Austerity: When The Government Tightens Its Belt

By Marc Davis AAA

When a government tightens its belt in tough economic times the entire nation feels the squeeze. With less money to pay for the full spectrum of government services because of declining tax revenues and increasing debt, deep cuts in expenditures would seem inevitable. A reduction in government spending, however, is usually a last resort as long as legislators permit deficit financing of what government provides for its citizens. Deficit financing means borrowing money to pay for government services and benefits, and taxpayers incur the debt.

A government austerity program may be imposed when its debt reaches unsustainable levels and the government can't even service that debt - meaning pay interest on what it owes - without borrowing or printing more money and thus causing inflation.

In addition to government debt are its operational expenses: salaries, pensions, healthcare costs, defense and military spending, infrastructure repair and maintenance, and all the many other commitments of government.

What Is An Austerity Program?
At its simplest, an austerity program, usually enacted by legislation, may include one or more of the following:

  • A cut, or a freeze without raises, of government salaries and benefits.
  • A freeze on government hiring and layoffs of government workers.
  • A reduction or elimination of government services, temporarily or permanently.
  • Government pension cuts and pension reform.
  • Interest on newly-issued government securities may be cut, thus making these investments less attractive to investors, but reducing government interest obligations.
  • Government expenditures may cut. Previously planned government spending programs - infrastructure construction and repair, healthcare and veterans' benefits, for example - may be cut, suspended or abandoned.
  • An increase in taxes, including income, corporate, property, sales and capital gains taxes.
  • The Federal Reserve may either reduce or increase the money supply and interest rates as circumstances dictate to resolve the crisis.
  • In times of war the austerities imposed by government may include rationing of critical commodities, travel restrictions, price freezes and other economic controls.

The result of these austerity measures will ripple through the entire economy and citizens will feel the economic squeeze.

Whether or not these austerities produce the desired results - a return to economic health and growth, or a reduction in government debt - has been debated by economists. Although consensus thinking favors most of the measures cited above, other economists have insisted that government spending - which requires the borrowing of more money and or printing more money - is the best way to emerge from hard economic times. In the case of war, the austerities imposed have proven effective in providing the money and material required for a major national military effort.

Austerity Programs in the 19th Century
The major entitlement programs of the 20th century - social security, Medicare and Medicaid, government pensions, targeted tax incentives or abatements, etc., - did not yet exist. In the free-wheeling decades of the 19th century, government intervention in the U.S. economy was minimal to non-existent.

Government land grants were awarded to individual homesteaders and prospectors, industries such as railroads, cattle and mining, and to state universities as the nation expanded westward. Government also gave special tax breaks and inducements to the telegraph industry, river and canal transport ventures, and overland mail routes. Tariffs were imposed on imports by the government to protect domestic goods and services. These were basically government gifts designed to stimulate growth and economic development.

And so, while government in the mid-19th century was generous in its gifts to individuals and business, government largess was far from costing the trillions of dollars spent in more recent times on the many entitlement programs enacted into law throughout the 20th century.

Austerity Programs in the 20th Century
In the years immediately preceding World War I, the American economy was booming, running the government became more expensive and Congress enacted the modern income tax law in 1913 to finance its operations. The government had imposed income taxes previously, notably to finance the war of 1812, and the Civil War, but those tax rates were relatively low and taxable levels of income were high.

After the U.S. entered World War I in April, 1917, among the first austerities enacted was an increase in the income tax to a maximum effective rate of 77%. Food production and distribution was controlled by the government in an effort to cut domestic consumption and increase distribution to military forces abroad and to the civilian populations of countries in which food production was reduced by the war. Prices of staples and critical commodities were fixed and fuel consumption, including gasless days, was regulated. Daylight savings time was instituted, strikes were outlawed for the duration of the war, and wages and hours were dictated by government in critical, war-related sectors of the economy.

Depression Era Austerities
Without the government economic programs which helped individuals, business and industry enacted during the administrations of U.S. president Franklin D. Roosevelt, economic conditions in the early years of the Great Depression, which followed the stock market crash of 1929, were very difficult. Unemployment at its peak rose to almost 25% around 1932. Bankruptcies and bank failures were frequent. The gross national product - the dollar value of all goods and services produced by a country's residents both domestically and abroad - fell 30%, and the wholesale price index declined a staggering 47%, reflecting the weakened economy.

Rather than impose austerity measures on citizens practicing their own involuntary as well as voluntary austerities, the government spent money through various programs designed to create jobs and stimulate the economy.

Austerities of World War II
With America's entry into World War II in 1941, government and industry geared up for the war effort and the economy finally emerged from the depression.

At the same time, the government imposed widespread austerities on its citizens in the form of commodity rationing, including food, gasoline and other commodities essential to the war. Travel restrictions were imposed, wages and work hours were fixed, and new automobile manufacturing was stopped as plants which previously made cars turned out tanks, Jeeps and other military vehicles.

Belt-Tightening after the Great Recession
In the wake of the Great Recession which began roughly in 2008, the U.S. federal government, and state, county and municipal governments accumulated debt at a higher rate than seen in the previous 60 years. This was lower as a percentage of gross domestic product (GDP) than back in the 40's, but was increasing at a fast rate. These obligations taken on around 2008 included social security, Medicare and Medicare, pension requirements at every level of government, and of course the interest on debt - Treasury Bills, municipal bonds, general obligation bonds, and other promissory instruments.

As a result of these financial imperatives, widespread and deep cuts were imposed, and other cuts were discussed - some of which were both vigorously supported and vigorously opposed.

In addition to the austerities cited in the first section of this article, and with some specific programs noted below, many of the following were also implemented, or proposed for implementation:

  • A reduction in pension benefits for new hires in the public sector - federal. state and local.
  • A reduction in Medicaid benefits, which vary from state to state.
  • Lower yields on government bonds, another form of belt-tightening.
  • Cutbacks in budget appropriations for defense, education, infrastructure.
  • Cutbacks in every form of previously provided social services.
  • Cutbacks in foreign aid to targeted nations.
  • The elimination of various bureaucratic redundancies and the elimination of certain departments of government deemed unproductive or unnecessary.

What's In Our Future: Austerity or Prosperity?
Do austerity programs work? America continues to test that hypothesis in the real world, in real time, rather than speculating on the theory of austerity. Belt-tightening worked well during World War II, but economic circumstances then were different than they are today.

What are the prospects for America? There are no certainties in economics - part science, part art, and subject to unpredictable variables. A burdensome austerity program and overwhelming debt may plague the American economy, and consequently its taxpayers, for the indefinite future. Or a vigorous economic recovery and long-term boom may be coming as a result of the austerity programs. Many a knowledgeable economist and savvy business people might predict a long period of exceedingly slow growth, if any. While economists may study their economic indicators and historical precedents and make their forecasts, nobody knows for certain when the next boom will begin, although if history is any indication, and with a little luck, good economic times are inevitable, sooner or later.

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