Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I have said it before that when the facts get in the way of mainstream economic theory – which is just about always – the professors (my peers) tell their students that the facts are wrong. They have a pathological obsession with hanging on to their theories. Apart from the arrogance that accompanies this I have never really been able to work it out. As a tenured professor I could overnight become an adherent of the Austrian School or whatever and my job wouldn’t be threatened. A tradesperson who loses his/her skills has a problem. But academic life is different. We can explore new ideas any time we choose and take time to develop the news skills commensurate with these ideas. That, in part, is what research is all about. So it is more about their unwillingness to let go of what are essentially religious beliefs that leads the mainstream economists to constantly pump out rubbish and lie when they are found out (by the facts). The overwhelming fact is that the push for austerity is not based on any evidence-based understanding of how the system works. It is driven by stylised economic models that bear no relation to the real world and fail when confronted with data from the real world. As the clock ticks by – tick tock tick tock – the evidence mounts that nations that introduce austerity fare poorly.
I thought this article in the New York Times (February 22, 2011) – Why Budget Cuts Don’t Bring Prosperity – was interesting.
The writer David Leonhardt points out that all the austerity proponents seized on news that Germany had started to grow strongly in the second quarter 2010 as evidence that the:
… American stimulus had failed and German austerity had worked. Germany’s announced budget cuts, the commentators said, had given private companies enough confidence in the government to begin spending their own money again.
It is always better when involved in the game of economic commentary to: (a) have a good understanding of the way things operate; and (b) notwithstanding that, to be relatively cautious before you pronounce a trend. It is always better to wait a few quarters before you assume that something is consolidating.
The first requirement – a good understanding of the way things operate – had me concluding that Germany’s growth resurgence was probably the result of the fiscal stimulus modest though it was. Given that Germany trades extensively in the Eurozone, I also concluded that there is so many negative portents coming from that area that as the fiscal stimulus was being withdrawn Germany would also flag a bit.
But I also thought it was better to wait before making any definite conclusion because it was possible that Germany had succeeded in eking out new export markets in China and India which might have given it a sustained growth boost. Remember they are still running budget deficits so there is an on-going stimulus coming from public net spending.
The tendency – no certainty – that the deficit terrorists will “jump on any data that helps them” makes me laugh. They conveniently ignore Ireland and now Britain. Germany was their miracle baby and they were milking it for what it was worth.
As David Leonhardt tells us – with just a hint of “I told you so”:
Well, it turns out the German boom didn’t last long. With its modest stimulus winding down, Germany’s growth slowed sharply late last year, and its economic output still has not recovered to its prerecession peak. Output in the United States – where the stimulus program has been bigger and longer lasting – has recovered. This country would now need to suffer through a double-dip recession for its gross domestic product to be in the same condition as Germany’s.
The New York Times article provided this graph which shows the evolution of real GDP (indexed to 100 at March 2008) for the United States, the United Kingdom and Germany to demonstrate that “the German boom didn’t last long. With its modest stimulus winding down, Germany’s growth slowed sharply late last year, and its economic output still has not recovered to its pre-recession peak. Output in the United States – where the stimulus program has been bigger and longer lasting – has recovered”.
The next graph is my version of the NYT graph so as to include a few more nations. The same design principle is used – Real GDP is indexed to 100 in the March quarter 2008. All the data is taken from the OECD Main Economic Indicators (http://www.oecd.org).
Of the nations compared, only the US and Australia are now back to the levels of GDP at the time the crisis began. Australia, courtesy of a very significant and timely fiscal stimulus, clearly had a slight slow down and has since maintained growth. However, even in the case of Australia, the withdrawal of the fiscal stimulus (record mining boom notwithstanding) has seen growth stall and start flat lining. But the other three nations are still mired in real GDP levels well below the pre-recession levels.
I thought it would be useful to examine the relative labour market performance as well and it is here that interesting results are seen.
The next graph provides the same comparison (but with Germany included separately now due to data availability) using total employment (seasonally adjusted). The index is set at 100 for the March quarter 2008. If I had have made the scales of the vertical axis comparable then you have lost some of the detail but you would have seen that the variance of employment was lower than Real GDP (that is, it fluctuated within a narrower band).
I note that the employment indexes do not take into account underemployment (tendency for a rising proportion of part-time jobs to under-provide hours relative to the preferences of the labour force). Clearly, Australia’s superior real GDP performance is mirrored in its relative employment performance.
While Germany has not succeeded in reaching its pre-recession real GDP levels it managed to insulate employment from the output collapse.
The stand out is the US which shed jobs dramatically as real GDP plummeted and as real growth has returned the recovery in the jobs market is virtually non-existing. There is a crying need for direct job creation schemes in the US to address this tendency to grow without jobs.
Finally, the next graph provides the same comparison using the unemployment rate (seasonally adjusted). As before the index is set at 100 for the March quarter 2008.
Germany once again is the only nation of those compared that has been able to insulate its unemployment rate from its real GDP loss. The analogue of the employment collapse in the US is the very stark rise in the unemployment rate since March 2008. The United Kingdom is also a poor performer in that regard.
The two nations that are now leading the charge in austerity – the UK and the US – have severely debilitated labour markets and show very little sign that any nascent growth to date – which has been driven solely by the public stimulus – has provided any tangible benefits to the labour market.
The worry is that with the UK and the US already locked into a residual high unemployment as a consequence of their inadequate fiscal responses to the private spending collapse in 2008 and 2009, as the fiscal austerity bites, their unemployment rates will ratchet up again. Already, they are experiencing rising long-term unemployment given how long the labour market has been depressed.
I saw a news alert from the US Bureau of Labor Statistics today which says that mass layoffs rose in the last month.
I heard a podcast yesterday (February 23, 2011) – The Business podcast: Youth unemployment – that relates that “One in five adults under 25 are out of work” in Britain and this group are becoming a “lost generation”. The push for austerity will reinforce that malaise.
I also saw a program on ABC TV the other day (Foreign Correspondent) – Goodbye, My Ireland – which documented the flood of young Irish workers who are moving to Australia (mostly) because there are zero prospects for work in the Ireland in the coming years. So the unemployment rate, already massive, is being held down by supply exits to other countries. Some government leadership!
Leonhardt makes a reasonable point that if there is poorly targetted or inefficient government spending in the US then a fierce political debate can help to make cuts where the spending is not advancing public purpose (my words). He actually said:
If the economy were at a different point in the cycle – not emerging from a financial crisis – the coming fight over spending could actually be quite productive. Republicans could force Democrats to make government more efficient, which Democrats rarely do on their own. Democrats could force Republicans to abandon the worst of their proposed cuts, like those to medical research, law enforcement, college financial aid and preschools. And maybe such a benevolent compromise can still occur over the next several years.
This would only be viable if the economy was at full capacity and the spending cuts were going to ease inflationary pressures. There is no room for net public spending cuts in the US at present. I would alter the composition of spending rather drastically over time but at present I would be adding to net spending as I re-arrange the deck chairs.
Leonhardt clearly understands that now is not the time to be making major public spending cuts:
The immediate problem, however, is the fragility of the economy. Gross domestic product may have surpassed its previous peak, but it’s still growing too slowly for companies to be doing much hiring. States, of course, are making major cuts. A big round of federal cuts will only make things worse.
Exactly. Spending equals incomes. If you cut spending you cut income and those cuts multiply throughout the economy creating even larger reductions in overall spending. Spending cuts now will severely damage and already struggling labour market in the US. It is madness to contemplate such cuts.
The US politicians should only be arguing about how large the spending impulse should be to directly create jobs. That is the only valid political challenge facing the US at present.
I particularly liked Leonhardt’s take on Ricardian Equivalence. He says:
Let’s start with the logic. The austerity crowd argues that government cuts will lead to more activity by the private sector. How could that be? The main way would be if the government were using so many resources that it was driving up their price and making it harder for companies to use them.
Yes. At full employment, any sector that competes for resources at market prices will drive their price up and squeeze the other sectors. The US is not even remotely at that position at present. It has millions of workers idle who can all be brought back into production if there is sufficient spending.
I often here the turn of phrase – but “there are not enough jobs” to which I typically reply – “there are plenty of jobs – a near infinity of them – just no-one willing to pay the wages for workers to perform those jobs. The US government is in a unique position that it can always afford to pay those wages and should do so by immediately announcing a Job Guarantee.
Leonhardt notes the slack in the system:
… there is no evidence that the government is gobbling up too many workers and keeping them from the private sector. When John Boehner, the speaker of the House, said last week that federal payrolls had grown by 200,000 people since Mr. Obama took office, he was simply wrong. The federal government has added only 58,000 workers, largely in national security, since January 2009. State and local governments have cut 405,000 jobs over the same span.
The claim by Boehner was wrong but also irrelevant. There are several million workers without work. By definition these workers are attracting a zero bid for their services from the private sector. The public sector can employ these workers at a living minimum wage (which at least provides income security at a reasonable standard of living) and when the private sector decides it is ready to hire again – the dynamic is simple.
Offer them an interesting job at a wage above the Job Guarantee wage and you will attract these workers out of the JG pool.
Leonhardt notes that “(w)ithout the government spending of the last two years – including tax cuts – the economy would be in vastly worse shape. Likewise, if the federal government begins laying off tens of thousands of workers now, the economy will clearly suffer.”
This is the basic macroeconomic rule – you cannot have growth in output or employment without increased spending. You do not get growth by cutting spending.
At present private spending in the US (and the UK) and almost everywhere is subdued. There is an incredible private debt overhang to eliminate as a result of the out of control credit binge (which was urged along by the very same people and ideas that are now posturing for austerity).
There is a long way to go before the private sector will have adequately restructured their balance sheets such that they will be prepared to spend freely again. Until that time economic growth will have to be driven by public spending. Cut it and you will cut growth. While I noted above that I am cautious about making predictions based on one month’s data – I am categorical about that prediction – cut spending and you cut growth.
That’s the historical lesson of postcrisis austerity movements. The history is a rich one, too, because people understandably react to a bubble’s excesses by calling for the reverse. When Franklin Roosevelt was running for president in 1932, he repeatedly called for a balanced budget.
But no matter how morally satisfying austerity may be, it’s the wrong answer. Hoover’s austere instincts worsened the Depression. Roosevelt’s postelection reversal helped, but he also prolonged the Depression by raising taxes and cutting spending in 1937. Only the giant stimulus program known as World War II finally ended the Depression. When the private sector is hesitant to spend, the government has to – or no one will.
I like the reference to the motivation – moral satisfaction. That is ultimately what all this is coming down to – a religious crusade by zealots aided and abetted by a much more sinister motivation which is to destroy the capacity of unions to bargain for gain for their members.
And in Britain
The catastrophe that is Ireland speaks for itself. Its austerity campaign has been under way for nearly 2 years now and things keep getting worse there as any reasonable understanding of how a macroeconomic system operates would predict. There is no such thing as a expansionary fiscal contraction.
The news from Britain which is just about to really feel the chill from the austerity cuts continues to deteriorate. The UK Guardian article (February 21, 2011) – Gloom over household finances dents recovery hopes – reports that the latest “Markit household finance index fell this month to its lowest level since March 2009 as business confidence declined for the fourth consecutive quarter”.
That is not consistent with the main thrust of neo-liberal macroeconomics. The bulk of my profession try to spin the story (that is, they lie) that private sector spenders are Ricardian in nature – that is, they allege that private spending of late has been subdued because they are households and firms are so scared that the government will ramp up taxes to pay the budget deficit back.
Now that the government has announced it will be cutting discretionary net spending (which is not the same as saying that the deficit will fall), the mainstream economics prediction should have seen private spending booming by now.
The UK Guardian article says that:
Consumers and businesses are increasingly gloomy about the outlook for their own finances over the next year, leaving the government with a headache as it tries to boost confidence in the UK’s economic prospects.
The Markit household finance index fell this month to its lowest level since March 2009, while a measure of business confidence declined for the fourth consecutive quarter.
That is consistent with the view that households are scared of losing their jobs and so are trying to save and firms will not spend (invest in new productive capacity) unless they think they will be able to sell the increased production in the future. With households feely gloomy and government spending falling there is nothing that would excite private business firms. Hence their confidence is declining as well.
Further, governments do not pay back deficits!
The Survey shows that household confidence “has slumped back to the levels seen during the worst part of the recession”.
All the indicators are that real household incomes will continue to decline (see latest Bank of England Inflation Report).
I recommend this article in the UK Guardian (February 20, 2011) – These cuts don’t go far enough – it’s time we taxed Colin Firth’s Bafta – which concludes that:
In fact, as anyone sensible could guess, the cuts are based on emotional and ideological rather than economic concerns – in short, our politicians want us to be bloody miserable … We may have safeguarded some trees and be fighting library closures, but there are so many other areas of vulnerability left open, so many other pleasures that can be redefined in terms of monetary value and tax revenue. Every day, voters arrogantly use doorknobs without paying any kind of fee. Conversations are thoughtlessly carried on using copyrighted brand names, privately generated phrases and words that could and should be registered properly with clearly defined owners who can benefit from their regulated exploitation
A light-hearted way of saying these austerity ideologues are out of control and without the intellectual authority to wreak such damage on their nations.
That is enough for today!