Expansionary Austerity: A Myth for Both Countries and Firms

Just a follow-up to my last post. Firms that engage in wanton cost cutting are falling into the same trap as the advocates of the notion that cutting spending in a macro economy will fuel growth.

In a macro economy such as Canada’s, where government spending accounts for about 20% of nominal GDP, cutting government spending signficantly can only have one result: contraction of the economy due to less expenditure and its subsequent shifting of the demand curve.

In a micro economy, such as that of a firm, the same logic applies. Cut costs too deeply and business performance becomes seriously impaired. This comes about because, in the fixation to temporarily boost profit levels, the organization cannot the make the investments it needs to sustain and grow revenues, which are its lifeblood. In addition, indiscriminate cost-cutting reduces or eliminates vital resources which are essential for serving customers. This depresses customer satisfaction and retention, leading to a loss of market share and sales volume.

Expansionary austerity – the notion that you can grow by reducing spending and costs – is a myth. There is no evidence for its success and it violates principles that any student of macro 101 would know. Wash, rinse and repeat if you are thinking of trying it in your firm.

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