The Fine Line Between Growth and Austerity

The Fine Line between Growth and Austerity

The world seems to be spinning out of control as years of excessive growth take their toll. Drastic efforts by industrialized countries, companies, and households to cut back spending are making headlines. Austerity might well make sense today, but it could also trigger negative effects before long - as the extreme opposite of the frenzied spending seen in recent years.

When the proportion of income to expenditure is out of balance and spending exceeds revenue, something has to give. This simple homespun wisdom also applies on a broader basis when we examine the global debt crisis. There is no question that income has to correspond to spending. But in a global economy, it does not have to happen in the same place, or even necessarily at the same time. If expenses and income are not available in the same place and at the same time, credit can be used to bridge the gap. 

Otherwise, no economic growth would have been possible during the last 1,000 years. While Robinson Crusoe had to save up the seeds to plant his own field himself, an open economy with multiple players allows surplus assets (i.e. savings) to be exchanged. Interest is the compensation for risk and the reward for not spending in the past. 

Seeking Economic Balance
It is very easy to illustrate this point at the macroeconomic level – initially without making reference to the crisis-stricken Eurozone countries, just for once. For example, a consumption-intensive national economy like that of the US can finance its current account deficit from another national economy, such as China's, which has earned current account surpluses by having stronger exports than imports (which depend on consumer spending and investments). In this case, the foreign exchange reserves are invested in US debt obligations, among other instruments. But if the country with the surplus has doubts as to whether the debt obligations can be repaid in full, the perceived risk will...