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Amidst the slow growth in the EU, the persistently high budget deficit and ballooning public debt have become major concerns for many governments in the EU. As a result, they have implemented ‘austerity measures’ to reduce their budget deficit by raising taxes and cutting back on public spending.

Explain what would limit the effectiveness of the austerity measures in the EU. [10]

The aim of the austerity measure is to prevent budget deficit and cut down the public debt and to do so, the government needs to be prudent in government spending and capable in raising tax revenue by creating economic activities that are taxable. There is also a need for the government to ensure that austerity measures will be able to sustain or even raise production, employment and economic growth. However, the effectiveness of these measures is affected by certain economic factors.

Main Body

1) Explain the different types of government expenditure that the EU governments can decrease, so as to cut public debt and prevent budget deficit

One such economic factor to consider is the composition of government expenditure, which can be classified as ordinary or developmental governmental expenditure. The cut down in expenditure will not be feasible since the salaries of civil servants cost of welfare and ordinary public spending cannot be reduced easily. If the reduction in spending is for developmental expenditures, the government will able to reduce such public spending but this will undermine the development of the nation. Thus, there is a need to consider the types of government expenditure which the government can reduce to ensure that there is a balance in achieving the aim to cut public debt and budget deficit without compromising development and the proper functioning of the government.

2) Explain how austerity measures affect other aggregate demand components, besides government expenditure

There is also a need to consider the influence of other aggregate demand components and the impact of the austerity measures on these aggregate components. If the aggregate demand components like export demand and private and foreign investment can be raised during this period, the cut down in government will be feasible and will not undermine the economic activities. If the cut in government expenditure will lower down the consumption level as the government expenditure is extensively for transfer payment. Thus such cut is less likely to be feasible as this is not supported by the people.

3) Explain how the size of multiplier will affect the effectiveness of austerity measures

Another factor to take note is the size of multiplier as the cut down to balance budget or a small surplus may be beneficial as it will still be able to generate adequate expansion of the circular flow of income to raise economic growth and sustain production and employment if the size of the multiplier is large or still equal to one for balanced budget. This will lead to extensive contraction of the circular flow of income if the size of the multiplier is large when the budget is in deficit although it may help to reduce public debt. The fall in economic activities may undermine the economy from raising tax revenue and this may render the effort to cut government expenditure as the lower tax revenue will make it more difficult for the government to reduce public debt.

4) Explain how savings will affect the effectiveness of austerity measures

It is also important for EU to consider the level of private or public saving and the extent of distribution of the saving among the population as this will help the government to consider the areas of government expenditure it may reduce so as not to lower the private consumption level as high level of saving among the group of consumers will enable them to sustain consumption when the transfer payment is reduced and the public expenditure is cut.

In sum, it is not an easy economic implementation when the government in EU attempts to introduce austerity measures as there many economic factors that will undermine such measure. Many sacrifices must be made to ensure that the aims of the austerity measures are met.

Simon Ng

Founder, JC Economics & General Paper Tutor at Economics Focus
JC Economics Tutor Simon Ng of Economics Focus has been teaching A Level Economics and A Level General Paper since 2003. Simon set up Economics Focus to assist students in their pursuit of academic excellence at the examination by providing economics tuition for H1 and H2 students. JC1 and JC2 students are inspired by Simon's clear teaching methods that enabled them to comprehend economics terms and concepts. Simon developed the Rational Thinking methodology to aid students to excel in their JC economics essays and CSQs.