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‘Crowding out’ and the fallacy of fiscal austerity

In the lead-up to the federal government’s budget in May, we’ve been told to expect deep cuts in government spending. Such a policy is said to contribute to a short run decline in Australia’s economic…

The “crowding out” theory underpinning arguments to slash government spending should be viewed with scepticism. Image sourced from www.shutterstock.com

In the lead-up to the federal government’s budget in May, we’ve been told to expect deep cuts in government spending. Such a policy is said to contribute to a short run decline in Australia’s economic activity, but will lead in the longer term to a greater sustained expansion as the private sector grows and blooms like flowers in spring.

This argument is a fallacy - grounded in a false economic theory. I’ll explain why.

The fiscal austerity argument is essentially based on “crowding-out”, which contends that expanding the size of government will in the long run crowd out the private sector. So shrinking government through fiscal consolidation will release resources enabling the private sector to expand.

The fundamental basis for this argument is that competitive market forces push the economy toward a state in which resources, capital and labour, are fully employed - referred to as “full employment”.

In economic theory, this long run tendency to full employment is essentially based on the “substitution principle”; that the demand for labour and capital will each functionally increase as their respective prices decline in relation to each other.

The theory can be illustrated this way. Suppose the economy is in a downturn and there is unemployment. The competition for jobs would then drive down the real wage of workers in general, and because the cost of employing people has fallen, it will be more profitable for firms to employ a more labour-intensive technique of production. So they substitute labour for capital, increasing the demand for labour.

However, if there is unemployment, then it means there is not a sufficient demand for products in the economy. So for the economy to adjust there requires also to be a reduction in interest rates to generate private investment spending and stoke aggregate (or total) demand, to get the full-employment caravan back on the road.

This investment response also relies on the substitution principle. Lower interest rates make borrowing cheaper and make it more profitable for firms to employ a more capital-intensive technique, brought about by higher expenditure on capital equipment.

A significant group of economic writers have objected to this tendency to full employment traditionally on the grounds that even in conditions of unemployment, wages will not decline as is required by the theory.

But there is a much more substantive scientific objection to this theory of a tendency to full employment.

Some 50 years ago, leading theorists in economic science, predominantly from Cambridge University and the Massachusetts Institute of Technology joined in what is called the “capital debates”. These debates were controversial because they demonstrated some serious logical inconsistencies in the traditional theory of production and distribution. They essentially revolved around the problem of measuring the total stock of capital of an economy as a homogeneous quantity when it consists of heterogeneous capital goods (that is, different kinds of machines, equipment).

What the capital debates established is that the substitution principle, which underlies the theory of adjustment to full-employment, is only valid in an economy which produces one type of commodity. So, for an economy - such as Australia - which produces a multitude of different goods (most of which are used as inputs for producing other goods) using a variety of different production methods, the substitution principle is not valid, completely undermining the theory.

What this result means is that in general, if real wages do decline due to unemployment, it is as probable that the demand for labour will decline as it will increase, as firms find more capital-intensive techniques are more profitable than labour-intensive ones. So demand for labour declines, substituted by capital.

Similarly, a reduction in the interest rate can make a more labour-intensive technique more profitable for firms to employ than a more capital-intensive technique, causing a reduction in investment spending rather than an increase as supposed by the theory.

The consequence is that there is no predictable relationship between real wages and the demand for labour and the rate of interest on capital and the volume of investment expenditure. Hence, the economic theory which supposes that competitive forces cause a long run tendency to full-employment output is in general not valid.

Deprived of this theory, crowding-out has little merit - and fiscal consolidation leading to private sector growth, has little theoretical support. As I said at the beginning, it is a fallacy.

It can of course be argued that a fiscal policy which changes the composition of government expenditure and the tax mix could in the long run induce stronger growth - but that would rely on contestable assumptions about how in general the private sector responds in terms of capital spending, consumption and technical innovation to increase productivity. It could not rely on a theory that competition operates as a tendency to a full-employment economy.

In fact, by increasing the rate of labour unemployment and unutilised capital equipment in the short term, fiscal consolidation runs the risk of contributing to slower longer term growth.

Higher unemployment tends to undermine consumer confidence and spending, while firms with greater unused productive capacity are likely to downsize their investment expenditure so that the overall growth in private investment is slowed.

Hence, the most useful thing governments can do to promote stronger trend growth is to use fiscal policy to prevent significant downturns in their economy which undermines the confidence to spend.

Recent historical evidence appears to support our contention. According to the statistical data of the International Monetary Fund, in the years since the UK’s Conservative-Liberal coalition government chose to implement an austerity fiscal policy in 2010, a year in which the economy recovered from the depressing effects of the global financial crisis, the annual growth rate has declined with the average below 1%.

More spectacularly, in the several years since the European sovereign debtor countries of Spain, Portugal, Italy and Greece each implemented fiscal austerity, their economies have contracted with no signs yet of any sustained recovery.

If it is indeed the objective of policymakers to wind back public debt as a proportion of GDP, then the best policy is one which promotes sustained economic growth and a healthy growth in tax revenue, and that will not be achieved by fiscal austerity.

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104 Comments sorted by

  1. Pamela Green

    Futurist

    Thoughtful article but is anyone who should be, listening?

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    1. David Stein

      Businessman

      In reply to Pamela Green

      Good point Pamela - the only thing any of us can do is keep talking about it, keep making noise and ensure we show our support or otherwise.

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    2. Robert Tony Brklje
      Robert Tony Brklje is a Friend of The Conversation.

      retired

      In reply to Pamela Green

      The point being no ever believed the economic theory, it was just a public excuse to justify a disposable labour force and as such majority disposable citizens where a minority controls government.
      All it means in Australian terms a minority and totally opposed to egalitarianism and basically want their cheap maids, butlers, gardeners and chauffeurs back.
      They want the benefits that poverty provides, the ability to ruthlessly including sexually exploit the majority and their families.
      Economics…

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    3. Garry Baker

      researcher

      In reply to Robert Tony Brklje

      "' Just as for foreign investment, the big Liberal party drive for foreign investment has nothing at all to do with the future of Australians "

      Ah, but it does. Porters will be needed at the airports to welcome them, and house cleaners, along with servants will be gainfully employed in this ownership transition. Jobs, that's what Mr Abbott is on about.
      ,

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    1. Aleksandra Hadzelek

      Lecturer in International Studies at University of Technology, Sydney

      In reply to Jim Howe

      Excellent analogy, Jim. Thank you for your thoughtful comment.

      Indeed, I wouldn't want to be operated on by a surgeon whose training was not based on empirical evidence. It is very disturbing to see that a whole society is to effectively undergo what amounts to an experiment. The disregard for scientific and expert advice is plaguing our political decision-making process. As you rightly point out, our politicians are unable to understand scientific evidence, or are choosing not to listen to it…

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    2. Garry Baker

      researcher

      In reply to Jim Howe

      Jim an excellent response to a very good 'story' ... however

      Theories .. so that's how the dice get rolled at LNP central. Play the numbers game alone

      ie: "The theory can be illustrated this way. Suppose the economy is in a downturn and there is unemployment. The competition for jobs would then drive down the real wage of workers in general, and because the cost of employing people has fallen, it will be more profitable for firms to employ a more labour-intensive technique of production…

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    3. Jim Howe

      Neurologist at Neuropalliative rehabilitation

      In reply to Aleksandra Hadzelek

      The medical students I tutor do make these connections Aleksandra, but they are in a very pragmatic, science informed, evidence seeking apprenticeship.

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  2. Lynne De Weaver

    Managing Director

    A very interesting & informative article - too bad all the neocons don't pay more attention to this viewpoint. Your suggestions/solutions make so much sense - especially when you look at the economies of the 'PIGS' - most of them are still really suffering especially the young & unemployed.

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  3. Ben Marshall
    Ben Marshall is a Friend of The Conversation.

    Writer

    I have a hypothetical question for the clever people in the room.

    If, for some weird reason, you had an evil government in power who, for evil reasons, decided to plunge Australia into a deep recession, causing maximum pain and distress to the general population and small business, what sorts of things would they need to do to achieve that aim?

    Would a general list of those evil things in any way match what the Coalition is doing?

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    1. Greg North

      Retired Engineer

      In reply to Ben Marshall

      Hypothetically in reply Ben, not that I would claim to be too clever.
      I suppose if there was a weird reason, could it be that voters were also weird and even a little evil in desiring an evil government or is that the evil government was able to present as the sheep in wolf's fur or that the non evil are into fairytales like as in Goldilocks went to visit Grandma.
      Then again, as weird as it may seem to be to you, I do not think that any government sets out to be evil to plunge their country into…

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    2. David Stein

      Businessman

      In reply to Ben Marshall

      Yes, yes and yes. I don't impugn their motive since there are serious, but misguided people around who genuinely think that 'growth through austerity' is possible. It's a magic pudding argument - more from less but genuinely held nonetheless.
      As for how these theories came about in the first place, suffice it to say the stagflation of the 1970's caused a huge rupture in economic theory since the strange mix of symptoms - high unemployment, high inflation and slack demand - were a combination that…

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    3. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Greg North

      What 'methodical examination' would that be Greg? How is our credit card 'maxxed'?

      I also don't suspect evil intent from this Government Ben. Just ideological incompetence of the kind displayed by the Newman government in Queensland. They're up here making all the moves and watching the economy go to the dogs with this kind of confused frustration. It would be funny if it is was not causing so much hardship. If you do want a good bargain though, I suggest you come on up. The best everyman indicator of economic strength is the quality of the sales and we've got some great ones at the moment.

      Ideologues aren't evil they are just stupidly misguided. Sadly, this doesn't temper the tragedy of the outcomes.

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    4. Michael Shand

      Software Tester

      In reply to Ben Marshall

      I wouldn't think that any government would want to tank it's own economy for any reason.

      I might be wrong but to me it seems very very unlikely

      an unstable economy is the biggest factor in whether people will vote against you or take to the streets

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    5. David Stein

      Businessman

      In reply to Greg North

      How about an alternative hypothesis.
      A political system reliant on money - political donations to fund TV ads which are proven to win elections.
      A lot of very rich people which a lot of cash not earning very much incensed that interest rates are extremely low. Forget that low interest rates are an important way the government is attempting to attract business to invest, spend and, you know, employ people.
      Rich people constantly funding think tanks who constantly warn that inflation is just around the corner and we need to jack up rates to fight a problem that's only imagined, not real.
      Higher interest rates, of course, just enrich those with huge pools of underinvested and rent seeking cash who don't give a hoot about unemployment - they are just interested in their own returns.
      Rinse, repeat.

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    6. Jay Wulf

      Digerati at nomeonastiq.com

      In reply to Greg North

      The fundamental problem with the way coalition is 'trimming' the 'Christmas debt' is ideological.

      There are two ways to do this. One is to cut the expenditure, the other is to rise the tax base.
      Since Politicians for decades now have been elected on platforms of responsible financial management, cutting waste and especially cutting Public Service, there is hardly any fat to cut.
      Any 'fat' that there is, is programs to keep homeless off the streets in WA or Healthcare card for the oldies…

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    7. Brandon Young

      Retired

      In reply to Ben Marshall

      Maybe it is the most insidious kind of evil Ben - the kind where you don't even realise that you are carrying out the evil agenda of powers you do not even comprehend - puppets of evil.

      These chumps are clearly being played.

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    8. Greg North

      Retired Engineer

      In reply to Jeff Payne

      You may not have a credit card or cards maxxed Jeff and that is great, I living that way too whereas not everyone does the same.
      If you are implying that the national credit is maxxed out, we are a ways from that and would want to be even further so as to keep interest payments minimal for like our own personal borrowing for a house say, if we just let the borrowing continue to drift rather than get it down, we will always run the risk of misfortune making the debt being paid off all the more difficult.
      We are likely to see some of that misfortune growing as more of our industrial activities decline.
      Most Queendlanders I speak to seem to be reasonably content with how the state economy is heading, it being accepted that some tough decisions are necessary to address the B and B blundering and plundering years.

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    9. Ben Marshall
      Ben Marshall is a Friend of The Conversation.

      Writer

      In reply to Michael Shand

      Hi Michael,

      I hope it's just paranoia but...

      If the Coalition send us into a recession we didn't need to have, and successfully manage to blame the massive unemployment and associated disasters on the previous shower of b******s, then portray themselves to the voters as the only party capable of getting us out of the mess, they will win votes. Voters just need to be convinced the recession wasn't the Coalition's fault.

      Greg North, in these comments, ably resuscitates the meme of Labour being insane spendthrifts when in power, and it's a meme that just keeps giving to the Coalition / IPA / Murdoch Axis of Ee-vill - regardless of how inaccurate it is.

      It's a plan. It could work.

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    10. Patrick Maher

      Retired Doctor of Psychology and Academic

      In reply to Ben Marshall

      Damn! That's persuasive, Ben. I sometimes think we live in a simple society of children playing shop-keepers - with their little stalls set up outside their houses peddling some strange stuff they call 'lemonade'. Goodness knows what is in the 'lemonade' but we seem to be putting farmers into power who then swing the vote to the the shop-keepers, who could not and would not be in power without the farmers. Maybe what is in the 'lemonade' begins with 'b' and ends with 't'. Seems to work, as you so eloquently say.

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    11. Andy Cameron

      Care giver

      In reply to Ben Marshall

      "you had an evil government in power who, for evil reasons, decided to plunge Australia into a deep recession, causing maximum pain and distress to the general population and small business, what sorts of things would they need to do to achieve that aim?"
      Well in the past they elected Gough Whitlam as their leader and Jim Cairns, Treasurer.

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    12. Andy Cameron

      Care giver

      In reply to David Stein

      "As for how these theories came about in the first place, suffice it to say the stagflation of the 1970's caused a huge rupture in economic theory since the strange mix of symptoms - high unemployment, high inflation and slack demand - were a combination that didn't match available economic theories of the time."
      That's not true David. A small group of economists have been writing about the consequences of the tilt towards socialism long before the Yom Kippur War. Hayek won the Nobel Prize before any world leader had a clue why things were going to hell in a hand-basket. And Milton Friedman was his Nobel right in the eye of the 1970s storm, in 1976.

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    13. Andy Cameron

      Care giver

      In reply to Ben Marshall

      "If the Coalition send us into a recession we didn't need to have"
      Ben, the days are gone when a government or a PM could ever screw us all so badly economically. If the Reserve Bank had been independent BEFORE Keating got into power, we would never had had that recession.

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    14. Dhugal Fletcher

      Critical Thinker

      In reply to Andy Cameron

      And Friedman nailed the primary cause of the great depression on too much money supply... Which was also a primary cause of stagflation. Was it deliberate? Were the economists in charge of reserve banks catastrophically incompetent? One of the two is true and there's little evidence to say which.

      So I'll take the high road and say savagely incompetent. Then when they figured it out, they used Thatcher as a cover while fixing it in the background.

      And a government would take their country into ruin if they believed it would lead to a greater good. The Shock Doctrine shows clearly the justification used since the 70s to rape a country for wealth and move the profits overseas. What they say in public is never the real motivation. It's just uncontrolled, psychopathic greed.

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    15. Dhugal Fletcher

      Critical Thinker

      In reply to Andy Cameron

      Lies, lies and more lies. We would have had a much worse recession to justify more extreme policy.

      Keating was a fool to hand over control and we're collectively fools for giving control of our monetary policy to unelected officials running a secret operation.

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    16. David Stein

      Businessman

      In reply to Andy Cameron

      Hmmm... Andy, not cool but that's OK - I mean that caringly, and givingly.
      It's hardly socialism to ensure business sustains sufficient sales to keep people in jobs. You need to do a little more research amigo. But just in case folks read this and think just because you throw around words like 'truth', or more to the point, saying things I have written are untrue, that you know what you are talking about. Something, by the way, which should not be done unless you are on seriously firm ground which…

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    17. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to David Stein

      Although once again David I am in full agreement with you I think you need to be a little cautious regarding Friedman's enthusiasm for stimulus. He did grudging agree with stimulus but only because, the thought, governments had already stuffed things up. Stimulus was required in times of crises but crises only occurred because of government mishandling and union practices distortions. I agree with you on Hayek. He did not only agree with letting economic crises run their course but, as do many contemporary economists also agree, he thought they were good. How could one be so heartless?

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    18. David Stein

      Businessman

      In reply to Jeff Payne

      Hi Jeff - thanks. It's particularly galling to be told things I say are "not true" and then have someone turn around and reference Friedman as some champion of current conservative thinking.
      Fact is, conservatives have been telling us for years now that we should be fighting inflation, that monetary policy settings are disastrous, that stagflation is just around the corner. Five years on - all these supposed horrors are still just around the corner.
      So, it's rather enjoyable to go back to what…

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    19. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to David Stein

      All strength to your arm David. It is good to see someone who is successful think of the many who are not. I'm wondering if you are a self made man. I find they often understand the realities of this world.

      I too believe in capitalism. What an amazing way to order society. I look at little things on the shelves and wonder about the people who made them. How were the resources managed and the labour ordered to produce this little thing sitting here for 3 bucks. There has never been such a successful…

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    20. Brandon Young

      Retired

      In reply to David Stein

      "Even though I am a capitalist and have done well from capitalism, I think of the misery of the unemployed and feel compelled to keep going."

      Hi David, that is a noble statement of what you are trying to achieve. But the problem is that capitalism in its current form is not sustainable. Do you not accept this? Do you not see peak debt and peak resources as eventualities that would mean a collapse of the whole economic system?

      Feel free to ignore these questions if you would rather not engage…

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  4. Greg North

    Retired Engineer

    Theories upon theories Matthew and you base your assertions on what a group of alleged leading theorists did some fifty years ago!
    And then
    " Recent historical evidence appears to support our contention. According to the statistical data of the International Monetary Fund, in the years since the UK’s Conservative-Liberal coalition government chose to implement an austerity fiscal policy in 2010, a year in which the economy recovered from the depressing effects of the global financial crisis, the…

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    1. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Greg North

      I want somebody, and I mean this, anybody, point to me one example where austerity has worked. The examples were stimulation have worked are readily found but I would be truly interested if somebody can point to one example where austerity worked.

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    2. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Dennis Alexander

      This the big difference between left wing and right wing economics. Right wing economics is theoretical whereas left wing economics is empirical. That is, left wing economics acknowledges corruption, greed, trust, collusion etc. Right wing economics, in ignoring all this, breaks down the minute it is imposed on the world. The irony to all this, is that the brainwashing has been so effective that people believe the delusion and think free market principles work better than any others. This is good economics, everyone, it is good information control.

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    3. David Stein

      Businessman

      In reply to Greg North

      Greg - do you have any facts to back up your assertions here? That fighting deficits is more important than actually growing the economy?
      The point of the Matthew Smith's excellent post is that Ireland's problems were precisely because they followed the medicine you are proposing. Only, the cure was worse than the disease.

      Facts please.

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    4. Michael Shand

      Software Tester

      In reply to Dennis Alexander

      The biggest problem I see with much of these theories is the assumption of rational actors

      Idea's like "The banks would never take more risk than they could handle as that might put them out of business which means they could not continue to make a profit...." - as if the executives care

      Other assumptions like "If business has more money, they will invest it, expand their business and hire more people, if we tax them then they will not be able to take the risks needed to expand and hire more people" - it's just nonsense, executives, shareholders are just as likely to pocket the extra money

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    5. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Jeff Payne

      The plithy final sentence was supposed to read, "This is not good economics, everyone, it is good information control." Kinda loses its punch. A bit like storming out of the room after a great one liner only to realize you've forgotten your mobile phone and must meekly return.

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    6. In reply to Greg North

      Comment removed by moderator.

    7. David Stein

      Businessman

      In reply to Michael Shand

      Michael - that's why sensible, prudent regulation is so important. Ensuring banks have adequate capital ratios, people need a certain % downpayment on a house, no third party / parental loan guarantees, banks shouldn't be taking on large institutional risks etc. Wait a minute...
      Seriously though, the government needs to act as the flywheel of the economy - acting to reduce risk, creating demand when needed and curbing excess where identified. Business cycles prove we act in a pretty pro-cyclical way - like lemmings we buy high and sell low - exactly the opposite of what we tell ourselves!

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    8. David Stein

      Businessman

      In reply to Jeff Payne

      Jeff - it's the easiest but most dishonest sell for conservatives - that the economy is like a household budget. "Live within our means" etc. I think the irony is after all the rhetoric, Hockey isn't even planning to implement a particularly harsh budget, according to recent reports. So, you have to ask whether they don't really even believe their own rhetoric - after all, if they really believe what they say, no amount of harsh austerity would be enough to magically solve Australia's problems.

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    9. Greg North

      Retired Engineer

      In reply to Jeff Payne

      Jeff, call it austerity if you like and others might call it responsible restrictions and then you claim stimulation works which it may seem to do so for some, especially if they have employment or reasonable welfare and do not have any regard to the debt and interest bills being continually accumulated.
      It is obvious that people do not like being told to live within their means, especially if they have forever been supported by a country using credit.
      There is always the soft and hard landings…

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    10. Greg North

      Retired Engineer

      In reply to Jeff Payne

      " That is, left wing economics acknowledges corruption, greed, trust, collusion etc. Right wing economics, in ignoring all this, breaks down the minute it is imposed on the world. "
      Come Jeff, who is initiating the enquiry into corruption within work places?
      Which party was it that removed the authority set up to oversee the construction industry?
      Which party had a PM supporting a MP?, reliant on him to stay in power and who now may get a prison sentence.
      Which party also supported a speaker of the HR, a speaker who then resigned within hours? and is now facing various charges in the courts.
      Do you want to look into a few other corruption issues and involvements?

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    11. Greg North

      Retired Engineer

      In reply to David Stein

      The facts are David that you fight deficits as well as grow the economy.

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    12. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Greg North

      You are missing my point Greg. Although I don't believe that the inquiry into work place corruption has much to do with detecting corruption, I'm not talking about politics. What I'm trying to say is that left wing economics tries to understand the actually workings of an economy not the way it is supposed to work on paper. "Here is Rhodes, jump here." Markets, on paper, may work best under conditions of competition and tend towards equilibrium over time but, in the real world, sometimes economies…

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    13. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Greg North

      All you need to do Greg is show the many examples around the world, Greece?, Spain?, or England?, where austerity measures have worked. Matthew is explaining why this is the case. Interestingly, austerity measures are often supported by the very wealthiest in society as economic downturns help concentrate wealth.

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    14. David Stein

      Businessman

      In reply to Greg North

      Hi Greg - deficit reduction (or even better surplus generation) works to help grow a low inflation economy during boom times - and kudos to John Howard during the 2000's although some argue he handed too much back through tax cuts and family payments. The question is what happens during a downturn - the facts are that deficit reduction during a slump only exacerbates the problem. The argument isn't never reduce deficits, it's a question of timing and economic circumstances.
      Deficit reduction which shrinks the economy only makes deficits worse. The sort of old fashioned pragmatism that 'conservatives' used to believe in.

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    15. Greg North

      Retired Engineer

      In reply to Jeff Payne

      Matthews article does I admit Jeff put forward some different ideas on how economies will behave with different circumstances though that does not necessarily mean that reducing government spending will not see growth in the private sector.
      In fact there are a few disconnects for want of a better term.
      " This argument is a fallacy - grounded in a false economic theory. I’ll explain why.

      The fiscal austerity argument is essentially based on “crowding-out”, which contends that expanding the size…

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    16. Greg North

      Retired Engineer

      In reply to David Stein

      I think what we can agree on David is that there does need to be a good balance continually rather than swinging like a pendulum.
      Unfortunately, Australia will always be getting the cold when someone sneezes, be it the US or of later times Chinese and other Asian countries resources demand.
      Deficit reduction can also help grow an economy when reduction is by identifying waste and trimming costs generally though even the Coalition recognise the difficulties to be faced with declining manufacturing and other industries.
      One thing for sure, indefinitely increasing borrowing will come to definitely difficult times, the more debt, the likely more difficult for more people.

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    17. Andy Cameron

      Care giver

      In reply to Jeff Payne

      Jeff, have you studied any Economics? Who are these right/left economists, and what is "left-wing economics"?

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    18. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Andy Cameron

      I've done political economy, which is 'left', and I'm studying economics now. Two 'left' economists might be Marx and Keynes and two 'right' economists might be Hayek and Friedman. The difference in the approach to economics from these thinkers to someone as learned as you Andy would be evident. This was Marx's argument against the economists after all. An argument well learnt by the erudite Keynes. I don't think too many economists who have actually read these authors would disagree with my categorizing.

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    19. Dhugal Fletcher

      Critical Thinker

      In reply to Greg North

      Ideological poppycock.

      The evidence is against your religious views.

      The IMF and majority of economists around the world applauded Labor's action to avert recession when the rest of the Western world went under.

      The same global authorities condemned Howard's pork barrel tax cuts and complete lack of infrastructure spend or ability to turn the resources boom into long term benefit for Australia like Norway did.

      The Liberals are just a mouthpiece for huge finance and corporate i terests tied to farming interests to get enough votes to form a minority government through four different parties cobbled together.

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  5. Daniel Boon

    logged in via LinkedIn

    Matthew Smith ... you are the man,
    but as Pamela Green says "is anyone - who should be - listening"

    My perception is that corporate government is all about moving profitable operations from government to corporate ... inept people mismanage it, and corporate 'advisers' say they can improve it and reduce the financial impost from the public ....

    'they' arr like pick-pockets, nothing personal about moving wealth from public hands to their pockets .... even Glenn Stevens (RBA) is in on the game (suggesting foreign companies / countries own Australia's resources to drive the value of our $ down) ...

    Thompson was just a little more stupid in his endeavors, but higher up (LNP and Labor) he is but small fry ...

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  6. David Stein

    Businessman

    Excellent post Matthew - thank you.
    Testing theories through the fire of policy implementation is generally difficult since there are so many other things going on in an economy. Notwithstanding, there could not have been more clear economic experimentation than austerity in various Europe from 2009 onwards. With crystal clear results and disastrous social consequences.
    Aggregate demand matters! I'm pleased the discussion has turned the corner with overwhelming recent evidence backed up of course by historical precedent.

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  7. John Campbell

    farmer

    Thank you it all makes a great deal of sense to me.

    Not being involved in academia for some time now I would have thought that there would now be many economic computer models (similar to the much maligned climate ones) that would be being continually refined and tested against historical outcomes that would enable some distinction between reality and dogma ?

    One thing that seems blindingly obvious though is that internal consumption will go down with lower wages and increased unemployment. This would seem to particularly apply to Australia which cannot compete effectively on the international stage as far as manufacture of goods is concerned. Another is the inability of current capitalist implementation to provide full employment.

    It seems we are about to be dragged back to the post GFC debacle by politicians with little knowledge and strong opinions.

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  8. Jay Wulf

    Digerati at nomeonastiq.com

    Matthew, thank you so much for this difficult article, laying down in reasonably accessible language a difficult and complex issue.

    Having been brought up in a Communist regime, now, more than ever I see that there is very little difference between the Communist party with its slogans and banners and the Liberal approach to economy which it is show more and more is based on obsolete, disproven economic assumption, favouring a specific, elite class at the general detriment to people and the greater community.

    Sure the ideology and songs are different but the approach and the stalwart faith in a disproven system... as long as it brings personal advancement and gain is identical.

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    1. John Campbell

      farmer

      In reply to Jay Wulf

      Thank you Jay you have confirmed what I thought for a long time, the two systems were very similar just the language to describe them was different.

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    2. David Stein

      Businessman

      In reply to John Campbell

      John - I'm not sure a command economy is comparable to a discussion of varying economic theories regarding free market economies. While differing free market economic policies create winners and losers, it's hardly comparable to the kleptocracies that masquerade as 'communist' regimes where those at the top simply snatch the loot to be squirreled away in Switzerland. The board positions or ambassadorships are a very paltry reward by comparison. Indeed - all so-called 'communist' regimes are not alike - totalitarianism seems to be the thing that holds them together.
      Hyperbole aside, I really don't question the motives of our elected leaders - I really don't think there's institutionalized corruption of the kind a totalitarian regime allows. This is really about a discussion of ideas that fit within a free market capitalism paradigm.

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    3. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to David Stein

      Although I'm not sure if this is off topic and as it is a recent post we should give Matthews fascinating article a good run but I would be very cautious about reaching quick conclusions. It is always easy, as we have been told for years that it is the case, that 'communist regimes' are mad totalitarian societies of corruption while liberal democracies have largely achieved a more 'just' society. The problem with reaching this conclusion is because the nature of 'property', the nature of 'theft…

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    4. John Campbell

      farmer

      In reply to David Stein

      Yes and no David, the worst of both systems is/was particularly bad. I was not really referring to the likes of North Korea or of ('pre communist' ) Cuba either for that matter.

      Nor was I referring to the appalling dictatorships of some countries I was rather referring to their economic/governmental systems which were sustained by a ideological dialogue, which many would call spin or propaganda, with very little empirical evidence to support them. It is in this area I think the two were very…

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    5. David Stein

      Businessman

      In reply to John Campbell

      Fair points John. I was taking the extremes and tried to admit to a little hyperbolic license, but Bjelke-Petersen - yikes! An excellent point in only two hyphenated words. (And as a side bar - long may upper houses remain.)

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    6. David Stein

      Businessman

      In reply to Jeff Payne

      Jeff - I enjoy your contributions immensely since you are a thinker. Never having done anything postgraduate, I am also extremely jealous. This may be slightly off topic, but it's meant to be a 'conversation', no?

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    7. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to David Stein

      No, I wasn't suggesting you were off topic David, I was expressing concern about my own wanderings. Keep up the good posts.

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  9. Brandon Young

    Retired

    We need a systems approach to economics, and that means removing the negative bias created by the failure to put an economic value on public goods.

    Unfortunately, there are a lot of businesses and banks that depend on that negative bias for their profits, and they have accumulated a great deal of power with which they can defend their stake, so we need to work out how a transition to systems economics can be made while not compromising these vested interests. It can, and must, be achieved.

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    1. Brandon Young

      Retired

      In reply to Brandon Young

      Even the IMF are starting to push the idea of a systems approach to economics, calling for a 'Circular Economy'. Surely the good folk here at TC can at least slow down a little and give it some thought?

      There is plenty of good news in the systems approach:

      Economic outcomes can be controlled to serve our goals. Think about that. We can decide what we want our economy to achieve, and then we can make some changes that automatically achieve it.

      Regulation and complexity can be dramatically…

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  10. Jeff Payne

    PhD in Political Science and Masters in Public Policy

    Good article Matthew. It indicates that we know, and have known for some time, that certain strategies don't work but we keep on tryin' em.

    I think a lot of what causes this passive acceptance is a result of the way that 'economics' is taught at both high school and university. I recently began some post-grad course work study in economics at one of the top tertiary institutions in Australia. I enthusiastically enrolled in the compulsory 'Marcroeconomics' course which I was very much looking forward…

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    1. Brandon Young

      Retired

      In reply to Jeff Payne

      Good point Jeff - that the failure to debate economics with an open mind is caused, in a large part, by the way it is taught, or not taught.

      You stopped just short of asking whether something was fundamentally wrong with economics itself. I will go that extra step - even though most minds are closed to it - and repeat that economics does indeed have one fundamental flaw that threatens our very existence.

      The long term effect of this flaw is the systematic destruction of resources that don't…

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    2. Andy Cameron

      Care giver

      In reply to Jeff Payne

      Macroeconomics is no better than voodoo. Having suffered through macroeconomteric model building, I remained convinced that the universities should shut down all their macro teaching/research, replacing it with Economic History.

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    3. Andy Cameron

      Care giver

      In reply to Jeff Payne

      "I wanted to see their theories expressed mathematically and learn how to play with the maths to identify limitations and strengths. Was I disappointed when I discovered the course content was more like a manual for government workers. This wasn't macoeconomics, it was macoideology."
      While I thought Macro was crap (and still do), one thing was certain, there was no sparing the mathematics! - constrained optimisation, group theory, linear programming, matrix algebra, multivariable calculus...

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    4. Brandon Young

      Retired

      In reply to Andy Cameron

      Yes Andy, economists have had to invent some useful tools in their endeavour to make irrational ideas into a rational science - poor buggers, the task they have been set is a fool's errand.

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    5. Jeff Payne

      PhD in Political Science and Masters in Public Policy

      In reply to Andy Cameron

      I'm looking forward to grinding the numbers, Andy. It will be a challenge for me but I need to see the world differently.

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    6. Andy Cameron

      Care giver

      In reply to Jeff Payne

      Jeff, ultimately I was persuaded of the need for rigorous mathematics in economics. From a non-partisan position, mathematics provides the most rigorous method of achieving internal consistency in economic thinking. And even if I decided against macroeconomics, it was only after I'd actually studied it. If you are a scholar who really does think they can improve their/our understanding of the macroeconomy, then you really must learn the math. If you sincerely believe you can systematize dozens of…

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  11. John Kampert

    aged pensioner

    I love the article, however it puzzles me to find it closing with a reference to winding back public debt as proportion of GDP.

    True this is a problem for the EU countries referred to in the prior paragraph, as they have given up their sovereign currencies and are now in the same position as the Australian States or local governments having to rely on taxation or private sector borrowing. But the Commonwealth is not in that position, the Commonwealth has the legal power to create Australian Currency…

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    1. Dhugal Fletcher

      Critical Thinker

      In reply to John Kampert

      Really good points.

      Why isn't all fed govt expenditure paid by created money that carries no debt?

      Because the banks don't like it. That's the only reason.

      Make the reserve serve the people first by making it a transparent government entity that reports to the people directly. Use the govt budget to introduce new money to the system. Any more new money needed can go to private loans which owe debt to the government directly.

      Why are we paying bankers bonuses for screwing us all?

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  12. David Stein

    Businessman

    Matthew - as a follow up from a business perspective, it doesn't matter to a business whether the government or another business is spending the money - what matters is that the customer walks through the door at all. Which is what makes austerity just so toxic for business. Sure, it's used as an excuse for wage reductions and cuts in bureaucracy which help short term profits, but any business person will tell you what gets them to employ someone is an increase in sales. You can cut your way…

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  13. Patrick Maher

    Retired Doctor of Psychology and Academic

    Yes, exactly. I am not for a moment dissing our esteemed Treasurer or PM, but as yet I have not heard either of them construct anything other than simplistic legalistic reasoning - cause and effect - bad guy, good guy - spend, save.

    Matthew Smith makes a very sound case with applied examples of the kind of mental gymnastics needed to both grasp and take part in the any economic debate. I did a second MBA to try to get the thinking processes under my belt and with great teachers as mentors, and…

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  14. Israel McIntosh

    Retired

    Could you explain why the US has not recovered from the GFC given all Obama's fiscal spending - approx $8 trillion. Why is unemployment up since the GFC?

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    1. Gary Murphy

      Independent Thinker

      In reply to Israel McIntosh

      Number of jobs has increased by 4 million since 2010.

      Real GDP is now higher than pre-GFC.

      Compare to European austerity victim countries.

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    2. Israel McIntosh

      Retired

      In reply to Gary Murphy

      And how many extra Americans are unemployed. In Australia's case, we have a further 200,000 unemployed than when John Howard lost office. Just sayin'

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    3. Troy Howard

      Mechanic at -

      In reply to Israel McIntosh

      Oh god please ignore him, he destroyed the last conversation comments section he blundered into.

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    4. Gary Murphy

      Independent Thinker

      In reply to Israel McIntosh

      What are you sayin'? The GFC reduced economic activity throughout the whole world.

      The topic of the article is: "Does austerity grow or shrink the economy?"

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    5. John Holmes

      Agronomist - semi retired consultant

      In reply to Israel McIntosh

      Could the legacy of Ann Rand and its effect on the Tea Party have something to do with what you are claiming.

      "....Like a true murder groupie, Rand seems more outraged at the public than Hickman probably was. But there’s an eerie similarity between her loathing for the public with their unnamed “worse sins and crimes” and the contempt shown by the likes of Perkins and Zell for average Americans who simply long for the promise of the American Dream that their parents and grandparents once took…

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    6. Israel McIntosh

      Retired

      In reply to Gary Murphy

      Both the Rudd & Gillard governments economic policies were based on government spending to create jobs by using borrowed money. Over 200,000 became unemployed under these policies.

      The Australian taxpayer is now paying interest on that money. If we take the $260 billion borrowed since 2008, and use an average rate of interest of 4%, that's $10.4 billion in interest we are currently paying, and will be for the foreseeable future.

      That's a hell of a lot of Gonkis or NDIS's that can't be funded.

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    7. Israel McIntosh

      Retired

      In reply to John Holmes

      I believe that Ayn Rand's economic policies on found one supporter in Australia - Malcolm Fraser. And we all know what happened to him and how conservatives view him. What did he get as best PM ever - 4%

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    8. Dhugal Fletcher

      Critical Thinker

      In reply to Israel McIntosh

      Standard short term, simplistic thinking I expect from conservative ideologues.

      Using this logic; Sydney should never have built the harbour bridge or the opera house, Australia should never have built national highways or telecommunications infrastructure and we should all live in mud huts until foreign corporations come and build us houses we can pay them for indefinitely.

      Its just nonsense. Money spent on infrastructure, health and education is a smart investment that every government makes in its people. Money spent on corporate welfare is the waste that you are talking about - especially places like the mining industry where all the government handouts go straight to profit margins.

      Here's what other people who rely on evidence rather than religious beliefs say on the topic:

      http://www.smh.com.au/federal-politics/political-news/imf-chief-urges-spending-on-health-education-20140220-3348y.html

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    9. Dhugal Fletcher

      Critical Thinker

      In reply to Israel McIntosh

      Also, dont be quoting statistics that do not support your case.

      If they hadn't performed the correct action of applying stimulus during an economic downturn, there would have been massive unemployment.

      Once again, your ideology is at odds with the facts.

      When will you be changing it to actually match reality?

      "Australia was one of the least affected countries in the OECD over this period, with the harmonised unemployment rate rising just 1.3 percentage points to 5.6%. This was less than the rises experienced in Canada (2.1), New Zealand (2.2), the United Kingdom (2.0) and the United States (3.5). The unemployment rate in Germany has been relatively unscathed by global conditions, rising just 0.2 percentage points, albeit from a high base (7.3%)."

      http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/4102.0Main+Features20Mar+2010

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  15. MItchell Lennard

    Researcher - Distributed Energy Systems

    Thanks for the clear explanation Mathew,

    Unfortunately the Government don't do economics, they do politics.

    Some years ago Howard and Costello decided that rather than try and continue with the Keating reform agenda it was just so much easier to hand out lots of windfall Taxation income to people who didn't need it ( but did live in selected electorates) and to demonise government debt. We are living with the result of this negligence today.

    I have no doubt that there are complex arguments surrounding the level of government debt, when to build it up and when to pay it off. I am sure that If we asked 10 economists we would get 15 opinions, but none of that matters.

    This government do not do policy, economic or otherwise…. they just do very crude Howard era style politics, they do it very well and it works, they were elected.

    It makes no sense trying to have a policy discussion with such a intellectually and ethically bereft group.

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  16. Bec Taube

    Engineer

    Matthew, I am wondering if you believe that land tax reform would be a solution to the problem of stimulating the economy, as this would allow for more tax dollars to be collected if instituted correctly, so that we wouldn't have to have the government tighten it's belt, in fact it could spend more money in the community. This would also help to reduce the speculation of house prices which affect our everyday lives which the government seems to want to ignore. If we really wanted to focus of having an economy built around productive work we could even look at a Tobin style tax on foreign exchanges and stocks etc. This would mean that If businesses and Banks wanted to make profit they could no longer use speculation on the share market to do so but instead would have to invest in the community.

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    1. Dhugal Fletcher

      Critical Thinker

      In reply to Bec Taube

      Financial transactions tax is something we should do ASAP. The UK did it years ago with little perceptible change in the market.

      Make banks pay their social debt.

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    2. Andy Cameron

      Care giver

      In reply to Dhugal Fletcher

      Ah yes, I remember when I defected from Trotsky to Tobin's Tax.

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    3. Israel McIntosh

      Retired

      In reply to Dhugal Fletcher

      We had a financial transactions tax previously levied by both state and federal governments. They were abolished after the GST was approved by the people of Australia at an election.

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  17. Douglas Lawrence-Plant
    Douglas Lawrence-Plant is a Friend of The Conversation.

    Carer

    A problem in my opinion with comparing Australia's proposed budget cuts, with those of the United Kingdom, is that the UK had large sections of there economy almost collapse which pushed economic instability. Australia in comparison is dealing with fall out from the economic problems of our major trading partners. We have for the most part been the envy of less fortunate Country who have massive debt and major industries failing. Although the UK did cut Government jobs and spending in some areas…

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    1. Brandon Young

      Retired

      In reply to Douglas Lawrence-Plant

      Well said Douglas. At least you are thinking things through and offering extra perspective, which is a better contribution than most can manage. The funding cuts can not be justified by a rational mind - we are dealing with something else here. Cheers.

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  18. Garry Baker

    researcher

    The 'Fiscal Austerity' bit in the headline speaks of an ill wind blowing in from the LNP.

    Yet any smart business operator knows there is good spending, and bad spending. The Muppets when they were in power, simply spent - Indeed, as if they were at a mad hatters tea party with their extravagances, yet few country building results came from their sprees... consequently we are now deep in debt.

    As a major project ...In fact, one of pressing urgency, the Carpetbaggers now running the show…

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    1. Dhugal Fletcher

      Critical Thinker

      In reply to Garry Baker

      Open the door so the country can be sold to the lowest bidder.

      I don't think anybody here is that naive.

      This wont return the country to prosperity. This is the phosophy of the spoiled brat turned alcoholic who sells the family property to pay for the ever increasing bills he causes. This is short term profits at the expense of the country as a whole.

      Once you've sold everything that brings in revenue to foreign nationals, then what?

      Once you've gutted the country of natural resources, then what?

      Your future would see Australia a foreign owned and run corporation operating for someone else's benefit.

      That doesn't sound clever or forward thinking to me. That sounds like someone with no ideas pretending we can continue the sins of the past.

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