempt to refuse to meet the non-government sectors saving demand.
If this is all new to you you might be wondering: if this is all so obvious and based on a basic understanding of how things actually work why am I reading about it in an article by a random blogger? Everything I have talked about is part of a branch of marco-economic research called Modern Money Theory. It is well developed and has good researchers pursuing it. It is, however, not part of the mainstream of economic theory. Why is that? Well… why did some civilisations sacrifice people? Sometimes bad ideas are popular and nothing significant has changed in the human brain in 100 000 years that would mitigate that.
Is Austerity Really Always Unemployment?
You might be thinking that I am talking about a more vicious type of austerity and that it could take a more socially responsible form. I agree that there are many things the government could spend money on, some good some bad, and there are changes that could be made to what money is spent on. Some spending plans will give rise to an economy that is capable of doing more things but you have to recognise an inescapable truism: When the government spends it buys something produced by doing a job. What the government choses to buy dictates what jobs are to be done to get the money needed to pay the tax bills. Let’s say that the government choses to buy one thing that can only be produced by a tenth of the population. If the government agreed to buy unlimited amounts then a tenth of the population suddenly has a job (if they want it). If the government runs a balanced budget via income tax then, by pure laws of mathematics, nine tenths of the population must be unemployed. This is because whatever that tenth is doing only earns exactly what is needed to pay the tax bill. If, on the other hand, the government chose to tax everyone, rather than just workers, then the unemployed would need to find some way to get those with pounds to give some up. This is, essentially, the historic basis of taxation: the government bought military service. If the government choses to tax less than it spends, that tenth will have money left over to spend. A private sector would come into existence based on the demand characteristics of the public serving tenth. Is this an optimal economy? Probably not. Can austerity fix it? No. The government can rethink what it spends it’s money on, but there is no way to improve the economy’s employment levels through austerity. Reducing the budget isn’t just a thing that causes unemployment, it is literally the act of doing unemployment.