By Nick Mann | 4 May 2012

Fiscal austerity is making it harder for countries worst hit by the economic crisis to reduce their budget deficits and restore market confidence, the National Institute for Economic and Social Research said today.

The economic think-tank’s latest global economic forecast predicts worldwide growth of 3.7% this year, accelerating to 4% in 2013. China and India will drive this growth, helped by an improving situation in the US, it said.

But the eurozone economy is expected to shrink by 0.3% this year. The NIESR said that the approach being taken to deficit reduction in some countries could create a vicious circle that damaged prospects of short-term growth.

‘Fiscal austerity is depressing growth in those countries most affected by the crisis; this in turn reduces tax revenues, making the restoration of fiscal sustainability and hence market confidence even more difficult,’ it said.

‘This risks a negative feedback loop; downside risks, both economic and political, therefore remain high.’

Spain, in particular, faces ‘significant questions’ about the economic viability of its current policies aimed at front-loading fiscal consolidation. As with other ‘peripheral’ eurozone countries, this approach does not appear to have restored market confidence, increased fiscal sustainability or paved the way for growth and recovery, the NIESR said.

The NIESR forecasts that the UK will have little or no growth this year and reiterated its call for an increase in government investment of 1% of GDP. This would boost GDP by around 0.7%, it said.

‘A temporary boost to net investment, which has been cut extremely sharply, would have no direct effect on the government’s primary fiscal target of balancing the cyclically adjusted current budget in 2016/17,’ it said.

It also warns that its forecast of US growth picking up from 1.7% last year to 2.1% in 2012 and then to 2.5% next year, is based on there being no further reduction in government investment. If fiscal policy is tightened ‘abruptly’, growth would be ‘significantly slower’, it said.

The NIESR’s warnings over the impact of fiscal austerity echo comments made by the International Labour Organisation this week. The UN agency said that reductions in government investment could add to the 50 million job deficit created by the economic crisis.