SSN Commentary

Austerity Is Bad Economics

Policy field

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University of Vermont

Editor’s note: This commentary is by Jane Knodell and Stephanie Seguino, both of Burlington and both professors of economics at the University of Vermont. Knodell served for many years on the Burlington City Council, and Seguino is a Fellow of the Gund Institute for the Environment. 

When Covid-19 led to sharp declines in spending, resulting in a massive increase in unemployment in Vermont and elsewhere, governments responded by providing funding and loans to families and businesses to soften the blow of lost income. This type of support will be needed for some in order to ward off bankruptcies, mass deprivation, and hardship. High marks go to those governments with the most vigorous responses. 

But backsliding is already on the horizon, with talk of cuts to the Vermont state budget due to the projected decline in revenues. This is the wrong strategy. There are evidence-based alternatives to budget cuts, grounded in lessons economists have learned from past economic crises. In the 1930s, for example, state governments’ efforts to balance their budgets nullified the expansionary policy of the federal government, prolonging the recovery from the Great Depression. Further, the Great Recession of 2008 demonstrated that if austerity measures (cuts to government spending) are adopted too soon, the recovery will be delayed for years, contributing to deterioration of our human capital, resiliency, and small business viability, which will result in long-term damage to our economy and our social fabric. This evidence has influenced even conservative institutions like the International Monetary Fund to proclaim that cutting spending during a crisis is bad economics. In fact, the evidence indicates that deficit spending is the best way to fight the pandemic and economic destruction it has thus far caused. 

Why is austerity a bad idea right now? Budget cuts reduce spending by definition. This leads businesses and families to cut their consumption and investment, further lowering their spending. This is especially true if the state government cuts personnel (wages and salaries), which seems an inevitable effect of cuts. Businesses cannot survive without customers, and so businesses respond by laying off more workers. This “multiplier” effect means that precipitous cuts in government spending in response to budget gaps due to Covid further depress employment, incomes and, as a result, tax revenue. The result is the opposite of what was intended — a deterioration, not improvement, in the state’s budget position. We should be clear — there is no other savior on the horizon. The economy is in an “induced coma.” The effect of cuts is less economic activity, higher unemployment and business survival prospects, leading to a worsening of the budget gap. Those are only the short-run negative effects of budget cuts at a time like this. 

The long-run effects, especially of untargeted cuts, are worse. Take, for example, the effect on children’s development. Brain neuroscience research shows that everyday hardships have a substantially bigger impact on the poor than the wealthy, and that in children, they cause neurobiological changes that can have long-term negative effects on self-regulation and learning, emotional control, memory and language. This is just one example of how austerity today raises costs in the future, in this case, of social services for kids who have faced deprivation. The costs of cuts clearly outweigh any hypothesized benefits. 

Although Vermont has a history of being economically frugal, now is the time to find innovative ways to fund the budget gap. We are one of just a few states that do not require a balanced budget, providing us space to creatively respond to this crisis. Vermont has reserves of about 14% of expenditures, among the highest in the country apart from resource-rich states like North Dakota and Alaska. What can Vermont do then? It can use some of its rainy day funds.  It can also borrow from the Federal Reserve’s dedicated Municipal Liquidity Facility to finance budget gaps for the near future. Vermont has a credit rating of Aa1, and could borrow for up to three years at 2% interest. As the state emerges from this crisis, higher employment and thus incomes will generate the tax revenue to pay down the debt — and state expenditures will fall. 

People often assume that budget gaps are due to reckless overspending. Whatever the circumstances in other cases, this time is different. There is no profligacy. The economic patient is in a coma, and it is in all of our interest to keep the patient alive for the time it takes to recover — and we have the means to do so. It is not only the evidence-based right thing to do. It is also the compassionate approach needed during economic hard times. We are all in this together.