Austerity may do more harm: IMF

New Delhi: While India is hotly debating the fiscal deficit framework, the IMF, a long-time supporter of free market economics and tight deficits, in a recent controversial paper has said that austerity may not be good and could even do more harm. The paper said that the cost of tight fiscal deficit could be much more than the benefit.

“The reason is that, to get to a lower debt level, taxes that distort economic behaviour need to be raised temporarily or productive spending needs to be cut — or both. The costs of the tax increases or expenditure cuts requ-ired to bring down the debt may be much larger than the reduced crisis risk engendered by the lower debt,” said the IMF paper called ‘Neolibera-lism: Oversold?’.

However, IMF said that this is not to deny that high debt is bad for growth and welfare. “But the key point is that the welfare cost from the higher debt (the so-called burden of the debt) is one that has already been incurred and cannot be recovered; it is a sunk cost,” said the paper.

It said that austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand and thus worsen employment and unemployment.  It said that, in practice, episodes of fiscal consolidation have been followed, on average, by drops rather than by expansions in output.

“On an average, a consolidation of one per cent of GDP increases the long-term unemployment rate by 0.6 percentage point and raises by 1.5 per cent within five years the Gini measure of income inequality,” it said.

Even though finance minister Arun Jaitley in the budget agreed to curb fiscal deficit further to 3.5 per cent of GDP for the current fiscal from  3.9 per cent last year, there has been huge debate on its merit. Some have urged that India should not have set a tight fiscal deficit target and should have increased investment to boost growth when private investment is down.