Austerity refers to a set of unpopular government economic policies that a country typically adopts reluctantly to control public deficits and reduce government debt. These drastic measures are usually implemented by governments when their public debt reaches such alarming levels that the risk of defaulting on debt service payments becomes a serious concern.
When a nation, corporation, or individual accumulates excessive debt, lenders respond by demanding higher interest rates on future loans, exacerbating the debt situation and making it costlier to raise capital.
Austerity became essential after the 2007 global financial crisis, which bankrupted numerous Western governments due to declining tax revenues, revealing unsustainable government spending and debt levels. Several European countries, including Greece, Spain, and the United Kingdom, were compelled to implement austerity measures to reduce their budget deficits, driven by the economic conditions brought on by the recession across Europe. Many Eurozone members struggled to effectively manage their growing debts because they lacked control over the euro currency, preventing them from printing more money and devaluing their currency as needed.
There are three main types of austerity measures. The first type focuses on increasing tax and fee revenues, often to stimulate additional government spending and economic growth. The goal is to use higher tax revenues to invigorate the economy.
The second type is frequently referred to as the Angela Merkel model, named after the long-serving German chancellor. This approach involves simultaneously raising taxes and reducing expenditures on services deemed less essential.
The third type advocates for reduced taxation and simultaneous spending cuts, a method favored by free-market proponents. Most economists agree that higher taxes can boost overall revenue collection, and many struggling European nations adopted this form of austerity to address their budget issues. For example, Greece increased its national value-added tax (VAT) rate to 23% in 2010 and imposed additional import duties and higher income tax rates on higher earners, alongside new property taxes.
In addition to increasing taxes and boosting revenues, governments can also reduce their spending. This is often considered a more effective way to decrease the deficit, although it tends to have a more severe impact on lower-income classes and the poor, who may lose access to essential government services such as quality healthcare, welfare, and rent subsidies. Spending cuts can include reductions in subsidies, grants, wealth redistribution, government services, entitlement programs, national defense, government employee benefits, and foreign aid.
There are numerous historical examples of austerity measures. One of the most successful modern implementations of austerity measures include the U.S. during the 1920-1921 recession, where President Warren Harding significantly reduced the federal budget by nearly 50 percent while simultaneously lowering taxes across all income brackets and cutting the national debt by over 30 percent.
Greece presents a more somber case of spending cuts and tax increases. While the country has managed to reduce its national deficit and debt through these programs and policies, it has experienced prolonged and painful recessions for much of the past decade as a direct consequence of these austerity measures.
