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Austerity For The Simple Folks

By:
Barry Norman
Updated: Jan 1, 2011, 00:00 UTC

One of the first things you learn in business school is that when profits fall, you need to cut expenses and increase income. The ECB seems to have

Austerity For The Simple Folks

One of the first things you learn in business school is that when profits fall, you need to cut expenses and increase income. The ECB seems to have forgotten the second part of this lesson. You cannot simply cut expenses, as revenue will continue to fall, profits might climb for a short while, but eventually the loss of income will far exceed  the reduction in expenses and profits will tumble.

Let’s look at the math, if a country collects  business and personal taxes of let’s say in the amount of 1 billion euros. If that same country has expenses of 1.2billion euros, they will have a budget deficit of .2billion euros. Now that is simple to follow. That country needs to cut expenses. How does a country do this, they start by reducing waste and government spending. That helps in the immediate time, but as you continue to reduce waste, businesses that supplied that “waste” lose revenue and they pay fewer taxes. So your income begins to drop ever so slightly. Next comes along the spending reductions, which means a cut in government employees as well as spending. As you terminate employees, more and more citizens go on the government payroll under unemployment or welfare benefits. They also no longer pay taxes but take money from the government pot. What do we have now, an increase in expenses and a reduction in income. As governments stop spending businesses suffer, as businesses suffer, they pay less tax and cut their employees who go on government programs. Again cutting income and increasing expenses.

Of course it is not a one-one ratio and austerity and reduced government spending and waste is necessary, but harsh austerity programs demanded by the European Central Bank and the International Monetary Fund, eventually work the opposite of what they are supposed to.

If this is business 101, where did these economist and government leaders go to school?

Successful businesses know that when you are cutting expenses you need to increase advertising, to increase income, which will generate higher profits in a more streamlined economic model. This would have worked, if it had been balanced. Even the tough austerity measures could have worked in isolated situation, but when the global economy is suffering, how would a country like Greece who is already looking at declines in tourism and exports due to the global recession, ever generate enough income to sustain or meet the criteria set by the ECB.

Now Angela Merkel has admitted that this model is not working, Ireland recently realized the same thing and is trying now to turn things around before needing additional bailout funds.

The question is if this austerity program is failing, what is to come of Portugal, who is now in worse shape than Greece, having the same problems, while implementing austerity measures their budget deficit continues to grow. Behind Greece sits Spain and Italy waiting and looking at failure. Where is the new model? How do you help these countries spur on growth? Growth should have been the key word all along.  Is it that the EU dynamic duo has set their sails on a course and it is too late to change directions as the winds are already shifting?

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