Greece was the disaster austerians were looking for
This may sound too good to be true – and it was. But policymakers knew what they wanted to hear, so it was, as Business Week put it, “Alesina’s hour”. The doctrine of expansionary austerity quickly became orthodoxy in much of Europe. “The idea that austerity measures could trigger stagnation is incorrect,” declared Jean-Claude Trichet, then the president of the European Central Bank, because “confidence-inspiring policies will foster and not hamper economic recovery”.
Besides, everybody knew that terrible things would happen if debt went above 90% of GDP.
Growth in a Time of Debt, the now-infamous 2010 paper by Carmen Reinhart and Kenneth Rogoff of Harvard University that claimed that 90% debt is a critical threshold, arguably played much less of a direct role in the turn to austerity than Alesina’s work. After all, austerians didn’t need Reinhart and Rogoff to provide dire scenarios about what could happen if deficits weren’t reined in – they had the Greek crisis for that.
At most, the Reinhart and Rogoff paper provided a backup bogeyman, an answer to those who kept pointing out that nothing like the Greek story seemed to be happening to countries that borrowed in their own currencies: even if interest rates were low, austerians could point to Reinhart and Rogoff and declare that high debt is very, very bad.
What Reinhart and Rogoff did bring to the austerity camp was academic cachet. Their 2009 book This Time is Different, which brought a vast array of historical data to bear on the subject of economic crises, was widely celebrated by both policymakers and economists – myself included – for its prescient warnings that we were at risk of a major crisis and that recovery from that crisis was likely to be slow. So they brought a lot of prestige to the austerity push when they were perceived as weighing in on that side of the policy debate. (They now claim that they did no such thing, but they did nothing to correct that impression at the time.)
When the coalition government came to power, then, all the pieces were in place for policymakers who were already inclined to push for austerity. Fiscal retrenchment could be presented as urgently needed to avert a Greek-style strike by bond buyers. “Greece stands as a warning of what happens to countries that lose their credibility, or whose governments pretend that difficult decisions can somehow be avoided,” declared David Cameron soon after taking office. It could also be presented as urgently needed to stop debt, already almost 80% of GDP, from crossing the 90% red line.
In a 2010 speech laying out his plan to eliminate the deficit, Osborne cited Reinhart and Rogoff by name, while declaring that “soaring government debt … is very likely to trigger the next crisis.” Concerns about delaying recovery could be waved away with an appeal to positive effects on confidence. Economists who objected to any or all of these lines of argument were simply ignored.
But that was, as I said, five years ago.
To understand what happened to austerianism, it helps to start with two charts.
The first chart shows interest rates on the bonds of a selection of advanced countries as of mid-April 2015. What you can see right away is that Greece remains unique, more than five years after it was heralded as an object lesson for all nations. Everyone else is paying very low interest rates by historical standards.
This includes the United States, where the co-chairs of a debt commission created by President Obama confidently warned that crisis loomed within two years unless their recommendations were adopted; that was four years ago. It includes Spain and Italy, which faced a financial panic in 2011-2012, but saw that panic subside – despite debt that continued to rise – once the European Central Bank began doing its job as lender of last resort.
It includes France, which many commentators singled out as the next domino to fall, yet can now borrow long-term for less than 0.5%.
And it includes Japan, which has debt more than twice its gross domestic product yet pays even less.
The Greek exception
10-year interest rates as of 14 April 2015
Chart 1Source: Bloomberg
Back in 2010 some economists argued that fears of a Greek-style funding crisis were vastly overblown – I referred to the myth of the “invisible bond vigilantes”. Well, those bond vigilantes have stayed invisible. For countries such as the UK, the US, and Japan that borrow in their own currencies, it’s hard to even see how the predicted crises could happen. Such countries cannot, after all, run out of money, and if worries about solvency weakened their currencies, this would actually help their economies in a time of weak growth and low inflation.
Chart 2 takes a bit more explaining. A couple of years after the great turn towards austerity, a number of economists realised that the austerians were performing what amounted to a great natural experiment. Historically, large cuts in government spending have usually occurred either in overheated economies suffering from inflation or in the aftermath of wars, as nations demobilise.
Neither kind of episode offers much guidance on what to expect from the kind of spending cuts – imposed on already depressed economies – that the austerians were advocating. But after 2009, in a generalised economic depression, some countries chose (or were forced) to impose severe austerity, while others did not. So what happened?
Austerity and growth 2009-13
More austere countries have a lower rate of GDP growth
Chart 2Source: IMF
In Chart 2, each dot represents the experience of an advanced economy from 2009 to 2013, the last year of major spending cuts. The horizontal axis shows a widely used measure of austerity – the average annual change in the cyclically adjusted primary surplus, an estimate of what the difference between taxes and non-interest spending would be if the economy were at full employment. As you move further right on the graph, in other words, austerity becomes more severe. You can quibble with the details of this measure, but the basic result – harsh austerity in Ireland, Spain, and Portugal, incredibly harsh austerity in Greece – is surely right.
Meanwhile, the vertical axis shows the annual rate of economic growth over the same period. The negative correlation is, of course, strong and obvious – and not at all what the austerians had asserted would happen.
Again, some economists argued from the beginning that all the talk of expansionary austerity was foolish – back in 2010 I dubbed it belief in the “confidence fairy”, a term that seems to have stuck. But why did the alleged statistical evidence – from Alesina, among others – that spending cuts were often good for growth prove so misleading?
The answer, it turned out, was that it wasn’t very good statistical work. A review by the IMF found that the methods Alesina used in an attempt to identify examples of sharp austerity produced many misidentifications.
For example, in 2000 Finland’s budget deficit dropped sharply thanks to a stock market boom, which caused a surge in government revenue – but Alesina mistakenly identified this as a major austerity programme. When the IMF laboriously put together a new database of austerity measures derived from actual changes in spending and tax rates, it found that austerity has a consistently negative effect on growth.
Yet even the IMF’s analysis fell short – as the institution itself eventually acknowledged. I’ve already explained why: most historical episodes of austerity took place under conditions very different from those confronting western economies in 2010.
For example, when Canada began a major fiscal retrenchment in the mid-1990s, interest rates were high, so the Bank of Canada could offset fiscal austerity with sharp rate cuts – not a useful model of the likely results of austerity in economies where interest rates were already very low. In 2010 and 2011, IMF projections of the effects of austerity programmes assumed that those effects would be similar to the historical average. But a 2013 paper co-authored by the organisation’s chief economist concluded that under post-crisis conditions the true effect had turned out to be nearly three times as large as expected.
So much, then, for invisible bond vigilantes and faith in the confidence fairy. What about the backup bogeyman, the Reinhart-Rogoff claim that there was a red line for debt at 90% of GDP?
Well, in early 2013 researchers at the University of Massachusetts examined the data behind the Reinhart-Rogoff work. They found that the results were partly driven by a spreadsheet error. More important, the results weren’t at all robust: using standard statistical procedures rather than the rather odd approach Reinhart and Rogoff used, or adding a few more years of data, caused the 90% cliff to vanish.
What was left was a modest negative correlation between debt and growth, and there was good reason to believe that in general slow growth causes high debt, not the other way around.
By about two years ago, then, the entire edifice of austerian economics had crumbled. Events had utterly failed to play out as the austerians predicted, while the academic research that allegedly supported the doctrine had withered under scrutiny. Hardly anyone has admitted being wrong – hardly anyone ever does, on any subject – but quite a few prominent austerians now deny having said what they did, in fact, say. The doctrine that ruled the world in 2010 has more or less vanished from the scene.
In the US, you no longer hear much from the deficit scolds who loomed so large in the national debate circa 2011. Some commentators and media organisations still try to make budget red ink an issue, but there’s a pleading, even whining, tone to their exhortations. The day of the austerians has come and gone.
Yet Britain zigged just as the rest of us were zagging.
By 2013, austerian doctrine was in ignominious retreat in most of the world – yet at that very moment much of the UK press was declaring that doctrine vindicated. “Osborne wins the battle on austerity,” the Financial Times announced in September 2013, and the sentiment was widely echoed.
What was going on? You might think that British debate took a different turn because the British experience was out of line with developments elsewhere – in particular, that Britain’s return to economic growth in 2013 was somehow at odds with the predictions of standard economics. But you would be wrong.
Austerity in the UK
Cyclically adjusted primary balance, percent of GDP
Chart 3Source: IMF, OECD, and OBR
The key point to understand about fiscal policy under Cameron and Osborne is that British austerity, while very real and quite severe, was mostly imposed during the coalition’s first two years in power. Chart 3 shows estimates of our old friend the cyclically adjusted primary balance since 2009. I’ve included three sources – the IMF, the OECD, and Britain’s own Office of Budget Responsibility – just in case someone wants to argue that any one of these sources is biased. In fact, every one tells the same story: big spending cuts and a large tax rise between 2009 and 2011, not much change thereafter.
Given the fact that the coalition essentially stopped imposing new austerity measures after its first two years, there’s nothing at all surprising about seeing a revival of economic growth in 2013.
Look back at Chart 2, and specifically at what happened to countries that did little if any fiscal tightening. For the most part, their economies grew at between 2 and 4%. Well, Britain did almost no fiscal tightening in 2014, and grew 2.9%. In other words, it performed pretty much exactly as you should have expected. And the growth of recent years does nothing to change the fact that Britain paid a high price for the austerity of 2010-2012.
British economists have no doubt about the economic damage wrought by austerity. The Centre for Macroeconomics in London regularly surveys a panel of leading UK economists on a variety of questions. When it asked whether the coalition’s policies had promoted growth and employment, those disagreeing outnumbered those agreeing four to one. This isn’t quite the level of unanimity on fiscal policy one finds in the US, where a similar survey of economists found only 2% disagreed with the proposition that the Obama stimulus led to higher output and employment than would have prevailed otherwise, but it’s still an overwhelming consensus.
By this point, some readers will nonetheless be shaking their heads and declaring, “But the economy is booming, and you said that couldn’t happen under austerity.” But Keynesian logic says that a one-time tightening of fiscal policy will produce a one-time hit to the economy, not a permanent reduction in the growth rate. A return to growth after austerity has been put on hold is not at all surprising. As I pointed out recently: “If this counts as a policy success, why not try repeatedly hitting yourself in the face for a few minutes? After all, it will feel great when you stop.”
In that case, however, what’s with sophisticated media outlets such as the FT seeming to endorse this crude fallacy? Well, if you actually read that 2013 leader and many similar pieces, you discover that they are very carefully worded. The FT never said outright that the economic case for austerity had been vindicated.
It only declared that Osborne had won the political battle, because the general public doesn’t understand all this business about front-loaded policies, or for that matter the difference between levels and growth rates. One might have expected the press to seek to remedy such confusions, rather than amplify them. But apparently not.
Which brings me, finally, to the role of interests in distorting economic debate.
As Oxford’s Simon Wren-Lewis noted, on the very same day that the Centre for Macroeconomics revealed that the great majority of British economists disagree with the proposition that austerity is good for growth, the Telegraph published on its front page a letter from 100 business leaders declaring the opposite. Why does big business love austerity and hate Keynesian economics? After all, you might expect corporate leaders to want policies that produce strong sales and hence strong profits.
I’ve already suggested one answer: scare talk about debt and deficits is often used as a cover for a very different agenda, namely an attempt to reduce the overall size of government and especially spending on social insurance. This has been transparently obvious in the United States, where many supposed deficit-reduction plans just happen to include sharp cuts in tax rates on corporations and the wealthy even as they take away healthcare and nutritional aid for the poor. But it’s also a fairly obvious motivation in the UK, if not so crudely expressed.
The “primary purpose” of austerity, the Telegraph admitted in 2013, “is to shrink the size of government spending” – or, as Cameron put it in a speech later that year, to make the state “leaner … not just now, but permanently”.
Beyond that lies a point made most strongly in the US by Mike Konczal of the Roosevelt Institute: business interests dislike Keynesian economics because it threatens their political bargaining power. Business leaders love the idea that the health of the economy depends on confidence, which in turn – or so they argue – requires making them happy.
In the US there were, until the recent takeoff in job growth, many speeches and opinion pieces arguing that President Obama’s anti-business rhetoric – which only existed in the right’s imagination, but never mind – was holding back recovery. The message was clear: don’t criticise big business, or the economy will suffer.
If the political opposition won’t challenge the coalition’s bad economics, who will?
But this kind of argument loses its force if one acknowledges that job creation can be achieved through deliberate policy, that deficit spending, not buttering up business leaders, is the way to revive a depressed economy. So business interests are strongly inclined to reject standard macroeconomics and insist that boosting confidence – which is to say, keeping them happy – is the only way to go.
Still, all these motivations are the same in the United States as they are in Britain. Why are the US’s austerians on the run, while Britain’s still rule the debate?
It has been astonishing, from a US perspective, to witness the limpness of Labour’s response to the austerity push. Britain’s opposition has been amazingly willing to accept claims that budget deficits are the biggest economic issue facing the nation, and has made hardly any effort to challenge the extremely dubious proposition that fiscal policy under Blair and Brown was deeply irresponsible – or even the nonsensical proposition that this supposed fiscal irresponsibility caused the crisis of 2008-2009.
Why this weakness? In part it may reflect the fact that the crisis occurred on Labour’s watch; American liberals should count themselves fortunate that Lehman Brothers didn’t fall a year later, with Democrats holding the White House. More broadly, the whole European centre-left seems stuck in a kind of reflexive cringe, unable to stand up for its own ideas. In this respect Britain seems much closer to Europe than it is to America.
The closest parallel I can give from my side of the Atlantic is the erstwhile weakness of Democrats on foreign policy – their apparent inability back in 2003 or so to take a stand against obviously terrible ideas like the invasion of Iraq. If the political opposition won’t challenge the coalition’s bad economics, who will?
You might be tempted to say that this is all water under the bridge, given that the coalition, whatever it may claim, effectively called a halt to fiscal tightening midway through its term. But this story isn’t over. Cameron is campaigning largely on a spurious claim to have “rescued” the British economy – and promising, if he stays in power, to continue making substantial cuts in the years ahead.
Labour, sad to say, are echoing that position. So both major parties are in effect promising a new round of austerity that might well hold back a recovery that has, so far, come nowhere near to making up the ground lost during the recession and the initial phase of austerity.
For whatever the politics, the economics of austerity are no different in Britain from what they are in the rest of the advanced world. Harsh austerity in depressed economies isn’t necessary, and does major damage when it is imposed. That was true of Britain five years ago – and it’s still true today.
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“Since the global turn to austerity in 2010, every country that introduced significant austerity has seen its economy suffer, with the depth of the suffering closely related to the harshness of the austerity….It is rare, in the history of economic thought, for debates to get resolved this decisively. The austerian ideology that dominated elite discourse five years ago has collapsed, to the point where hardly anyone still believes it. Hardly anyone, that is, except the coalition that still rules Britain – and most of the British media.”
The long read: The case for cuts was a lie. Why does Britain still believe it?
THEGUARDIAN.COM|BY PAUL KRUGMAN
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