fiscal austerity and the us debt crisis

8/6/2019 Fiscal Austerity and the Us Debt Crisis

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FISCAL AUSTERITY AND THE US DEBT CRISIS: SHOULD AFRICAN STATES BE

CONCERNED?

By

Mutombi Brian Mackenzie

Abstract

The recent global developments in Europe have threatened the unity of the European Union and

the success of the euro as a common currency following the bankruptcy threats of the republic of

Ireland, Greece, Portugal and Spain. This has led to austerity measures been embraced by the

respective countries as part of the conditionality’s that will ensure that the countries caneffectively repay their debt obligations by cutting their expenditure significantly and has further

been complicated with the debt ceiling crisis in America that has threatened to make the country

default on its obligations and has even led to the closure of Minnesota State for 14 days as at

15/7/2011 following the lack of funds to pay salaries to over 22000 public servants. The paper

shows that fiscal austerity is not the solution for these bankrupt countries due to the adverse

consequences of budget cuts that lead to increased unemployment and increase in taxes. It

further shows that African states should be concerned with what is happening in Europe and

America as the economic effects of such happenings will affect them adversely in the long run

due to spillover effects just like the global financial crisis finally caught up with them. It further

recommends good corporate governance in the management of public funds to ensure

transparency and accountability so as to encourage future donations, grants and loans.

Introduction

Following the global financial crisis of 2008 which had adverse effects in almost all countries

due to the spillover effect, many countries embraced an emerging issue in government

budgeting, known as fiscal austerity which simply means budget cuts where the government cuts

on its expenditure either willingly or as part of a structured adjustment policies by the

International Monetary Fund (after it has lent money as a lender of last resort). To understand



this issue further, we need to understand what structured adjustment policies are; these are

requirements that date back to the Bretton Wood Agreement following the launch of the IMF and

World Bank to help in stabilizing countries after the 2nd world war which left many European

countries in financial difficulties. These institutions were charged with the power to lend to

countries whose currencies fell below a specified rate against the dollar (currencies were pegged

against the dollar). Under the SAPs, the two institutions would lend to countries only if they met

certain macroeconomics standards such as budget cuts, increased taxes, accountability and

transparency etc.

Global economic trend of fiscal austerity and its consequences

Recently, countries like Greece, Ireland, Portugal, Spain and the US have experienced financial

difficulties which have led to down grading of debt instruments issued by these countries as junk

instruments meaning that no investor is willing to invest in such instruments. This has forced

such countries to rely on the IMF, World Bank (as lenders of last resort) and other European

countries through a bailout plan. The announcement of fiscal austerity in Greece for example

was met with revolts and demonstrations all over Greece because the citizens knew what lay

ahead of them. Budget cuts translate to higher taxes, lower government expenditure on

infrastructure, education, lower salaries to government employees, lower government

contribution to pensions, cuts on healthcare, social welfare etc which translate to fewer jobs and

decrease in economic growth. These fiscal measures however contradicts with the Keynesian

theory (advocated during the great depression) that believes that countries facing difficulties

should increase government expenditures and lower taxes so as induce economic growth and

ensure employment levels do not drop.



According to the Wall Street Journal (9/5/2011) Greece has continued to slip into debt and the

country may require additional $ 43 Billion to finance its operations up to 2012. By 2009, the

country had debt obligations amounting to $72.1 Billion which it was unable to repay and was

forced to ask for assistance from other European Union countries (Nelson et al, 2010) hence the

austerity measures. The debt trap in Greece is expected to get worse in future following budget

cuts and a survey conducted by Bloomberg News revealed that 85% of investors expect Greece,

Spain and Portugal to default on their debt obligations since any further draconian budget cuts

will further worsen the situation in these countries. (The Washington Times, 18/5/2011)

The American debt crisis is a unique case because it is hard to imagine the world’s largest

economy in a crisis. How would one of the largest economies in the world default on its

obligations let alone a country with the richest billionaires in the world be unable to pay its

workers, the army and social security, all this because of a simple issue of whether to increase

the debt ceiling to allow the government to borrow additional funds? The Democrats, the

Republicans and the Tea Party are currently deadlocked on whether to increase the ceiling on

government debt from $ 500 billion or not even though the Washington Post (11/7/2011)

reported that the state of Minnesota has been closed for 11 days due to lack of funds leaving over

22,000 workers without jobs and further threatening failure to pay over $ 20 billion in social

security by August 3.

Critics who are against the debt ceiling increment (Republicans and Tea Party) argue that in

drives the country further into debt but the truth is that the Democrats inherited most of the debt

from former president Bush’s regime who ironically is a Republican. They also argue that the

debt crisis isn’t a big problem as the democrats are saying and that budget cuts should be made



on Medicare and Medicaid rather than taxing the rich even more. As for the democrats, they are

reluctant to cut Medicare and Medicaid and they are pushing for higher taxes for hedge fund

managers and Wall Street barons who enjoy tax benefits. This has threatened the US economy

due to narrow minded politics that may see the country default on its debt obligations and lower

the demand for their security following poor rating for their securities. Bloomberg (24/5/2011)

reported that Standard & Poor in April cut the outlook on the U.S.’s long-term credit rating from

stable to negative for the first time since the bombing of Pearl Harbor

To understand this issue further, we need to understand the current debt crisis in US, according

to the Business Insider (17/5/2011) the current debt of the American government has

mushroomed to $14 trillion and that it will further cost the American tax payers $210 Billion in

2011 alone to repay the interest on loan. Morrison & Labonte (2009) reported that by 2008;

China alone had invested more than $1.2 Trillion of its foreign reserves in American bonds

making it the second largest investor after Japan in American securities. Now imagine what

would happen if the US defaults on such obligations, further imagine budget cuts meant to curb

the growing debt in US, this means fewer jobs in America, higher taxes, reduced government

spending on social security, Medicare, Medicaid etc.

When countries employ fiscal austerity measures, they sink even further into problems since

issues of poor health systems, education, infrastructure and more importantly unemployment

(leading to closure of factories as a result of low demand, social evils and insecurity) afflict such

countries. In Spain for example, the level of unemployment is expected to increase from 20.1%

in 2010 to 20.7% in 2011 (Cushman & Wakefield, 2011). This makes it even more difficult for



such countries to recover from the financial difficulties and their economies continue to suffer

since the consumption component of national income is heavily affected by unemployment and

low demand for produced products.

Are African states economically stable and self sustaining: Should they be worried?

Most African countries are still developing and therefore need not balance their budgets (a deficit

budget will do so as to induce economic growth through increase in expenditure on

infrastructure, education, research etc which helps them to utilize their resources fully). So

should these African countries be concerned about the current worrying trend in Europe and US?

To answer this question we need to understand how globalization, technology and deregulation

have affected how we do business today. Globalization and technology have led to the opening

up of new markets, sourcing of cheaper funds, faster and better methods of producing, selling,

delivery and settlement and removal of trade tariffs and other trade barriers. Deregulation on the

other hand has led to market and product growth, innovation, securitization, technological

advancements and better risk management techniques. These three factors have led to increase in

the volume of trade and foreign direct investments.

To African countries, this translates to more jobs, more grants, donations and loans to finance

budgets, natural calamities such as earthquakes, flooding, tsunamis, HIV/AIDS, mudslides,

hunger and drought which are more common in African states due to poor planning, lack of

preparedness, corruption and poor policies.

If these so called donor countries continue to experience financial difficulties, then most African

countries which cannot fund 100% of their budgets will suffer the effects of lack of donations,



grants and loans and the reduced foreign direct investment which would otherwise provide jobs

to workers in these less developed countries.. Funds for free primary education, natural

calamities and hunger will continue to wither. (Already the funds for HIV/AIDS have begun to

decrease). For example according to the USAID, Kenya receives $2.5 billion annually as aid

from America (excluding loans). Further, the tougher times experienced in the US will lead to

reduced job opportunities to Kenyans migrating to the US which will lead to reduced remittances

from Kenyans in the Diaspora. This even threatens countries such as Afghanistan and Iraq that

require donations and grants to rebuild the already damaged towns and cities following a decade

of war on terror.

Finally, the new kid on the block in Africa, the Republic of Southern Sudan will also experience

difficulties as it tries to rebuild its nation that was damaged by war for decades. The inability to

get foreign support from the so called super powers means that the resources in this country will

remain unexploited.

Conclusion

African states therefore stand to lose more if the status quo in Europe continues as the

unemployment levels will worsen, food insecurity, illiteracy, heath related problems such as

cholera and HIV/AIDS, natural calamities, lack of foreign direct investments, closure of

multinationals etc will continue to afflict them and further make the Dark Continent continue to

be poor. Further, most African countries e.g. Kenya are more of service providers than

producing countries which means that they will be adversely affected if no one is willing to pay

for their services to economic difficulties. It is for this reason that acts such as nationalization of



private companies, corruption, poor polices in African states and more importantly issues of lack

of transparency and accountability should be frowned at.

A case in point is the recent issue of free primary education and funds meant for people dying

out of hunger? When such funds are misappropriated or unaccounted for, then the donors who

sacrifice their savings (given the bleak future as a result of higher debts which require more taxes

to repay the increasing interest rates) so as to help people in need in Africa may shun from

donating in future which will lead to harder times in Africa. Such short term dysfunctional

decisions should be discouraged and shunned because the financial implication of such acts will

be adversely felt in future following cancellation of future donations and grants.

References

Cushman & Wakefield (2011) Market Beat: Spain economic snapshot. Cushman & Wakefield

research publication.

http://online.wsj.com/article/SB10001424052748704681904576

http://www.bloomberg.com/news/2011-05-24/how-we-can-solve-the-debt-crisis-really-.html

http://www.businessinsider.com/how-to-tell-when-the-debt-crisis-gets-serious-2011-3

http://www.washingtonpost.com/national/no-new-talks-scheduled-as-minnesotas-government-

shutdown-enters-its-2nd-week/2011/07/11/gIQAmKpl8H_story.html

http://www.washingtontimes.com/news/2011/may/18/europe-debt-crisis-forces-nations-to-make-

tough-ca/



Morrison W.M. & Labonte M. (2009) China’s Holdings of U.S. Securities: Implications for the

U.S. Economy. Congressional Research Service: report for congress. 7-5700 www.crs.gov.

RL34314

Nelson M.R., Belkin P. & Mix D.E. (2010) Greece’s Debt Crisis: Overview, Policy

Responses, and Implications. Congressional Research Service: report for congress 7-5700

www.crs.gov. R41167

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