What Austerity Would Mean for America

Want to know what big cuts in federal spending would do to the United States? Look no further than the United Kingdom. Our former colonial power's economy has moved almost in lockstep with ours over the past decade, but the Conservative Party's austerity program has pushed it into a double-dip recession. With Republicans here proposing deep cuts in federal spending, the United Kingdom offers a worrying glimpse of our possible future.

As I've written in my new eBook (available free of charge from Amazon this week), fiscal austerity can be a necessary step for governments overburdened by their debts. When a country defaults on its debt or can no longer borrow from the financial markets at reasonable rates, it has to show that it's capable of imposing some discipline and tightening its belt. Once the cuts have been applied and a balanced spending plan for the near future is in place, investors will usually line up to lend money again.

That's what happened in Latvia in the wake of the recent global financial crisis. The crisis took a big chunk out of the Latvian economy, which reduced tax revenues and the government's ability to pay its debts. In February 2009, Standard and Poor's downgraded Latvian bonds to junk status, so big institutional investors like pension funds could no longer buy them. Later that year, when the government tried to issue a paltry $17 million in six-month bonds, no one was buying. So Latvia took the bitter pill. It slashed public spending while trying to keep benefits programs in place for the unemployed, and soon it was able to make a triumphant return to the markets. In June 2011, at the government's next attempt to sell bonds, an issue of $500 million brought demand for seven times that amount.

But the United Kingdom and especially the United States are not Latvia. In the wake of the global financial crisis, they still enjoyed favorable credit ratings and could borrow easily -- indeed, at some of the lowest rates in history. It's true that they both faced fiscal challenges in the long term; eventually, they would have to reduce their debts. There was no hurry, however. The priority in the short term should have been to bolster their economic recoveries.

By cutting spending instead, the Conservative government in the United Kingdom pulled the rug out from under its economy. To be sure, there are always areas where governments can reduce waste and improve efficiency. Yet in June 2010, the Conservatives implemented a plan that eliminated 550,000 jobs -- about two percent of the total jobs in the economy -- in just four years.

This was austerity on a grand scale, and at precisely the wrong time. Fast-forward two year to today, and the United Kingdom's economy has shrunk for three consecutive quarters. It's back in recession.

When Republicans in the United States talk about the need to cut the federal budget, the issue should not be just "how much" but also "when." Cutting too early, before the economy regains its usual strength, would be a dire mistake. The economy still needs fiscal help; the Federal Reserve can't support full employment all by itself. Remember that in November.