Explain the rationale for austerity programmes to reduce sovereign debt and discuss how far these have been successful in Greece and the UK.In this essay I will evaluate how well austerity programmes deal with sovereign debt and also evaluate if they have been successful in Greece and the UK. To help you understand the essay I am going to write , I will first break this question down and explain what the question means. An austerity programme is a policy that aims to reduce government debt , through two main points which are spending cuts and tax increases.
These austerity programme are used by governments when they struggle to pay their debts. The next part of the question talks about sovereign debt which is how much the government owes. We can first analyse if the debt that the government has actually matters and do they need to do something to reduce it. Firstly government debt can vary such as if you are in a period in the country with grow or in a recession for example .
With a country that has growth , the debt to GDP ratio is likely to fall compared to in a recession the debt to GDP ratio will likely rise. The debt that you have is a much bigger problem if there is growth in a country and they are still having to borrow , while there also is a structural deficit. Many worry that with high government debt, it can cause economic instability, as with high levels of debt investors within the country lose confidence , meaning there is higher bond yields which puts pressure on the government to stop spending money. However high levels of debt can also prevent a deeper recession within an economy as by spending it can prevent demand and economic growth collapsing. It also means that when in a recession people save more leading to the government being able to borrow cheaply to spend on public sector works.The European union began austerity programmes so they were able to maintain the euro meaning the devaluation of their national currency was eliminated from any potential policies. The EU were trying to cut their deficits to a maximum of 3% of every countries personal GDP. Each country were given aims to fulfil to reduce their sovereign debt so the EU currency could be maintained.Greece were arguably the worst effected country by this crisis and by 2010 Greece had been bailed out by the European central bank twice due to them being bankrupt. Due to this it there were massive implications on other EU countries. The reason for Greece being hit so hard was , just before 2008 there was a global boom which increased government revenue. This meant Greece thought they were in a good position, therefore they cut taxes and spent more in the country to keep on growing. This meant when the global recession hit most of Greece’s money was in long term projects or infrastructure. The global recession hit many countries and as published in The Economist (2013) Greece, Portugal, Ireland and Spain were all in massive debt. Greece had already way over 200% of GDP which was before the crisis and was very high(The Economist 2013). In Britain there debt to GDP was roughly 205% , this was down to investing programmes by the labour government who were in power in the UK at the time. By March 2012 Greece had the largest government debt ever in history. Due to the lenders and banks wiping off Greece’s debt, they aimed to reduce their sovereign debt from 160% GDP and aimed to make it 120% GDP. They did this by creating a five year plan in which they would raise more money through increasing taxes and cutting their spending. They cut 14.32 billion euros of public spending while also raising 14.09billion in taxes over their five year period. They managed to do this in various ways by raising property tax, tax would be introduced on luxury items and raising tax on fuel and cigarettes by one third. They also cut spending by cutting public sector wages by 20% and terminated all temporary contracts. They also cut lots of benefits within the country such as cutting monthly pensions by 20 %. Through doing all of this there was major riots in Greece and with the government cutting spending on policing etc there was a lot of crime in Greece. This was a negative externality and with workers taking time off to riot this was also a negative externality within the country. With all of this you see that Greece has suffered massively in the crisis and with further cuts to specific sectors it led to a severe recession in which their previous government couldn’t overcome. By 2015 the ECB cancelled any of its funding on Greece because of the bank rejection to anymore Greek bonds to finance. With all of this its shows that austerity programmes had worsened the Greek economy and instead of using austerity , something else should have been done to recover the unemployment hole.After the government debt crisis had occurred austerity programmes had to be put in place to cut government debt and reduce countries debts. When we look in the UK in 2010 David Cameron who had just been elected introduced massive austerity to reduce spending(BBC,2012) This was completely different to the former prime minister who spent lots on infrastructure to try to spend out of the recession, this was a Keynesian idea that he used. One of David Cameron’s austerity programme he used was the cut of NHS spending by Ј20 billion. This led to the NHS struggling for funding and with costs in the health sector rising , which aided the budget deficit only in the short term. Many discussions were made at this time to whether the NHS should be privatised which would cut massive costs for the UK government(Campbell.D 2014) Before austerity programmes were introduced in the UK, the economy was in a state of shock as the great depression had just hit in the UK. The UK’s GDP growth had fallen to minus 4.2 percent in 2009 where it had been at roughly 2% annual growth in past years. When these austerity programmes were introduced , it brought the GDP growth back up to 1.7%. Showing a huge improvement to the UK’s GDP growth. The way the uk government did this was by cutting 270,000 public sector jobs in 2011, they froze the unemployment budget , this was a major problem due to inflation rising in the UK. Many claimants of benefits were affected by the budget cuts and had to result to using food banks. Bedroom tax was introduced in the uk and reduced peoples incomes by roughly Ј16 per week. People were unable to claim for housing benefit payments which reduced the annual government expenditure by roughly Ј3.3million. This NHS did not get privatised however the UK did privatise the royal mail which meant shares were sold and it would be privately owned by them. This meant there was a cut in government spending and reduced the budget deficit. One problem with doing this though is that the quality you get when using this service could easily decrease and the income the royal mail was providing , were being given to private investors. To be able to effectively use this type of austerity programme, the country’s such as the UK had to have a strong exporting market as the debt will continue to decrease with the privatisation of public companies. This was the problem in Greece who did not have a strong exporting market and exported only few items and with high unemployment it meant Greece would have a large deficit.Carmen M.Reinhart and Kenneth S.Rogff wrote a paper called growth in a time of Debt, it showed the correlation between growth and debt in an economy. In it they found that that if a county has debt of 90% or higher than they will have lower growth than ones of a lower debt percentage. This image(Reinhart’s Rogoffs’s,2010) was evidence to what they found. It shows external debt , inflation and growth in an emerging over a 40 year period. In the image it shows that the lower the debt , the higher the GDP growth. There has been major criticism of Reinhart and Rogoff’s paper as stated in the paper Does High Public Debt Consistently Stifle Economic Growth?,( Herndon, T., Ash, M. and Pollin, R. 2013) this paper argues that Reinhart’s paper is inconsistent , they use selective data and there’s serious errors that then inaccurately show the relationship between growth and public debt. This basically meant that there were mistakes which was due to the spreadsheets that Reinharts and Rogoff were using, as they didn’t include guidance on specific data. Herndon the writer of this paper concluded that as Rogoff’s and Reinharts paper was misleading and there were errors it meant they did not agree with the idea of 90% or higher debt means there will be lower GDP growth.Governments will try not to use austerity programmes unless needing to by lenders or bond holders. These programmes act like contractionary fiscal policies. These austerity programmes often slow economic growth meaning its harder to pay off the sovereign debt. These programmes limit the terms of unemployment benefits , reduce government employees wages and cut other programmes for the poor. They also raise income tax especially on people who are wealthy , make sure there’s no tax fraud or evasion and also privatize government owned businesses as seen in the UK.So to look back at the question, is austerity programmes a good way of reducing sovereign debt , we can see it all depends. In the essay above we have seen the positives of using these austerity programmes such as the UK being hit from the global recession and with the use of austerity became the fastest growing advanced economy in 2014. However the austerity programme actually hasn’t reduced any of the sovereign debt that the UK had ,which people than fear that austerity only shrinks the economy. One major issue is that it has not been long enough since this global recession hit as the eurozone crisis forecasts are the only thing we use to whether the debt to GDP will actually decrease , and forecast are not very accurate and shocks within a market are unpredictable. As the forecasts are not trustworthy it means that any confidence in the market is low and therefore it means that any growth in these advanced economies will be gradual and people will be cautious as countries are still being affected because of the global recession. We can see that austerity hasn’t worked for a country like Greece who are less economically developed. This is because shrinking the economy will mean it’s harder to develop while debt will almost certainly increase as GDP falls. Greece have such a high young adult unemployment, therefore austerity programmes shouldn’t be used , they should be trying to invest into things that up employment such as doing training programmes or you could also invest into infrastructure as this also creates more jobs and this would create a multiplier effect which then increases GDP. This sort of way is known as the Keynesian way and is the complete opposite to what has been used which is a neo-classical fiscal policy. Countries that have the potential to grow should invest to boost the economy otherwise they will end up stagnating. All this obviously costs the EU banks however without them helping the countries will leave and ruin the euro.So overall I believe that austerity programmes should only be used to solve sovereign debt if you are a highly economically advanced country like the UK where as a country such as Greece who are not should invest as the austerity programmes have not worked in Greece. Greece have an increasing debt to GDP which is evidence that austerity isn’t the most effective policy is reducing sovereign debt.