Yesterday austerity, today growth – but leopards don’t change their spots

It has been interesting to watch how various members of my profession are dealing with the on-going crisis over the last 4 years. Clearly, imbued with the notion that the “business cycle” is dead, which the mainstream macro economists had been attempting to establish as a given in the public debate, most economists were in denial at the outset of the crisis. That denial moved into the manic deficit terrorism that has sought to reconstruct the private debt crisis into a sovereign debt crisis – which allowed them to vent on their pet topic – dislike of government fiscal policy when used to increase employment. They have no problems with active fiscal policy when it is aimed at contraction. They just hate the public sector supporting growth even when the private sector is incapable of doing so. But as the empirical reality has increasingly rejected the predictions of the mainstream macroeconomic models – there has been no inflation breakout or rising interest rates or sovereign government insolvency – there has been a shift going on. Some of those that were advocating austerity now seem to be advocating growth. But when you dig a little deeper there is no fundamental catharsis in my profession going on. The only motivation for those now saying Europe needs growth not austerity is that they are trying to distance themselves from the train wreck that the political leaders are creating there. As the title suggests – yesterday austerity, today growth – but leopards don’t change their spots.

The dominant macroeconomic models used by the mainstream for research and teaching failed, categorically, to predict the crisis even when it was obvious some years before the collapse of the US property market that the global economy would go into a very deep recession.

It was only a matter of when and how deep the recession would be.

So it wasn’t surprising that the majority of my profession were blithe to the reality that was unfolding, first in the US, and then, relatively quickly, throughout the rest of the world.

That denial was in most cases manifested as a sullen silence. One might assume that the profession had no idea of what was happening and the tools that they use on a daily basis in classrooms and in their journal article writing provided them with no answers.

Then there are those, a minority, who expressed this denial in more aggressive terms. These were some of the leading lights who had more to lose by way of reputation, given their role in perpetuating the neo-liberal myths of self-regulating, efficient markets. I’m thinking here of characters like Chicago economist Eugene Fama who claimed that the crisis demonstrated how efficient markets actually were.

You might like to read this interview that Fama gave to the New Yorker columnist John Cassidy in early 2010 – Interview with Eugene Fama.

Fama demonstrated an extraordinary arrogance when Cassidy pushed him about the credibility of the efficient markets theory in the face of the global financial crisis.

Fama said that the crisis was the result of poor “government policy … not a failure of the market”. He actually had the audacity to claim that the real estate and financial crisis was a reaction rather than a cause of the resulting real economic crisis.

When he was asked, then, what caused the real economic crisis he replied “We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that.”. The transcript of the interview notes that Fama was laughing at this point.

Similar examples of this type of bravado from my profession can be found throughout the written and spoken media. For example, Robert Barro from Harvard has given similar denials in the press.

However, it didn’t take long for the silent majority of my profession to become more vocal and to begin to reassert their neo-liberal leanings in the public debate.

At that point, the private debt crisis (clearly a failure of deregulated financial) was reconstructed as a so-called sovereign debt crisis and the attack on government fiscal activism became almost manic in its intensity.

Economists everywhere began lecturing the public on the evils of budget deficits, the impending hyperinflation that would result from these “excessive” deficits and the “cavalier” behaviour of the central banks, and the massive rise in interest rates that would follow.

All of these predictions came from their half-baked macroeconomic models, which dominate the university teaching programmes, but which failed to say anything about the crisis, either before its manifestation or after its appearance.

Obviously their predictions have failed to materialise. Miserably so. The reason? Answer: their models were inapplicable to the monetary system that they purported to explain. If any other profession had have been so wrong their certificates to practice would have been withdrawn by authorities.

The credibility of my profession is in tatters. That was obvious at the outset of the crisis but the message has not permeated the public debate because of a extremely biased, neo-liberal oriented media.

Most of the financial commentary just provides oxygen for the rabid ideas of mainstream academic economists. That’s no surprise given that most of the financial press have probably been educated (read: indoctrinated) in mainstream economic programs within the university system.

So it becomes a self-perpetuating myth-making machine – the type of which allows degenerating paradigms (in the Lakatosian sense) to maintain their dominance in the face of this obvious credibility loss.

But now after for some 4 years of crisis with no clear end in sight this credibility gap has reached gargantuan proportions. Even some of the deniers and austerity proponents are starting to change tune. At least on the surface the message is changing. However, when you dig a little deeper and piece together other statements that are made the conclusion is that the “tune change” is superficial, to say the least.

As an example, consider this blog – My Sunday media nightmare from early 2010.

Overlaying the thoughts expressed above, there is also the issue of changing terminology which seems to evolve to suit ideological needs. So what used to be called the centrist position in politics is now typically a right-wing position. Those who are typically thought of as being “progressive” parade as deficit terrorists – and – Keynesians as neo-liberals.

On February 5, 2010, the German paper Der Spiegel published an “Interview with German Government Economic Adviser” under the title – Euro Zone ‘Could Cope with Greek Bankruptcy’. The adviser in question was one Peter Bofinger who they describe as “a prominent economic adviser to the German government” – one of the “Five Wise Men” who make up the “government-appointed” German Council of Economic Experts. He is also an academic professor of economics in Germany.

He was asked by Der Spiegel whether the harsh austerity measures imposed on Greece by the EC were “risking a state bankruptcy?” The so-called Keynesian Bofinger said:

To the contrary. The tough stance against Greece is the only correct approach. A cash injection from Brussels would have set a dangerous precedent – it would have signalled to other problem countries like Portugal or Spain that when the going gets tough, the European Union will rescue them.

A very clear statement that fiscal austerity was correct and that the decision by the EMU not to have a fiscal redistribution capacity, which is the hallmark of any effective federal system remains correct.

He also clearly thought that it was reasonable that asymmetric demand shocks to a region in a monetary system have to be dealt with by invoking harsh reductions in standards of living on that particular region which ultimately threatens social stability.

This “German” vision of the EMU goes to the heart of its problems – its flawed design from the outset. If Germany or any other nation within the EMU didn’t trust other nations, and it is clear from the design of the SGP provisions that they didn’t trust the Club Med nations, then there is very little to be gained from entering the federation.

He was asked whether the unfolding Greek crisis (at the time) would threaten the Eurozone and he replied:

Some of my fellow economists are going too far. Compared to other currency zones, the euro zone is doing a lot better than many claim. The national debts and new state borrowing is lower than in the United States. And in an emergency it could also cope with a Greek bankruptcy. The country produces just 2.6 percent of the euro zone’s GDP.

So, he didn’t think it would be a problem. The Eurozone was basically sound and Greece was a minor (2.6 per cent) issue. Even if Greece went bankrupt (and presumably faced riots in the streets) then the Eurozone would cope because Greece “produces just 2.6 percent of the euro zone’s GDP.”

That was once again a clear statement that the nations within the EMU do not share common goals such as advancing public purpose within the zone. As long as Greece doesn’t damage Germany then who cares!

Spiegel then asked him whether his assessment of the euro zone debt to GDP ratio (88 percent) was low? He had indicated in an earlier answer that it was below other nations. Bofinger replied:

It is not low, but it is lower than in the US. There, the national debt is 92 percent of GDP. In Japan, it is even 197 percent. And the United Kingdom’s budget deficit is far worse than that of the euro zone. And as far as a possible loss of confidence is concerned, let me point out that the state of California has been on the verge of bankruptcy for months and its share of the US’s GDP is about 13 percent. Viewed from that perspective, my fear of a domino effect is limited.

Here is is confusing the readership by conflating different monetary systems and making invalid comparisons between them. This tactic has been regularly used by the mainstream economists to distort the debate.

The reality is that any one of the EMU nations could become insolvent because they gave up their currency issuing capacity and the ECB has stated they will not be bailed out under Treaty rules.

However, Japan, the US and the UK are sovereign, currency-issuing nations and as such face no risk of insolvency. Their central banks can control yields if they desire to and the governments can always meet interest servicing payments.

It is hard to tell whether economists such as Bofinger understand this distinction or deliberately ignore it. My conjecture is that they don’t understand it because the mainstream monetary theory is constructed in such a way that such important (crucial) distinctions are not entertained, which is one of the reasons that theoretical framework fails.

Further, the reference to California is interesting. There is limited fiscal redistribution operating from the federal down to the state government level in the US. During this crisis, that federal mechanism has been deliberately insufficient and this has meant that the overall public sector contribution to real GDP growth has been inadequate – hence the duration of the recession has bee longer than it could have been.

But at least the US federal system has a capacity for such federal-state fiscal redistribution.Such a capacity is essential for any monetary system where regional units (member states) are subject to asymmetric demand shocks (which are transmitted via differing industry composition and trade structures).

The EMU designers decided not to incorporate that essential element in their system largely reflecting their ideological aversion to the “state”. As a result, they are left with the Eurocrisis and, by hook or by crook, they are being forced to create ad hoc versions to stave off the bankruptcy of some of its member states.

The only thing that is preventing a widespread disintegration of the EMU at present is the quasi-fiscal role the ECB is playing (via its Securities Markets Program) a fact that must grate severely with the Euro elites who abhor such an eventuality.

Spiegel then said to Bofinger “you’re a follower of Keynesian economics. As such, you believe in stimulating demand in order to increase production and employment and you support the idea of hefty government deficit spending to make that happen. But don’t the exploding deficits make you uneasy?”

Bofinger: After the Lehman bankruptcy, there was no alternative to expensive bank bailout programs and very expansive financial policies. But now the key thing is to organize an exit that is both cautious and rigorous exit strategy. That’s why in our new annual report (editor’s note: provided by the panel of economic advisers to the German federal government), we propose a European consolidation pact under which all EU member states would be obligated in a transparent and credible way to once again achieve balanced budgets. The growing disquiet in the markets shows how important such action is. But equally as bad as the state deficits is the anarchic state of currency policies.

Refer back to my point above about shifting terminology. Apparently, Bofinger thinks this representation is a “Keynesian” position.

There is nothing in Keynes that says that a balanced budget is desirable, achievable or otherwise. It is all about context. Representing balanced government budgets as the benchmark to get back is straight out of mainstream (neo-liberal) macroeconomic ideology.

The balanced-budget-is-good ideology is what is driving the damaging fiscal austerity and prolonging the crisis.

It is now two years since Bofinger gave this interview and the Euro leaders (as well as other heads of state such as the UK government) have followed his advice to the tee.

The results have been disastrous and four-years after this mess began we are still calling it a crisis with the potential to deteriorate even further.

Bofinger’s views at the time were clearly part of the problem rather than the solution.

Now fast-track to February 6, 2012 – two years later.

It is reasonable for one to change one’s views if confronted by evidence that confirms the previously-held views were erroneous. If these views were integrated within a unified theoretical framework and the evidential challenge demonstrated the inadequacy of that framework then you would also expect the person to embrace a paradigm switch.

One urban myth that abounds (probably via the writing of American economist Paul Samuelson) is that John Maynard Keynes responded to criticism during the Great Depression that he had altered his viewpoint with the following statement:

When the facts change, I change my mind. What do you do, sir?

It is a lovely quote but no primary source which links Keynes to the quote. The Wall Street Journal article (February 11, 2011) actually offered a $US20 reward for any researcher who could find a definitive attribution.

But the sentiment is sound and all “scientists” should recast their theories when confronted with evidential repudiation.

The UK Guardian article (February 6, 2012) – Europe can’t cut and grow – was co-authored by the same Peter Bofinger.

The sub-title read “The EU needs a growth compact, not a fiscal one. Swift action on tax and jobs is the way out of the crisis”.

That doesn’t sound like advocacy for harsh fiscal austerity and the authors couldn’t be more emphatic:

Overspending by governments, we have been told, triggered this crisis. The cure thus lies in immediate austerity, hence last month’s German-led push for a eurozone fiscal compact and the UK’s pursuit of similar policies.

But, as demonstrated by the experiences of Greece, Portugal and Spain, this course leads to biting, deep recessions and worsens public indebtedness. The IMF acknowledged as much last week. A focus on growth, not austerity, is the correct answer for Europe’s ills.

So an about-face! As I will argue later we should have deep suspicions about this given other recent offerings from Bofinger.

The authors provide an impeccable rationalisatin of why the Ricardian justifications of fiscal austerity were mis-placed:

The case for “growth-friendly austerity” relies on the argument that public cuts are compensated for by consumers and businesses spending more, and with greater efficiency. However, the collapse of confidence wherein everyone expects the economy to worsen before (if) it gets better, along with excessive levels of private indebtedness, means that consumers and firms are busy repaying debt or building rainy-day funds, not spending and investing.

It is a pity that Bofinger wasn’t saying this a few years ago. It was obvious at the time that it the Ricardian assertions (that private spending would boom after governments cut their deficits because private agents would stop saving for expected higher future taxes) were built on flawed assumptions about human behaviour (including perfect foresight of fiscal dynamics) and the predictions of the proponents of this notion had been systemtically negated by evidence on many occasions since the ideas surfaced.

The Ricardian claims are just bare-faced drivel designed to provide some “authority” to the anti-state statements of the proponents.

It was always obvious that private setor spending would contract further once the government started to cut net spending. When unemployment is rising, consumers (en masse) are not about to increase spending, especially when they have just been on a credit-binge and are now carrying record levels of debt and watching housing prices fall (collapse in some nations).

Further, business firms were never going to ramp up investment in productive capacity if consumer spending growth was going backwards. First, they could meet current demand for goods and services with existing capacity (with plenty of idle capacity to spare). Second, they were not going to risk building new capacity when the future state of aggregate demand was so uncertain.

This has always been the case. But in the current recession – which originated as a “balance sheet” recession – the conservatism of private spending was reinforced by the events that preceded the crisis.

The hallmark of the neo-liberal years leading up to the crisis was the redistribution of national income towards profits in most advanced nations as real wages growth was deliberately suppressed and the gap between it and productivity growth widened.

Consumption growth could only be maintained by increasing indebtedness. That was an atypical trend. Previously, consumption growth was real wage-driven as a result of productivity growth.

So as we watched the gap between productivity and real wages growth opening through the 1980s and on it was obvious that the growth strategy being employed by governments (who were deregulating financial and labour markets) was flawed and unsustainable. The crisis was inevitable.

The authors of the Guardian article continue to mount the case against fiscal austerity (as if they knew this all along) and call on EU leaders to “adopt a binding pledge to increase growth-enhancing public investments”:

The axe of austerity falls first and foremost on public investment, as it is easier to cut than other forms of public expenditure. This undermines current growth by shrinking the level of economic activity, and also jeopardises the potential for future growth. Every euro of cuts today could result in many euros of lost growth.

Of-course it does. It is a pity that Bofinger didn’t argue this two years ago.

The authors also note that if you want to increase tax revenue the best way to do it is to increase growth not cut spending. A part of the blindness of the proponents of fiscal austerity is their faith that the automatic stabilisers will work in a pro-cylical manner. They never have and that is why budget deficits rise in recessions and fall in growth periods without the government doing anything.

When governments are busily cutting discretionary net spending which deliberately undermines economic growth then the automatic stabilisers are likely to deliver larger deficits. The strategy becomes self-defeating in terms of its goals (to reduce the deficit) and highly damaging in terms of the real economy.

The authors still seem obsessed with budget aggregates though and launch into an extended discussion about the need to “crack down on tax evasion and avoidance”.

While tax systems should be fair and operate to reduce aggregate demand and/or reallocate real resources into more productive uses the lack of revenue growth in the Eurozone at present is not the problem.

The problem is a lack of growth and that is the result of a lack of spending. The ECB has all the capacity it requires (as the Euro-issuing authority) to support public spending sufficient to generate growth and a return of private confidence and a better mix of public and private spending.

The unwillingness of the Euro leaders to see that is the problem.

The authors of the Guardian article also do not seem to see it. They think the solution lies in collecting more revenue from “under-taxed” sectors and redistibuting that revenue to public investment.

That would be a sensible strategy if the desire was to reduce the capacity of the private sector to spend in an environment where total spending was more or less sufficient to achieve full utilisation of productive resources – including labour.

But what the Eurozone requires is a massive expansion in overall aggregate demand. Redistributing tax revenue will not be sufficient even if the increased taxation on some sectors, people, and activites was desirable.

So the question that the authors fall short of answering is where the spending that would support the growth pact will come from. They cannot bring themselves to articulate the obvious logic of their position – that budget deficits have to rise and the only way that can happen in the flawed environment of the EMU is if the ECB funds it all.

Having failed to come to terms with that reality, the authors then fall back to form with their finale:

Finally, the structural reforms in crisis countries must continue and the liberalisation of services in the single market must be accelerated. These policies will help boost future growth but work best in a growing, not shrinking, economy. Without a growth compact, the social and employment crises in Europe will only get worse. With it, we have a fighting chance to emerge stronger.

More deregulation, privatisation and welfare retrenchment. We have had two or more decades of that strategy – and it hasn’t delivered on its promises.

The other reason I suspect that characters like Bofinger are still cut in the neo-liberal mould and this reversion to “growth” rather than “austerity” (in a two-year period) is not the full monty is because in other recent articles that he has co-authored a different message emerges.

Previously, Bofinger had written (with co-authors) several articles advocating pro-EMU arrangement without full fiscal capacity.

In this article (November 9. 2011) – A European Redemption Pact – which was “the joint work of the five members of the German Council of Economic Experts”, he “proposes a novel solution to the crisis”.

The “novel solution” juxtaposes “two equally important yet conflicting principles”:

The principle of accountability demands that member countries engage into an irrevocable consolidation of their public finances and, eventually, into a reduction of public debt back into the realm of universally acknowledged fiscal sustainability.

The principle of solidarity, on the other hand, requires the stronger member countries to support the weaker ones in times of severe crisis, thereby weakening the incentives among the recipients of any aid to display sufficient fiscal discipline once the climax of the crisis has passed. (emphasis was in the original)

Note the terminology – “irrevocable consolidation of their public finances”, “universally acknowledged fiscal sustainability”. They are all neo-liberal buzz words.

I could have easily said that the principle of accountability should be to the people that elect the member governments and that requires they pursue full employment and that the ECB is then required as the central bank of all member states to fund appropriate levels of spending to achieve that accountability.

That is the anathema to what Bofinger and his “German Council of Economic Experts” are on about.

Who “universally” acknowledges the Stability and Growth Pact rules regarding “fiscal sustainability”? Only those who invoked them! There is nothing definitive or scientific about the fiscal rules at all. They were imposed by conservatives as a way of limiting the role of the state.

The “German Council of Economic Experts” how propose to develop “a mechanism” for “combining these two principles” which will “be able to calm markets by demonstrating convincingly that solidarity will prevail”.

And so their proposed mechanism – the “European Redemption Pact” – maintains the myth that the Stability and Growth Pact represents sound fiscal constraints. They propose some accounting tricks to segment public debt into a SGP-compliant portion (up to 60 per cent), which the bond markets would continue funding and the remainder, which would be funded via the European Redemption Fund, a cross-country loans scheme.

They say that there should be “strings attached to the participation” and these would be in the form of “debt brakes” (aka as fiscal austerity). Who would have thought?

Harsh penalties are proposed for nations that deviate from the rules.

At the end of it the authors claim they support a “long term commitment to the Eurozone” but think it needs tighter fiscal rules. A very German-centric view.

In other words, they haven’t learnt a thing from this crisis. They still think that the EMU can function as a viable monetary system capable of withstanding asymmetric aggregate demand shocks while at the same time delivering widespread prosperity. The neo-liberal myth!

They are wrong on that account and clearly are part of the problem.

An earlier similar proposal from Bofinger (May 20, 2010) – Fixing Europe: A ‘European Consolidation Pact’ proposal – talked about various elements that should comprise this “Pact” including obligatory balanced budgets where “fiscal consolidation were organised as a disciplined march of the whole troop rather than a courageous foray by the vanguard”,

So Europe goose-stepping its way into extended recession and high unemployment.

Another element they proposed was automatic tax increases “in case that country is straying from the defined path” (of debt).

You get the drift.

Conclusion

More and more economists are trying to distance themselves from the obvious failure of the fiscal austerity programs, that they formerly advocated with relish.

The problem is that they don’t understand what the actual problem is. And while they were advocating austerity yesterday and growth today, when it comes to detailing how the growth might occur they lapse back into austerity-thinking – balanced budgets etc.

The reality is that there is no fundamental change in thinking emerging from this quarter.

I am still in Darwin today where the weather is very hot (tropical climate) and the sky is broad.

I am presenting a workshop at the Charles Darwin University later today and having discussions with their officials about potential development. I may post the seminar audio tomorrow. Topic – why neo-liberalism has failed and how regional development strategies have to start with a firm grounding in macroeconomics (read: Modern Monetary Theory (MMT)).

Here is where I was early today for a meeting with the Northern Territory Treasurer:

That is enough for today!