It’s Official: Austerity Economics Doesn’t Work

http://www.newyorker.com/online/blogs/comment/2012/12/austerity-economics-doesnt-work.html

by gruseom • 14 years ago

32 70 14 years ago

Consider if you've been living the high life based on borrowed money. At some point, you decide to go on an "austerity" program, and cut back the spending so you are no longer borrowing.

In order to pay back the debt, your standard of living is going to necessarily drop below that of what it would be if you'd never started the borrow and spend, and certainly would be far less than it was when you were living on borrowed money.

Does that mean your austerity program is a failure?

conradfr• 14 years ago

Don't they say the analogy between a person's and a government's debt doesn't work ?

WalterBright5• 14 years ago

If the government can print money, then yes, it is different, but only in that the government can keep printing more money rather than needing to convince lenders to loan it more.

It can't change the fact that if you live beyond your means long enough, you run out of means one way or another.

rjknight2• 14 years ago

The analogy between governments and people doesn't work, not least because governments are immortal and can print their own money.

However, if we choose to ignore this for a moment, there's a good counter-argument: the way to get rid of debt is to pay it back, and the way to pay it back is to work more and invest wisely. The individual or household that needs to pay off some debt would do better if, say, the people in the household got jobs (if they don't have them) or extra hours at work (if they do). Allowing the unemployment rate to rise as it has done in countries operating "austerity" doesn't fit that analogy at all.

My point is not that the above argument is correct, just that it's possible to argue both for and against austerity using "intuitive" arguments based on analogies with households, and these are rarely correct. That said, neither are most of our mainstream economic theories! (At least some of them must be dead wrong, as they can't all be right).

paganel• 14 years ago

> governments are immortal and can print their own money

The part with governments being "immortal" is actually incorrect. The fact is that for example UK paper money is just that, colored paper, when it comes to paying up debts taken in foreign currency. A couple of failed States come to mind as examples, like Germany in the early 1920s and Argentina in the late 1990s.

seanmcdirmid2• 14 years ago

This is very correct.

In many developing countries, there is no option to work harder, get another job, or work at all. The opportunities just do not exist, and the cycle perpetuates. This is why the New Deal was so necessary, it was a jumpstart to the economy by getting people back to work anyway possible.

pdelgallego• 14 years ago

> governments are immortal and can print their own money

The part with governments "can print their own money" is actually incorrect for many European countries. That is the main problem for the PIIGs right now.

wtracy• 14 years ago

The argument in the article seems to be that reduced government spending has depressed the economy, which in turn has killed its income from taxes. So, yes, they reduced spending, but they reduced their income at the same time, so there's no net benefit.

varjag4• 14 years ago

Eventually there has to be a switch from spending imaginary money though, and I doubt there ever will be a point when such transition is painless.

lutze2• 14 years ago

Economically no.

But scrounging poors are literally dying on their feet, so I'm guessing that's seen as a win.

Hyperbolic? Maybe a little. But I currently live in a country where people are dropping dead after failing "medical" tests for incapacity benefit and being told to get a job.

http://blogs.mirror.co.uk/investigations/2012/04/32-die-a-we...

It's fucking disgraceful.

sambeau• 14 years ago

That analogy doesn't work with Governments.

Here's a better example:

Imagine a grandmother taking a loan for her grandchild so they can have a car to drive to work. The household income increases as a result.

If she stops paying the loan the car gets repossessed. The grandchild can no longer earn money. The household income decreases.

The grandmother does this for all her many grandchildren. The grandchildren all work and the family become rich.

In our modern economies the now-wealthy grandchildren refuse to pay the grandmother back, but they agree to pay the interest on the loans. She doesn't push it because her house is big and busy and her family have a lovely lifestyle.

Should she default and let the cars be repossessed or would it be better to get her spoilt grandchildren to start paying back the loans?

antihero3• 14 years ago

This is more like, you go on an austerity program which also includes your train ticket to work. So you are spending less money but there's no money available to generate more - because you are not working you are not generating money and so your debts are increasing.

saraid2163• 14 years ago

> Consider if you've been living the high life based on borrowed money. At some point, you decide to go on an "austerity" program, and cut back the spending so you are no longer borrowing.

I'm confused about your scenario. Are you continually borrowing, or are you living off a finite quantity of borrowed money? Does an income exist, and if so, where does it come from? Who are you borrowing from, and why did they give it to you in the first place and in what form do they expect it back? Are you obligated towards anyone besides yourself, such as children, aside from the established debt?

eli_gottlieb6• 14 years ago

It means your analogy is incomplete.

The real question is: why were you borrowing in the first place? Your story here indicates you assume the initial borrowing happened because we were "living the high life", purchasing luxuries we simply couldn't afford on our incomes, while our incomes remained steady.

In the real world, what has almost universally happened is that our incomes dropped, and we started borrowing to maintain the same standard of living we always had. "Austerity" thus involves a double-whammy: the initial drop in income from straight-up income reduction plus a further drop in standard of living from debt service.

Then we notice that the same guy who owns our credit card and our mortgage is the one who cut our salary. And that's when someone calls me a Communist ;-).

WalterBright5• 14 years ago

Consider you have a business selling widgets for $.90. They cost you $1.00. You receive a government subsidy of $.20, meaning you make a profit of $.10 per widget.

Government austerity begins, and your subsidy gets cut off. You are now losing $.10 per widget, so you close your business. The GDP drops $1.00.

Is this austerity a failure? Or was the prosperity resulting from that subsidy a false prosperity?

dnu2• 14 years ago

But that subsidy must come from somewhere. For every $.20 the widget company gets, some other company is taxed $.20

And GDP is a joke. If I buy your laptop for $1 bln, and you buy it back from me for $1 bln, nothing will change for us, but it will look very good on the GDP.

brianchu• 14 years ago

That's not how GDP is calculated. In your example, GDP is unchanged. The laptop only affected GDP the moment you originally purchased the laptop from the laptop store, and at that moment GDP went up by the price you paid for the laptop (excl. taxes). Used goods transactions do not count in GDP calculations.

EDITS (replies to below):

In the case of the two poems, as archgoon points out, the government will collect sales and income taxes which is why that situation never happens... ever. And if you didn't report the transaction to the government to avoid taxes, GDP will be unaffected because GDP is a statistic that is reported by the government, which can't report things it doesn't know about.

Technotony is right about the smashed windows paradox. You could argue that the "value" that is added is the tradesman gets paid (income), and the shopowner gets a new window.

The GDP is not a perfect measure of the strength of an economy. There are plenty of valid criticisms. But it's certainly one of many useful data points.

coolj• 14 years ago

> But that subsidy must come from somewhere.

It doesn't have to. Sure, subsidies can help the overall economy. But when you're falling off a fiscal cliff, the debt ceiling is rising, and your credit rating has already been downgraded, you have to be careful to take long term eventualities into account. If a significant number of US businesses are relying on government subsidies and programs to be profitable, and that funding dries up, we're gonna have a bad time. Such subsidies and programs are a tiny fraction of US spending, but they are also low-hanging fruit when it comes time for cuts, as compared with military, medicare, and social security spending. Not saying that will happen, but leaning towards austerity may have been a better choice in the long run than trying to "jump start" the economy, especially if we double-dip (knock on wood!). Time will tell. Interestingly, US and UK unemployment rates as of October 2012 are identical at 7.8.

> For every $.20 the widget company gets, some other company is taxed $.20

There are many sectors of government where spending can be reduced to increase available revenue for subsidies or tax cuts. You need taxes, tolls, tariffs, etc to generate absolute government revenue, but subsidies can be carved out of existing budgets without new taxation. The question of the right balance of both taxation and austerity, to maximally benefit the recovery of the economy, in both the short and long-term--that is the real issue. Seems nobody's discovered the magic formula yet.

ars• 14 years ago

That's not what happens though.

If you assume that people will always work at full capacity then austerity makes sense.

But people don't. If their work doesn't seem "worth it" to them, they'd rather relax and do nothing. And that's why austerity causes problems: It makes people not work at full capacity since it doesn't seem worth it.

i.e. artificially pay someone extra and suddenly he is motivated to work extra. The extra work helps the economy.

In theory a solution would be that everyone on unemployment must work on government projects, and that the government would guarantee a paying job to everyone (doing real productive work). The trouble is the details: Not all jobs are equally valuable and there is 0 chance the government will get it right.

brg2• 14 years ago

This is a common myth, and it was addressed 150 years ago.

http://www.econlib.org/library/Bastiat/basEss1.html

The economy is not a zero sum game. The inefficient production of widgets will be shut down, but the labor and capital used will be put towards a better end. They will not sit idle and rot.

In sum, by shutting down the widget company, you avoid the tax on the populace as a whole and free the labor and resources used in widgets to be used towards a better end.

onetwothreefour• 14 years ago

You just failed Econ 101. :)

dnu2• 14 years ago

When a country is still spending more money than it earnes, can we call it "austerity"? I mean, if you have a salary of $100000, even if spend only $130000 instead of the usual $160000 you are still living above your means.

pekk2• 14 years ago

During WWII, we in the US were spending far above our means and there was widespread rationing. Yes, that is austerity.

The question is who will live more austerely for the sake of whose pocketbook, and what they will be made to give up.

fleitz• 14 years ago

The primary problem is that we don't have enough time to consume what we can produce.

Ford an avowed capitalist as any identified this problem in the 20s and 30s and rectified the situation by slashing work hours and paying more money. Workers now had enough time to enjoy the benefits of a car, and now had the resources to buy one.

Effectively they were able to buy cars because they made cars, and wanted cars because cars let them take their family to the beach, camping, etc.

Now that manufacturing is automated we need people who can tell the robots what to produce and they need enough time off to consume all that the robots produce. Eventually the robots will produce so much that we will be paid just to consume.

WalterBright5• 14 years ago

Ford paid workers more because he had to to get them to work on the boring assembly line. He did not pay them more so they could buy his products - that's not a viable business plan.

seanmcdirmid2• 14 years ago

Somewhere in the middle. Ford was a bit more than just a focused capitalist. He had a product that few could afford, and saw a future of new consumers. He also needed work done in his factory, and saw an opportunity to do some social engineering and set an example...and it worked.

http://en.wikipedia.org/wiki/Fordism

pekk2• 14 years ago

Robots and materials and a few technical staff to run an automated factory all cost money. That money is only spent when there is an expectation of return. That return comes from selling the output of the factory. Nobody will pay others to consume. The typical person is dependent on a job and if unemployment is bad, they'll scrape. Ford won't rescue them.

eli_gottlieb6• 14 years ago

Ford, like many other capitalists of his day, actually recognized that overproduction could happen and could result in a Crisis of Capitalism (ie: as predicted by Marx). He didn't like Marxism, though, so he instead set out to structure his company in such a way as to become part of an economically self-sustaining engine that could actually afford to eat its own output.

tlocke4• 14 years ago

I'm from the UK and I'm broadly in favour of Osbourne's policy. We've run up a huge debt that resulted from the government spending more than it was receiving in tax revenue, for many years. Particularly bad were the years when Gordon Brown was Prime Minister (when he was Chancellor he did pretty well).

Now the UK government is cutting public spending, and a lot of public sector jobs have been lost. However, in that time the private sector has created more jobs than have been lost by the public sector, so employment is high, much higher than in the US.

It took us many years to get into this mess and it'll take many more to get us out, but Osbourne is on the right track.

arethuza• 14 years ago

"when he was Chancellor he did pretty well"

Most of the economic mess in the UK (particularly inflated public sector salaries) was done on his watch as Chancellor.

antihero3• 14 years ago

So basically we're going to repair the damage by effectively choking our economy by reducing spending everywhere? Fantastic.

I am from the UK and knowing many public sector workers, disabled people, women, people searching for jobs, and working class, I wholeheartedly think George Osbourne can go fuck himself. Ain't it weird that the supporters of his monstrous plan are those who are not affected by it in the least?

tlocke4• 14 years ago

The interest payments on UK debt is £43bn. That money is going to bankers at the moment, but it should be going to the people. Sooner or later we've got to pay down the debt. The longer we leave it, the more the poor will suffer. Look at Greece, it's far worse to be in poverty in Greece than the UK, and that's where we're heading if we don't take action now.

gazrogers• 14 years ago

It stuns me that the Tories have managed to convince so many people that the debt is all down to Labour and not the reckless profligacy of the banks. The vast majority of the debt was run up ensuring that the entire banking system in the UK didn't collapse taking the saving of hard-working British people with it. Virtually nothing has been done by the Tory-LibDem coallition to prevent this from happening again.

tlocke4• 14 years ago

The government bailed the banks out using taxpayer's money, which added to our national debt. It happened to be a Labour government, but the Tories would have done the same. The banks should have been allowed to fail, just like any other business.

joelhaus• 14 years ago

This shouldn't surprise anyone. Austerity (as implemented here) looks only to current account balances and does not consider the long-term impact on revenue. Ditch digging theories aside, when government can borrow at rate x and can reasonably expect to get a return > x on an investment, it should generally do so.

Debt levels must be taken in context. Alone, it is a meaningless number used to scare an ignorant public by people with an agenda of shrinking government. Rather, the focus should shift to promoting more effective government.

justincormack2• 14 years ago

Investment? It is all current spending basically. Not sure how to measure the return on that.

eli_gottlieb6• 14 years ago

Transfer payments can actually have fiscal multipliers greater than 1.0. Food Stamps, for example, are actually a net stimulus.

thewarrior3• 14 years ago

The problem I have with the Keynesian argument is that it cannot be falsified . They can always claim that the government did not do "enough" to stimulate the economy . One only needs to examine the case of Japan which spent huge amounts of money on ultimately pointless stimulus which did not leave any lasting benefit to their economy . No amount of stimulus can jump start the economy back into its unsustainable ways of debt fueled over-consumption . What might really jump start the economy are technological innovations in areas like energy and not unfalsifiable economic dogma forced upon us by ivory tower economists.

More information here :

http://www.theatlantic.com/business/archive/2010/12/japan-an...

EDIT : I would like to add the housing bubble was the deliberate result of Fed policy attempting to recover from the internet bust in 2000 . The crux of my argument is that there can be no real growth without an improvement in per person productivity and fair means of redistributing the resulting gains . The problem I see with stimulus is that we are allocating scarce resources according to arbitrary and unfalsifiable theories to achieve more growth but what ends up happening is that significant resources are used up in building bridges to nowhere and unused airports etc . Then the debt on those becomes a long term burden rather than a benefit.

aaronbrethorst• 14 years ago

Can't the same be said about any economic school of thought? Take, for example, this thread I found on Quora regarding austrian economics: http://www.quora.com/Austrian-School-Economics/Is-Austrian-e...

thewarrior3• 14 years ago

Precisely the reason I quoted the real world example of Japan rather than go into some pointless argument full of economic jargon. To take the US economy to where it was before 2008 you only need to do one thing . Get housing prices back to their pre bubble highs . The reason being that everything else fed off of the housing bubble. Thing is that those prices were totally unsustainable and unaffordable and so those times arent coming back . Politicians can do their crazy horse dance all year and its still not coming back . In the end as I said in my parent post genuine progress comes through innovation .

roel_v2• 14 years ago

To be fair though, and I myself am firmly in the Austrian school, is that the same is true for fiscal conservativeness. One can always say 'it didn't work because we didn't cut enough', since there is no chance that we'd ever cut all unemployment benefits / pensions / subsidies for whatever / ...

thewarrior3• 14 years ago

Sadly you are correct . Economics is badly in need of some einstein to anchor it on some better theoretical foundations .I am reminded of the following joke : Soviet leader Leonid Brezhnev is making a speech. He finishes, then, as usual, asks for questions. After a long silence, a man finally asks, "Was communism invented by scientists or by communists?" Somewhat stumped, Brezhnev finally answers that it was invented by communists. "I thought so too," responds the man. "Scientists would have tested it on mice first."

Fact is without witnessing it in action no economist at the time could have really predicted that communism would fail so hard.

eli_gottlieb6• 14 years ago

No amount of stimulus can jump start the economy back into its unsustainable ways of debt fueled over-consumption .

That's the symptom, not the cause. The proximate cause of the best was, indeed, rising private indebtedness, fueled by the stagnant and falling levels of real wages, and thus real household incomes. I don't think that falling wages leading to economic recession should surprise anyone, but the United States spent 30 years in the thrall of right-wing nutters who claimed it didn't work that way.

How did they claim it didn't work that way? A structural shift was made in the economy, from basing household incomes and purchasing power on wages and business revenues to basing them on growth in asset prices.

Problem is, any asset-price-based economic "growth" is inherently unstable and radically unequal. To create growth, such a system relies on increasing the gap between current asset-owners and those who do not yet own assets (not only poor people but wage-earners getting by without enough surplus to invest and young people starting out in life).

Increasing that gap will, you guessed it, increase the debt loads people have to take on in order to join the asset-owning class (nee "capitalist class") whom the economy has evolved to serve.

A decent link, but not the best: http://www.newamerica.net/publications/policy/america_s_exha...

cmdkeen• 14 years ago

The article failed to mention the pitiful level of cuts that have actually occurred! The USA has cut further and quicker, it is nowhere near the level of Irish or Greek austerity. The UK is not experiencing austerity.

The NHS (major spender) was protected, the welfare bill has gone up massively. The cuts amounted to a few departments and haven't been fully implemented yet.

The private sector has created many more jobs than have been lost from the public sector, but lots have gone to non-UK nationals, leaving unemployment down but not by as much as expected.

The Tories have taken the flack for cuts/austerity without actually really having it, it isn't in Labour's interest to expose this.

forgottenpaswrd• 14 years ago

A useful reminder: NewYorker means "from New York", the capital of the financial system, the owner of the private bank that controls the Federal Reserve, and the people who are most interested in printing money ad infinitum so their financial theater does not collapse today(it will but they can delay it kicking the can another day).

Another useful reminder: There is no austerity in Europe or anywhere!! There is not a single country in Europe that spends less that what they have(the definition of austere), all of them have deficits, so there is no such a thing like what the Feds or ECB want you to believe.

All of them are over-indebt, e.g next year Spain will have to give 25% of their taxes for paying interest of the debt they got. They are so in debt that the vicious circle makes impossible to pay the debt as interest rise more than GDP.

Blaming austerity for the problems of over leverage is a good trick on the financial hat, like blaming the bed for the handover.

Deleveraging will happen, debts will not be repaid, savers will lose most of their wealth and social instability will erupt as the system could not be trust. Someone has to pay for the malinvestment done when money was free. This already happened before, it was called the Great Depression.

ajuc2• 14 years ago

What level is "over-indebt"? There are countries in Europe (and EU, and Eurozone) with less than 10% public debt to GDP ratio.

Estonia has 6.1%. Even Spain public debt is only 69.3 % of its GDP. Average for the whole EU is 82.5%. USA has 105.5%.

brg2• 14 years ago

This comment is correct on one point, austerity has not been tried in Europe. No country has either spent less than what they have, nor have they spent less year over year.

netcan• 14 years ago

Its very strange to listen to this kind of certain, idealistic tone when relating to things that we just don't have certain knowledge about.

In macroeconomics, the relationship between fiscal spending and unemployment/economic output is unknown. We've been arguing about it for about a hundred years and we are not really any closer and answer. It may be that an economy is too complex to explain the way we've been trying. It would be like trying to predict the effect of releasing magpies on the squirrel population of a forrest.

A weirder example is nutrition, diets. We have different schools: evolutionists / paleo, low fat, atkins/low carb, weight watchers, all about - calories, all about growth hormones... They all have mountains of anecdote and a powerful conviction that they are right and everyone else is a blind, stubborn idiot. These Atkins idiots don't believe in thermodynamics. Calorie counters think we have furnaces for stomaches. Neither believe in evolution.

So.. obviously we don't really know why this generation got so fat or what individuals should be doing to reverse it. Naturally that doesn't stop people from being incredibly confident that their theory is undeniably true. Tellingly, they are mostly associated with charismatic motivators more than scientists or experiments.

This thread is back to back proof-by-contrived-metaphor.

eli_gottlieb6• 14 years ago

In macroeconomics, the relationship between fiscal spending and unemployment/economic output is unknown.

Not really, no. We know that fiscal spending is inversely correlated with unemployment. The question is what levels of fiscal spending are sustainable, and what particular fiscal acts by the government have a net-positive effect rather than being mere transfers (ironically, "transfer payments" can have >1.0 fiscal multipliers).

eli_gottlieb6• 14 years ago

I'll just leave this here: http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic...

It’s Official: Austerity Economics Doesn’t Work

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