Fiscal Austerity and the Fallacy of Composition

Extract from 'Macroeconomics' by William Mitchell, L. Randall Wray & Martin Watts

An explanation of why all countries can't rely on fiscal austerity or export led growth.

“During the global financial crisis (GFC), the conservative reaction to increasing government deficits was to enact fiscal austerity measures by cutting government expenditure and/or increasing taxes, and to encourage nations to cut domestic costs in order to stimulate their export sectors via increased competitiveness.

If one nation does this in isolation while all other nations are maintaining strong economic growth, this strategy might have a chance of working. In a similar way, one individual saver might reasonably assume that changing their consumption choices would not cause a wider effect that could impact their income. But if all nations engage in austerity and cut their growth rates, then overall spending declines, and imports will fall across the board, as will exports. This is another example of a fallacy of composition.

It is the interdependence between countries via trade, as well as a fall in net government spending, that undermines the policy prescription in this case. It is also clear that not all countries can rely on export-led growth (to more than offset a decline in net government spending) since for every exporter there must be an importer.”
~ William Mitchell, L. Randall Wray & Martin Watts, 'Macroeconomics'