The Peril of Austerity

Last year, the British government -- facing the same kind of deficit/fiscal crisis that has ensnarled the United States and the European Union -- undertook a dramatic program of austerity designed to get its fiscal affairs under control. The government raised taxes and imposed draconian spending cuts across the board. Why, they even took money away from the Queen.

From a distance, this seemed a classic example of traditional British pluck in the face of adversity. The people have been living beyond their means, and their political leaders decided to impose the harsh medicine needed to balance the books. Tough but reasonable.

But the results, at least thus far, were not what the government had in mind. When you raise taxes and slash spending, you take a lot of money out of the economy with predictable effect on growth. In the last quarter of 2011, the British economy actually shrank by 0.1 percent while net debt rose above a trillion pounds for the first time, to 64.2 percent of GDP, up from 59.4 percent the year before. For now, the government appears determined to stay the course, but the voters may object. Austerity inevitably generates political backlash, as we see on the streets of Greece today.

Meanwhile, Washington remains tied up in knots about the budget deficit and the soaring national debt, but there is no consensus regarding what to do about it. The Obama Administration's budget basically took a pass, ignoring the deficit. The loyal opposition continues to advocate draconian across the board spending cuts, and adamantly opposes any tax increases. There is a wide swath of middle ground between the two sides, but few political leaders are to be found there.

I believe the British experience offers us sobering guidance that both sides of the political spectrum should heed. The British are right that runaway deficits must be reined in. We all know that to be true. But if we go overboard and try to do too much at once, we may end up making the situation even worse. Our economy right now is doing modestly well, but it is fragile. Any combination of policies - tax hikes and spending cuts -- that would jerk a huge amount of wealth out of circulation, can and probably will have a devastating impact on economic growth. The result would be an even bigger deficit, which would negate the entire purpose.

What we need is a judicious combination of near term policies to encourage growth and a long term plan to curb growth of the debt. The near term measures should focus on improving international competitiveness by encouraging investment in infrastructure, technology, exports and R&D. Improving competitiveness will boost economic growth.

For the long term, we should enact the excellent Simpson-Bowles plan that offered prudent adjustments to entitlement programs. That is where the crucial challenge lies. An earnest plan to curb entitlements will offer real promise of long term fiscal restraint and thus restore public confidence which also will do wonders for near term growth.

Jerry Jasinowski, an economist and author, serve d as President of the National Association of Manufacturers for 14 years and later The Manufacturing Institute. Jerry is available for speaking engagements.