Social Europe

politics, economy and employment & labour

  • Themes
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter

The ‘paradox of debt’—or how to avoid austerity again

Jorge Uxó and Nacho Álvarez 15th January 2019

The Spanish government’s budget proposals show some break with the austerity of its conservative predecessor. But there is still an excessive commitment to the orthodoxy of rapid fiscal consolidation.

Jorge Uxo

Jorge Uxó

Macroeconomic analysis teaches us that certain decisions which seem reasonable for an individual may have opposite results when all individuals act in a similar way—or when the agent taking the decision is the government. One of these is the ‘paradox of debt’: in economic policy, any attempt to reduce the ratio of debt to gross domestic product (debt/GDP) by freezing or cutting public expenditure may actually end up increasing the weight of debt.

This is much more than a theoretical oddity—it has happened recently in Spain, and may well happen again, if we follow the recent recommendations made by institutions such as the European Commission, the International Monetary Fund or the Bank of Spain.

austerity

Nacho Álvarez

Changes in the debt/GDP ratio are the result of two different effects. The first is directly related to the government’s fiscal policy: with a primary budget deficit, the government has to issue new bonds (at least if the central bank cannot lend to governments directly), while debt decreases with a primary surplus.

The second is the ‘snowball effect’: on the one hand, the government has to pay the interest on current debt, which implies higher expenditure and fresh debt; on the other hand, if the economy is growing, these payments will represent a decreasing percentage of GDP. The snowball effect thus tends to reduce the weight of public debt when the growth rate is higher than the interest rate, and vice versa.


Our job is keeping you informed!


Subscribe to our free newsletter and stay up to date with the latest Social Europe content. We will never send you spam and you can unsubscribe anytime.

Sign up here

If the government’s objective is a decrease in the debt/GDP ratio, limiting public expenditure to obtain primary surpluses ‘seems’ a sensible recommendation. But this only holds true if fiscal-policy decisions do not affect the growth rate or if this effect (the fiscal multiplier) is small. If this is not the case, and fiscal policy does have an impact on economic activity, the losses derived from the stricter fiscal policy (reduced economic growth and a negative snowball effect) may offset what the government derives from the primary surplus (less new debt issued).

Indeed, the latter is the most likely outcome. The condition under which the ‘debt paradox’ occurs has been defined: in the Spanish case, this would arise with a fiscal multiplier above 0.7, and the empirical evidence shows that its value is much higher.

Austerity cul-de-sac

The negative consequences of the austerity policies applied in Europe to deal with the increase in public deficits and debt arising from the Great Recession should alert us to the strong risk of commiting the same error. They not only plunged us into a ‘lost decade’ but also showed very poor results in terms of reducing public debt. An investigation by two authors, including a former US treasury secretary, leaves no doubt: ‘Attempts to reduce debt via fiscal consolidation have very likely resulted in a higher debt to GDP ratio through their long-term negative impact on output.’

Nevertheless, the European Commission still recommends fiscal consolidation and public expenditure constraints in the coming years in Spain, citing two main arguments. First, although its own forecast is that the debt/GDP ratio will decrease, it thinks that it will do so at too slow a pace. Brussels is afraid of the Spanish economy’s vulnerability to possible interest-rate hikes (via a rapid withdrawal of monetary stimulus by the European Central Bank) and it encourages speedier debt reduction. The problem is that the likely outcome would be exactly the opposite: less growth and, consequently, a higher debt/GDP ratio. This approach is especially dysfunctional because most institutions foresee growth deceleration in Spain, with the unemployment rate stabilised at around 12-13 per cent, clearly above its pre-crisis level. Such an ‘austerian obsession’ would do nothing other than aggravate the slowdown.

Secondly, the commission argues that almost all of the current deficit in Spain is ‘structural’, not cyclical. But any economist with minimum critical sense knows that estimates of a ‘structural deficit’ are methodologically questionable—using them as the only marker for fiscal-policy decisions is more than risky. Indeed, the statement that the Spanish deficit is mainly ‘structural’ implies that the economy has reached its potential GDP and that, as a result, the supply side is currently the main constraint on growth (with 15 per cent unemployment!). This cannot be justified in economic terms and highlights the lack of practical usefulness of such ‘structural deficit’ estimates.

Another way

We must abandon the idea of running large and persistent primary surpluses and redirect fiscal policy towards different objectives: sustain economic growth while unemployment is so high, reverse cutbacks in basic public services and develop a public-investment programme to foster a real change in Spain’s productive structure. If fiscal policy is geared towards making a positive contribution to economic growth, these objectives are fully compatible with securing a reduction in the debt/GDP ratio.

The Spanish government has published its draft budgetary plan for 2019. Broadly speaking, it reflects the main lines of the political agreement between it and Podemos, which heralds an opportunity to pave the way towards a new fiscal agenda. If fully implemented, it could reverse some of the austerity policies introduced over the last decade, thanks to the additional revenue from the proposed tax reforms.

Nevertheless, its scope may be partially restricted by a straitjacket from which the government does not wish to be freed: its plan persists in mistakenly maintaining the policy of fast deficit reduction over the coming years, stemming from its obsession with achieving a German-style budget equilibrium. For too long, debates on fiscal policy in Europe—including in Spain—have mostly been confined to this almost bureaucratic consideration: obeying rules and very little else. It is time to open up a more far-reaching debate, centred on democratic discussion of the best economic-policy options.


We need your support


Social Europe is an independent publisher and we believe in freely available content. For this model to be sustainable, however, we depend on the solidarity of our readers. Become a Social Europe member for less than 5 Euro per month and help us produce more articles, podcasts and videos. Thank you very much for your support!

Become a Social Europe Member

Jorge Uxó and Nacho Álvarez

Jorge Uxó is Associate Professor at the University of Castilla – La Mancha. He currently belongs to the economic team of Podemos. Nacho Álvarez is Associate Professor at the Autonomous University of Madrid and Research Associate at the Complutense Institute of International Studies (ICEI). He is currently the Chief Economist of Podemos.

You are here: Home / Economy / The ‘paradox of debt’—or how to avoid austerity again

Most Popular Posts

European civil war,iron curtain,NATO,Ukraine,Gorbachev The new European civil warGuido Montani
Visentini,ITUC,Qatar,Fight Impunity,50,000 Visentini, ‘Fight Impunity’, the ITUC and QatarFrank Hoffer
Russian soldiers' mothers,war,Ukraine The Ukraine war and Russian soldiers’ mothersJennifer Mathers and Natasha Danilova
IGU,documents,International Gas Union,lobby,lobbying,sustainable finance taxonomy,green gas,EU,COP ‘Gaslighting’ Europe on fossil fuelsFaye Holder
Schengen,Fortress Europe,Romania,Bulgaria Romania and Bulgaria stuck in EU’s second tierMagdalena Ulceluse

Most Recent Posts

EU social agenda,social investment,social protection EU social agenda beyond 2024—no time to wasteFrank Vandenbroucke
pension reform,Germany,Lindner Pension reform in Germany—a market solution?Fabian Mushövel and Nicholas Barr
European civil war,iron curtain,NATO,Ukraine,Gorbachev The new European civil warGuido Montani
artists,cultural workers Europe’s stars must shine for artists and creativesIsabelle Van de Gejuchte
transition,deindustrialisation,degradation,environment Europe’s industry and the ecological transitionCharlotte Bez and Lorenzo Feltrin

Other Social Europe Publications

front cover scaled Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship
Women Corona e1631700896969 500 Women and the coronavirus crisis
sere12 1 RE No. 12: Why No Economic Democracy in Sweden?

Foundation for European Progressive Studies Advertisement

Discover the new FEPS Progressive Yearbook and what 2023 has in store for us!

The Progressive Yearbook focuses on transversal European issues that have left a mark on 2022, delivering insightful future-oriented analysis for the new year. It counts on renowned authors' contributions, including academics, politicians and analysts. This fourth edition is published in a time of war and, therefore, it mostly looks at the conflict itself, the actors involved and the implications for Europe.


DOWNLOAD HERE

Hans Böckler Stiftung Advertisement

The macroeconomic effects of re-applying the EU fiscal rules

Against the background of the European Commission's reform plans for the Stability and Growth Pact (SGP), this policy brief uses the macroeconometric multi-country model NiGEM to simulate the macroeconomic implications of the most relevant reform options from 2024 onwards. Next to a return to the existing and unreformed rules, the most prominent options include an expenditure rule linked to a debt anchor.

Our results for the euro area and its four biggest economies—France, Italy, Germany and Spain—indicate that returning to the rules of the SGP would lead to severe cuts in public spending, particularly if the SGP rules were interpreted as in the past. A more flexible interpretation would only somewhat ease the fiscal-adjustment burden. An expenditure rule along the lines of the European Fiscal Board would, however, not necessarily alleviate that burden in and of itself.

Our simulations show great care must be taken to specify the expenditure rule, such that fiscal consolidation is achieved in a growth-friendly way. Raising the debt ceiling to 90 per cent of gross domestic product and applying less demanding fiscal adjustments, as proposed by the IMK, would go a long way.


DOWNLOAD HERE

ILO advertisement

Global Wage Report 2022-23: The impact of inflation and COVID-19 on wages and purchasing power

The International Labour Organization's Global Wage Report is a key reference on wages and wage inequality for the academic community and policy-makers around the world.

This eighth edition of the report, The Impact of inflation and COVID-19 on wages and purchasing power, examines the evolution of real wages, giving a unique picture of wage trends globally and by region. The report includes evidence on how wages have evolved through the COVID-19 crisis as well as how the current inflationary context is biting into real wage growth in most regions of the world. The report shows that for the first time in the 21st century real wage growth has fallen to negative values while, at the same time, the gap between real productivity growth and real wage growth continues to widen.

The report analysis the evolution of the real total wage bill from 2019 to 2022 to show how its different components—employment, nominal wages and inflation—have changed during the COVID-19 crisis and, more recently, during the cost-of-living crisis. The decomposition of the total wage bill, and its evolution, is shown for all wage employees and distinguishes between women and men. The report also looks at changes in wage inequality and the gender pay gap to reveal how COVID-19 may have contributed to increasing income inequality in different regions of the world. Together, the empirical evidence in the report becomes the backbone of a policy discussion that could play a key role in a human-centred recovery from the different ongoing crises.


DOWNLOAD HERE

ETUI advertisement

Social policy in the European Union: state of play 2022

Since 2000, the annual Bilan social volume has been analysing the state of play of social policy in the European Union during the preceding year, the better to forecast developments in the new one. Co-produced by the European Social Observatory (OSE) and the European Trade Union Institute (ETUI), the new edition is no exception. In the context of multiple crises, the authors find that social policies gained in ambition in 2022. At the same time, the new EU economic framework, expected for 2023, should be made compatible with achieving the EU’s social and ‘green’ objectives. Finally, they raise the question whether the EU Social Imbalances Procedure and Open Strategic Autonomy paradigm could provide windows of opportunity to sustain the EU’s social ambition in the long run.


DOWNLOAD HERE

Eurofound advertisement

Eurofound webinar: Making telework work for everyone

Since 2020 more European workers and managers have enjoyed greater flexibility and autonomy in work and are reporting their preference for hybrid working. Also driven by technological developments and structural changes in employment, organisations are now integrating telework more permanently into their workplace.

To reflect on these shifts, on 6 December Eurofound researchers Oscar Vargas and John Hurley explored the challenges and opportunities of the surge in telework, as well as the overall growth of telework and teleworkable jobs in the EU and what this means for workers, managers, companies and policymakers.


WATCH THE WEBINAR HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube