What Are Austerity Measures?

FT Contributor  | 

Austerity measures are laws and changes made to the government’s budget when sovereign debt needs to be addressed immediately. Or, governments may implement austerity measures when revenue needs to increase to lower public debt. These measures are usually extreme and may include raising taxes or changing eligibility requirements for important federal assistance programs, such as Social Security.

Governments don’t put austerity measures in place until the situation is dire and lenders or bondholders that hold a country’s debt require austerity to be enforced. While austerity measures make lenders more confident that a government won’t default on loans, they can slow the growth of the country’s economy and negatively impact its citizens’ financial wellbeing.

What Do Austerity Measures Affect?

The specific areas of the federal budget and economy that austerity measures effect depends on the type of measures that lenders require. Government programs, taxes, and business cost regulations may be changed when these measures are enforced.

Government Programs

In the federal budget, mandatory spending is set aside to fund important programs that help individuals. The Congressional Budget Office (CBO) ensures the federal budget provides enough funding to support:

Additionally, mandatory spending helps pay government employee wages. When certain austerity measures are put in place, this funding is reduced or eliminated.

This may cause the government to change eligibility guidelines for these programs so not as many citizens qualify to receive benefits. The government may also need to reduce government employee benefits or the benefit payouts that eligible beneficiaries receive through these programs.

Taxes

To make lenders feel more confident, a country may also need to increase its revenue to show there’s room in the budget to pay off interest and debt. A common austerity measure that may be enforced is to raise income taxes for retirement income and workers throughout the country. Tax collection from individuals and corporations is one of the most important streams of revenue for the federal government.

Austerity measures may also implement stricter procedures to reduce tax fraud or evasion and increase the government’s revenue. Government-owned businesses, such as utility or transportation companies, may also be sold and privatized by states.

These measures help increase revenue in a government’s budget. Additionally, some austerity measures increase value-added taxes, which are the taxes implemented throughout the supply chain on manufacturers, retailers, and eventually consumers.

Business Cost Regulations

Some austerity measures are put in place to reduce business costs, which in turn increases the federal government’s revenue. These measures may remove or loosen certain protections against wrongful termination, such as workplace discrimination or poor performance.

The federal minimum wage rate may also be reduced or eliminated completely so businesses can lower their operating costs and increase revenue. In some cases, austerity measures may allow businesses to increase working hours legally by removing previous legislation that limited these hours.

When Do Countries Implement Austerity Measures?

Countries are forced to implement austerity measures when it becomes clear they may have trouble paying their sovereign debt, also referred to as public debt. In most cases, government officials ignore the signs that a sovereign debt crisis is beginning to occur, usually because they’re dealing with other political issues.

These governments may attempt to refinance their sovereign debts but once they’ve shown signs of potential default, they may find they’re only offered high interest rates or other unfavorable loan terms. As these governments continuously attempt to roll over debt, the money they owe to lenders keeps growing.

The indebted government may ask other countries for help. In exchange for financial assistance, additional lenders may require the country to implement austerity measures to restore confidence that the debt will be paid back.

In most cases, if the public debt to gross domestic product (GDP) ratio is 77% or higher, the lender is likely to ask for austerity measures to be enforced. These measures are an attempt to reduce the federal deficit so the government can afford to make payments on foreign debts without defaulting.

Examples of Austerity Measures

Several countries have been required to enforce certain austerity measures to satisfy their lenders throughout the years.

Greece

As a lender to Greece, the European Union required the country to enforce austerity measures related to taxes in 2014. Stricter policies were implemented to stop tax evasion and taxes were also raised. Greece was also forced to lower employee wages, reduce pension benefits, and privatize state-owned assets. As a result, Greece experienced a recession, which included an increase in unemployment and a weakened federal banking system.

European Union

After the 2008 financial crisis, the European Union was also forced to implement austerity measures due to its rising sovereign debt. It had invested in Greece’s sovereign debts and other businesses in the country. When Greece was in financial trouble, the EU also felt the effects.

Countries in the European Union slowed government spending, which also slowed down the economy. When its economy shrunk, the EU experienced a recession.

United Kingdom

The United Kingdom was forced to implement austerity measures after sovereign debt rose due to the financial crisis. The country eliminated government jobs, reduced government program benefits, and increased the retirement age for those who earned pension or retirement benefits. The austerity measures required in the UK negatively affected citizens by slowing the economy and reducing income.

United States

The U.S. wasn’t officially required to implement austerity measures. However, in 2011, the country decided to enforce certain fiscal regulations in an attempt to reduce public debt.

Tax increases and federal budget spending cuts were on the table for the 2011 budget, leading to disagreements in Congress that almost caused a government shutdown. The implementation of these measures led to the same outcome as other countries, including a shrinking U.S. economy and an increase in unemployment.

Since governments can’t go to jail for not paying their bills, lenders force them to take action to ensure they don’t default on sovereign debts. These countries may be forced to implement austerity measures so they can successfully address this debt. While these measures make lenders feel more confident that debts will eventually be repaid, these regulations can negatively affect the country’s citizens and economy.


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