A friends sister recently posted some reflections on
who bears the cost of various decisions on her (so far)
excellent blog. She touched on the Greek fiscal crisis and I felt compelled to comment on who bears the cost of fiscal austerity measures. This was my reply:
In my opinion the costs are borne mostly by lower income strata. What typically happens during booms? Usually during booms higher income strata’s income rises more than lower strata’s. This, to some extent, is an artifact of the nature of booms. They are often engendered by technological innovations or people taking entrepreneurial risk and coming up with new products or starting new businesses. Think of e.g. the dot-com era. However, entrepreneurs are seldomly people on the lower rungs of the income ladder even during that particular time when some of the people coming up with new businesses were college kids. Similarly, technological advances seldomly make the most poorly paid workers so much more efficient that it would cause wages to rise. At this point working the McDonald’s register is as technologically advanced as it is likely to get–until those people are made completely redundant by some sort of fast-food ATM.
The asymmetric nature of income distribution during booms is often taken sanguinely. After all a) risk takers
should be rewarded for starting businesses, &c and b) the rising tide lifts all boats. The 30+-year economic boom in China has benefited top income strata much more than bottom strata but it has been one of the greatest advances in poverty-reduction in recent history, lifting millions out of destitution.
In sovereign fiscal crises that are accompanied by recessions such as we see in Greece right now it is
also the lower income strata that are affected disproportionally. Where does the state have most direct control to curb spending? Government employees, entitlement programs, and taxes. Governments are usually reticent to raises taxes and choke off economic activity even more in the face of a recession. That leaves entitlement programs and the government payroll. Cuts to either usually affect lower income strata more severely, especially since austerity programs often need to be put into place quickly. You don’t have years to repair a state’s balance sheet, you have a few months until credit markets are sufficiently satisfied with your ability to dig yourself out of your debt-hole to lend you more money. That means you can’t redesign the tax system, make tax evasion harder, make entitlement programs smarter, &c to do more with less.
Dani Rodrik said it best:
“One of the most commonly stated benefits of financial markets [is that they discipline governments], yet the claim is patently false. When markets are in a euphoric state, they are in no position to exert discipline on any borrower, let alone a government with a reasonable credit rating. If in doubt, ask scores of emerging-market governments that had no difficulty borrowing in international markets, typically in the run-up to an eventual payments crisis. In many of these cases – Turkey during the 1990’s is a good example – financial markets enabled irresponsible governments to embark on unsustainable borrowing sprees. When ‘market discipline’ comes, it is usually too late, too severe, and applied indiscriminately.”
In the end, it is lower income strata who lose out: because of the nature of the economic cycle, because of the nature of government and, not least of all, because they typically can’t afford insurance either in the form that we’re all familiar with or in the form savings. This also is taken as terrible but necessary. “The Greeks/Turks/Argentines [insert favorite debtor country. Americans?] need to swallow their medicine”, a medicine which affects retirees and welfare recipients when it typically wasn’t them who feasted during the fat years.
In my opinion the costs are borne mostly by lower income strata. What typically happens during booms? Usually during booms higher income strata’s income rises more than lower strata’s. This, to some extent, is an artifact of the nature of booms. They are often engendered by technological innovations or people taking entrepreneurial risk and coming up with new products or starting new businesses. Think of e.g. the dot-com era. However, entrepreneurs are seldomly people on the lower rungs of the income ladder even during that particular time when some of the people coming up with new businesses were college kids. Similarly, technological advances seldomly make the most poorly paid workers so much more efficient that it would cause wages to rise. At this point working the McDonald’s register is as technologically advanced as it is likely to get–until those people are made completely redundant by some sort of fast-food ATM.
The asymmetric nature of income distribution during booms is often taken sanguinely. After all a) risk takers should be rewarded for starting businesses, &c and b) the rising tide lifts all boats. The 30+-year economic boom in China has benefited top income strata much more than bottom strata but it has been one of the greatest advances in poverty-reduction in recent history, lifting millions out of destitution.
In sovereign fiscal crises that are accompanied by recessions such as we see in Greece right now it is also the lower income strata that are affected disproportionally. Where does the state have most direct control to curb spending? Government employees, entitlement programs, and taxes. Governments are usually reticent to raises taxes and choke off economic activity even more in the face of a recession. That leaves entitlement programs and the government payroll. Cuts to either usually affect lower income strata more severely, especially since austerity programs often need to be put into place quickly. You don’t have years to repair a state’s balance sheet, you have a few months until credit markets are sufficiently satisfied with your ability to dig yourself out of your debt-hole to lend you more money. That means you can’t redesign the tax system, make tax evasion harder, make entitlement programs smarter, &c to do more with less. Dani Rodrik said it best: