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Debunking Economic Myths: Fiscal austerity measures aren’t always the solution for economic growth

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In the wake of financial crises, the instinctive response of many governments has been to implement austerity measures—cutting public spending, reducing social benefits, and increasing taxes—to restore fiscal balance. However, the efficacy of these measures in fostering economic growth remains highly contested.

Thus, amidst economic downturns, implementing austerity measures may seem prudent, aiming to tighten government spending. However, this approach risks exacerbating the situation, stifling economic growth by dampening consumer spending, curtailing investment, and diminishing crucial government services.

Q: “Premature austerity measures can inadvertently prolong economic stagnation, hindering the potential for recovery and prosperity.”

The adage “there’s a time for everything” serves as a poignant reminder. Rushing to implement austerity measures without considering their broader impact could be akin to putting the cart before the horse. Such hasty actions may yield unfavourable outcomes, with repercussions that are far from desirable.

While austerity is often touted as a means to promote fiscal responsibility, its application requires careful consideration of timing and context. Premature austerity measures can inadvertently prolong economic stagnation, hindering the potential for recovery and prosperity.

In an article by ‘Financial Times’ with the headline “Austerity policies are backfiring across Europe and beyond,” A look at Europe during the global financial crisis provides a telling example.

A report by the International Monetary Fund (IMF) in 2012 found that fiscal multipliers were larger than previously estimated during economic downturns. This meant that spending cuts and tax increases had a more significant negative impact on economic growth than anticipated.

The IMF admitted that austerity measures in Europe had deepened recessions and delayed recovery in several countries.

Greece:

Greece’s experience with austerity is one of the most illustrative examples. Following the 2008 financial crisis, Greece implemented severe austerity measures as part of its bailout agreements with the European Union (EU) and the IMF. These measures included deep cuts in public spending, tax increases, and structural reforms aimed at reducing the fiscal deficit.

While the intention was to stabilise the economy and restore growth, the result was a prolonged economic depression. Between 2008 and 2013, Greece’s GDP contracted by about 25 percent, and unemployment soared to over 27 percent. Public debt as a percentage of GDP increased from 109 percent in 2008 to 175 percent in 2013, demonstrating that austerity measures had failed to reduce debt levels, as reported by Vanguard News.

United Kingdom:

The United Kingdom provides another case study. In 2010, the UK government adopted a stringent austerity programme to address its fiscal deficit. The programme included significant cuts to public services, welfare benefits, and public sector wages.

Initially, the UK economy showed signs of recovery. However, the growth was sluggish compared to pre-austerity levels, and the long-term consequences became increasingly apparent.

According to a report by the British Trades Union Congress (TUC), austerity led to a “lost decade” of wage growth, increased income inequality, and deteriorated public services. By 2019, the average NHS worker earned £3,000 less in real terms than in 2010 due to pay freezes and caps (TUC).

Moreover, public service capacity was severely affected. The number of nurses per capita grew by less than 1 percent from 2010 to 2020, despite a one-third increase in demand for care. This starkly contrasts with the OECD average, where the number of nurses per capita rose by 10 percent (TUC). Additionally, the UK’s life expectancy stalled, and survival rates for common diseases fell below the OECD average (TUC).

Economic data further supports the contention that austerity hampered growth. The UK’s GDP growth rate from 2010 to 2019 averaged just 1.8 percent per year, significantly lower than the 2.7 percent average in the decade before the crisis.

Austerity policies also failed to achieve their primary goal of reducing public debt significantly. Public sector net debt as a percentage of GDP remained elevated, hovering around 80 percent throughout the austerity period (Institute for Government).

Portugal:

Portugal also followed austerity policies after the financial crisis, implementing tax hikes and spending cuts to reduce its fiscal deficit. However, these measures led to a significant contraction in economic activity. From 2011 to 2013, Portugal’s GDP shrank by about 5 percent, and unemployment reached a peak of 17.5 percent.

Although the fiscal deficit was reduced, the economic and social costs were substantial, including increased poverty and emigration. Studies have shown that the deep recession induced by austerity delayed economic recovery and contributed to long-term structural challenges.

The African experience: Nigeria and beyond

Nigeria:

Nigeria, Africa’s fourth-largest economy behind South Africa, Egypt, and Algeria, has grappled with economic instability for decades, exacerbated by fluctuating oil prices. In recent years, the government has adopted austerity measures, including cuts in public spending and subsidy removals, as part of its economic reform agenda. Despite these efforts, the outcomes have been mixed.

Nigeria’s austerity measures have often led to higher unemployment rates and reduced disposable income, contributing to social unrest and economic contraction. In 2016, Nigeria’s government removed the kerosene subsidy, according to a PwC report.

This move comes thirteen years after the deregulation of diesel. However, the removal of the kerosene subsidy led to a sharp increase in kerosene prices. Although all these were aimed at curbing the budget deficit, they resulted in inflation and economic hardship for many Nigerians.

Between 2015 and 2019, Nigeria’s GDP growth rate averaged about 1.19 percent per year, significantly lower than the average of 6.11 percent seen in the early 2010–2014 period. Additionally, the National Bureau of Statistics (NBS) reported that the unemployment rate rose from 10.4 percent in 2015 to 17.6 percent in 2019.

Inflation rose from 9.01 percent in 2015 to 11.4 percent in 2019, reflecting the adverse impact of austerity measures on job creation and economic stability, as revealed by macrotrends data. Public debt as a percentage of GDP also remained high, hovering around 29–35 percent, indicating that austerity did not significantly improve fiscal stability.

Fast forward to May 2023, and the implementation of austerity measures by President Tinubu through the cutting of government spending by removing fuel subsidies in 2023 has exacerbated hardship, throwing over 131 million Nigerians into poverty, according to the World Poverty Clock.

“When the austerity measures hit, it felt like the rug was pulled out from under us. My pension was slashed, and suddenly, I had to make impossible choices between buying medication and paying for utilities. The constant worry about making ends meet has taken a toll on my health. The government said it was necessary to stabilise the economy, but it feels like we were the ones who paid the price.” A pensioner said.

The inflation rate saw a 16-time consecutive rise, reaching 33.69 percent, while food inflation stood at 40.53 percent, according to the latest report by the NBS. The unemployment rate rose to 5.0 percent in Q3 of 2023, up from 4.2 percent in Q2.

South-Africa:

South Africa, the largest African economy as reported by the IMF in 2024, has similarly faced the challenges of balancing fiscal responsibility with economic growth. In response to rising public debt and fiscal deficits, the South African government has implemented austerity measures, including cuts to public sector wages and reductions in social spending.

The economy has struggled with slow growth and high unemployment rates. Austerity measures have further strained public services and contributed to social unrest. For instance, public sector wage freezes have sparked protests and strikes among civil servants, highlighting the social tensions exacerbated by austerity policies.

From 2013 to 2019, South Africa’s GDP growth rate averaged just 1.27 percent per year, significantly lower than the pre-austerity average of 2.87–3 percent from 2010–2012, as reported by macrotrends data.

The unemployment rate also increased, from 22.04 percent in 2013 to 25.54 percent in 2019, reflecting the negative impact of austerity on job creation and economic stability. Public debt as a percentage of GDP rose from 47 percent in 2013 to over 75 percent in 2019, indicating that austerity did not significantly improve fiscal stability.

Egypt:

Egypt, the second-largest African economy, as reported by the IMF in 2024, has also undergone significant economic reforms, including austerity measures, as part of its agreement with the International Monetary Fund (IMF) to stabilise its economy. These measures included subsidy cuts, tax increases, and a devaluation of the Egyptian pound.

While these measures helped Egypt secure necessary funding and support from international lenders, they also led to a sharp increase in the cost of living and inflation, causing significant hardship for many Egyptians. Social discontent has been evident, with numerous protests against rising prices and economic inequality.

Between 2016 and 2019, Egypt’s GDP growth rate averaged around 4.85 percent per year, showing some positive impact from economic reforms, as shown by macrotrends data. However, inflation rates soared, peaking at 29.51 percent in 2017, significantly eroding the purchasing power of ordinary Egyptians.

Unemployment rates remained relatively stable, fluctuating around 11–13 percent, but overall economic stability remained fragile due to high public debt levels, which stood at about 80.1 percent of GDP in 2019, according to a world economic source.

In essence, prudence in fiscal policy entails more than just slashing budgets. It necessitates a holistic approach that prioritises sustainable economic growth and social well-being. By recognising the interconnectedness of fiscal decisions and their consequences, policymakers can steer clear of premature austerity and pave the way for a more resilient and prosperous future.

The belief that fiscal austerity is always the solution to economic growth is increasingly challenged by theoretical insights and empirical evidence. While reducing fiscal deficits and debt levels is important for long-term stability, austerity measures can be counterproductive, especially during economic downturns.

The experiences of Greece, the UK, Nigeria, and other African nations illustrate the potential negative impacts of austerity on growth, employment, and social well-being.

By re-evaluating the role of fiscal austerity and considering alternative policy measures, governments can better navigate economic challenges and promote sustainable growth.

Investing in growth-enhancing areas, adopting counter-cyclical fiscal policies, and implementing structural reforms are viable strategies to achieve these goals without the adverse effects associated with severe austerity measures.

Oluwatobi Ojabello, senior economic analyst at BusinessDay, holds a BSc and an MSc in Economics as well as a PhD (in view) in Economics (Covenant, Ota).

Wasiu Alli is a business and finance journalist at BusinessDay who writes about the economy, business trends, and politics. He holds a BA. Ed. and M. Ed. in English Language and Education.