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Non-response on austerity

February 20th, 2012

Robert Carling and Stephen Kirchner have a letter in today’s Fin, responding to my piece last week, which restated points I’ve made on the blog (for completeness, it’s over the fold). The letter is notable for not responding to any of my criticisms of Alesina, and for backing away from his previously unimpeachable authority.

John Quiggin’s criticism of us (“Tales of austerity ring hollow”, Opinion, February 16) warrants a response. We referred to Alberto Alesina’s work not because it is the only or last word on this topic, but because it is an example of a much larger literature in support of fiscal austerity (or less pejoratively, “fiscal consolidation”).

It is incorrect to suggest that the case for consolidation “rests largely on the work of Alberto Alesina”. We could also have cited a lot of other empirical as well as theoretical work, as indeed does Alesina himself.

A full examination of the International Monetary Fund and Organisation for Economic Co-operation and Development literature over the years reveals a more nuanced view than Quiggin suggests (not that the IMF or the OECD are the final arbiters anyway). We recognise nuances that we could not canvass in a 600-word article.

One is that the arguments about fiscal consolidation have to be tweaked depending on country circumstances and the credibility of the policymakers. Greece, for example, will suffer from fiscal consolidation, but that is partly the fault of the exchange rate straitjacket they are in.

But, in general, we stand by our basic proposition that fiscal consolidation is essential to the economic rehabilitation of countries with large budget deficits and unsustainable public debt burdens.

The only point worth noting is that the “pejorative” term “fiscal austerity” isn’t mine, it’s from the title of Alesina and Ardagna’s 1998 paper “Tales of fiscal consolidation: can austerity be expansionary”. If austerity is now a pejorative it’s because people know what it means, while “fiscal consolidation” remains a vaguely defined euphemism. Readers with a long memory may recall the US Repubs and Cato dumping “social security privatisation” in favor of “social security choice”

Tales of austerity ring hollow

John Quiggin
PUBLISHED: 16 Feb 2012 00:09:01 | UPDATED: 16 Feb 2012 05:35:23

As philosopher George Santayana observed, those who do not remember history are doomed to repeat it. That’s even more true of those who learn the wrong lessons from history.

European governments appear determined to provide an example.

Faced with a severe economic downturn following the global financial crisis that emerged in 2008 and 2009, these countries have adopted austerity policies, focused primarily on cutting public expenditure. The hope is that by providing room for private investors, austerity will prove to be expansionary.

As Stephen Kirchner and Robert Carling (“Give austerity a chance”, The Australian Financial Review, February 8) have argued, this claim rests largely on the work of Albert Alesina and his colleagues, going back to the 1990s.

The central document in this literature is a 1998 paper by Alesina and Silvia Ardagna, titled Tales of Fiscal Adjustment: Is Austerity Expansionary? – a question to which the authors give a positive answer.

What Carling and Kirchner do not mention is that Alesina’s claims about expansionary austerity have been repeatedly refuted, not just by Keynesian critics but by the International Monetary Fund and even by one of Alesina’s own co-authors, Roberto Perrotti.

In fact, on the very day their piece was published, the Reserve Bank of Australia’s Statement on Monetary Policy joined the critics, noting “there are a number of elements that increase the probability that the large fiscal consolidations now in prospect could be significantly contractionary”.

(Myself and others suggested to Carling and Kirchner that they should have alerted Financial Review  readers to the fact that the research they were citing as authoritative was, at best, highly controversial, but they disagreed).

Fortunately, unlike many economic controversies, this is one case where readers can make their own judgments, since the cases studied by Alesina and Ardagna include Australia in the 1980s. It’s useful to compare the “tale” they tell with historical reality.

Alesina and Ardagna start off badly, with the statement: “In 1985, a single-party left-wing government took office and launched a stabilisation plan.” In fact, of course, the Hawke-Keating Labor government was elected in 1983, at the beginning of the recovery from the deep recession of the early 1980s.

The error here is more serious than just a wrong date. Alesina and Ardagna ignore the fact that the beginning of the expansion phase of the 1980s preceded, and made possible, the fiscal stabilisation represented by the Trilogy commitment of 1984. It is true that the government maintained fairly tight fiscal discipline but, as Keynes observed 75 years ago, “the boom, not the slump, is the time for austerity”.

Alesina and Ardagna miss this point, and get wrong just about everything else about the Australian economy in the 1980s. The real doozy, though, is their conclusion in which they proclaim Australia as a successful example of expansionary austerity because: “A private investment boom was associated with profits and easier access to credit following the financial deregulation process that took place in 1985-86.”

Many readers will remember that boom, led by such heroic entrepreneurs as Alan Bond, John Elliott and Christopher Skase. Even more will remember the crash that followed in “the recession we had to have”, and the years of high unemployment that persisted well into the 1990s. But Alesina and Ardagna, writing in 1998, chose not to mention it.

Of course, it wasn’t the fiscal discipline of the 1980s that caused the crash of 1989. Rather, it was the combination of deregulation and easy access to credit to which Alesina and Ardagna correctly ascribe the boom of the late 1980s. That boom turned out to be a bubble. Throughout that bubble, governments and commentators worried obsessively about the judgments of financial markets and, in particular, the all-powerful ratings agencies. Sadly, those judgments gave no warning of the impending crash.

The history of bubble, bust and financial crisis repeated itself in the US and Europe in the first years of the 21st century. Ignoring the gigantic financial-market failure that caused the present crisis, European governments have convinced themselves that their problems are the result of public profligacy.

Relying on the discredited idea of “expansionary austerity”, they are now seeking to cut their way to prosperity. History tells us they will fail.

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  1. Sam
    February 20th, 2012 at 19:47 | #1

    There is a much weaker, less hopeful brand of austerity advocacy now being promoted in Europe. This admits that fiscal contraction will be contractionary for the economy as a whole, but asserts that no other choice is possible, because European governments are no longer able to borrow at reasonable rates. What do people think of this?

  2. Sam
    February 20th, 2012 at 19:48 | #2

    I believe this has been called “the least bad” justification.

  3. James Haughton
    February 21st, 2012 at 08:36 | #3

    European governments are “no longer able to borrow at reasonable rates” because their own central bank has turned against them. If the ECB ran a proper expansionary policy including buying up govt debts (“quantitative easing”) the crisis would rapidly vanish.

  4. Dan
    February 21st, 2012 at 08:56 | #4

    @James Haughton

    That’s not the ECB’s brief, unfortunately. As well as which, I’m not buying ‘rapidly’ – despite QE and QE2 the US is still basically underwater.

  5. John Quiggin
    February 21st, 2012 at 09:46 | #5

    I agree that QE wouldn’t cure the crisis, it would just bring the EU back to a position similar to that of the US. But the determination of the ECB to “stick to its brief” has been a disaster.

  6. Freelander
    February 21st, 2012 at 10:17 | #6

    The real point of vacuous contributions like AA’s, and the looney right seems to have no shortage of them, is so libertarian evangelists can reference them in lieu of evidence or argument. This is, of course, how this one is being used. All of them products of that school of epistemology that believes you start with a conclusion and then find or create or misrepresent evidence and argument to support it.

  7. Ernestine Gross
    February 21st, 2012 at 11:18 | #7

    “All of them products of that school of epistemology that believes you start with a conclusion and then find or create or misrepresent evidence and argument to support it.”

    Isn’t this method called ‘outcomes based management’?

  8. James Haughton
    February 21st, 2012 at 11:51 | #8

    @Ernestine Gross
    I thought it was called “policy-based evidence”.

  9. Freelander
    February 21st, 2012 at 14:13 | #9

    @Ernestine Gross

    Interestingly output based management (OBM) and its later variant, outcome b Tased, was first invented in the soviet union. Although the idea of ‘prices’ on the outputs was the innovation from the NZ Treasury libertarian re-inventor. The idea of using highly aggregated output measures to direct portions of an economy, and to evaluate performance, had been thoroughly discredited and discarded in the former soviet empire long before the re-invention. That the re-inventor was some libertarian bureaucrat is ironic. The variant with outcomes followed. Outcomes often so conveniently down the track that one never need worry about actual performance or evidence derailing a spin-based career.

    “Policy-based evidence” I like it! The Productivity Commission and its predecessors’ speciality!

  10. Sam
    February 21st, 2012 at 16:11 | #10

    @James Haughton
    Would the crisis actually vanish though? Paul Krugman says that QE has some effect, but not much. According to him, they should certainly do it, but we shouldn’t expect European governments to get out of trouble.

  11. Ernestine Gross
    February 21st, 2012 at 16:12 | #11

    @Freelander
    I’d like to hear more. Can we more to the sand pit, please.

  12. Ikonoclast
    February 22nd, 2012 at 07:22 | #12

    John Quiggin :
    I agree that QE wouldn’t cure the crisis, it would just bring the EU back to a position similar to that of the US. But the determination of the ECB to “stick to its brief” has been a disaster.

    I agree but are you prepared to advance a theory of what would cure the crisis?

  13. Dan
    February 22nd, 2012 at 08:27 | #13

    Annexation by Germany.

  14. James Haughton
    February 22nd, 2012 at 08:28 | #14

    It would cure “the crisis” of the governments, particularly greece, being unable to meet their bond obligations and the banks being shaky because of their large holdings of bad government debt. I’m not claiming it would solve unemployment, bring about prosperity, etc. For that you would need standard Keynesian fiscal expansion IMHO.

  15. Ernestine Gross
    February 22nd, 2012 at 12:17 | #15

    @James Haughton

    IMHO, there is no such thing as a ‘standard Keynesian fiscal expansion’ (and there is no such thing as expansionary austerity).

  16. Hepionkeppi
    February 23rd, 2012 at 04:56 | #16

    Greece could do expansion in drachma spending while at the same time doing austerity in euro spending.

  17. James Haughton
    February 23rd, 2012 at 10:47 | #17

    @Ernestine Gross
    I bow to your superior knowledge of technical terminology, but I think you and most posters here know very well what I meant.

  18. Ernestine Gross
    February 23rd, 2012 at 18:30 | #18

    @James Haughton

    No, I wasn’t trying to be smart with technical terminology. Apologies for having been cryptic. I tried to say there seems to be a polarisation of arguments that relate to complex institutional matters into ‘Keynesian’ vs ‘Austerity’ policy arguments and I can’t see how this is helping to mitigate the contemporary crises.

  19. sdfc
    February 23rd, 2012 at 18:55 | #19

    I agree but are you prepared to advance a theory of what would cure the crisis?

    Inflation

  20. Chris Warren
    February 23rd, 2012 at 19:17 | #20

    @Ernestine Gross

    All the supposed Keynesian concepts – particularly costs – are open for interpretation and doubt.

    I am not sure what the problem with standard keynesian fiscal expansion is.

    Is it the word “standard”

    is it the word “Keynesian”

    is it the word “fiscal”

    is it the word “expansion”

    In essense the standard Keynsian fiscal expansion is “government spending using IOU’s today while expecting future growth to be sufficient to pay back the IOU’s later”.

    The economic rationalists naturally oppose ‘s.k.f.e.’ because a their supposed, more economically sound policy under capitalism, is to simply reduce the share of value going to workers (but not the workload which increases per employed individual) and to garner more benefit from oppressed workers offshore.

    Of course both ‘Keynesian’ and ‘Austerity’ arguments are wrong – but that is what you get under capitalism.

  21. Ernestine Gross
    February 24th, 2012 at 09:25 | #21

    @Chris Warren

    “Of course both ‘Keynesian’ and ‘Austerity’ arguments are wrong – but that is what you get under capitalism”

    This is your conclusion, not mine.

  22. Chris Warren
    February 24th, 2012 at 09:51 | #22

    @Ernestine Gross

    Yes, you have to come to some conclusion sometime.

    I would hope that people use the GFC to go through at least a bit of a learning curve.

    If some other conclusion was possible, I would like to see it in plain English.

  23. Ernestine Gross
    February 24th, 2012 at 10:21 | #23

    @Chris Warren

    Yes, you do come to some conclusion sometime. So do I. But my methodology differs from yours, it seems, and my conclusions differ from yours.

    My argument is that Keynesian ‘arguments’ are presented unconditionally. I do not agree with this. The same applies for Austerity ‘arguments’.

  24. Chris Warren
    February 24th, 2012 at 10:30 | #24

    sdfc :I agree but are you prepared to advance a theory of what would cure the crisis?
    Inflation

    So what would you inflate, bank balances? debt? or wages?

  25. James Haughton
    February 24th, 2012 at 10:30 | #25

    Chris’ definition of Standard Keynesian etc is pretty much what I had in mind, minus the perjoratives. As others have pointed out, when Keynes was advocating fiscal expansion in the context of the depression, the debt/gdp ratio of the UK was something like 200%, way higher than today. It worked then, so I don’t see how running up “IOUs” is unsustainable today (also worth noting: from post wwii to the mid 1970s, the era of expansionary keynesianism in Australia, our govt debt/gdp ratio steadily declined, in spite of a full employment policy). Of course, in an MMT framework, the money to pull the economy out of a hole doesn’t have to be backed by debt.

  26. sdfc
    February 24th, 2012 at 18:10 | #26

    What would I inflate?

    Dollars and cents GDP. I’d maintain loosepolicy settings until NGDP growth attains a level that will put downward pressure on the real value of private sector debt outstanding.

  27. Ernestine Gross
    February 25th, 2012 at 09:03 | #27

    ‘James Haughton, ‘pulling the economy out of a hole’ may not be as easy as you suggest. Building on your metaphor, the landscape of ‘the economy’ consists of mountains, holes, valleys, hills, flat land, and a network of channels connecting liquidity flows, some of which is underground. This pattern of ‘the economy’ is visible in regions, such as the EU, Australasia, the Americas, Asia and it is visible within ‘local economies’, such as the USA, Germany, Australia. And, it is visible in sub-local economies – cities, or even households. The landscape of ‘the economy’ has changed between 1940 and now – not radically everywhere but not uniformly either. What worked in the 1940s in some places may not work now in the same places, etc, etc. I don’t want to be around should the MMT idea of liquidity creation become the new religion. I thought the flood in Brisbane was bad enough. MMT has no flood control system, so to speak. It doesn’t even have a map of the existing liquidity flows, etc etc. The Austerity story is at least as unconvincing as the MMT story about ‘the economy’. The brilliance of Keynes was that he didn’t buy the story at the time but he didn’t start from scratch either.

    Chris W. do I get brownie points for trying to write in plain English?

  28. Red
    March 3rd, 2012 at 05:23 | #28

    You sadly use the laughable Paul Krugman as something to aspire toward. Why did this ridiculous academic clown rally against Bush deficits, yet now find Obama deficits okay?

    Be honest, this isn’t a real economist, is it? This is a political hack, that a person allegedly teaching youngsters, should be ashamed to quote, no? I’m I really wrong?

  29. John Quiggin
    March 3rd, 2012 at 05:31 | #29

    “no? I’m I really wrong?”

    I can’t quite make sense of this (I’m=am?), but, yes, you are really wrong. An introductory macroeconomics textbook will tell you why.

  30. Ikonoclast
    March 3rd, 2012 at 08:29 | #30

    This is all a difficult (“wicked problem”) issue. I want to ask a few questions from a slightly different angle. How does a citizen determine his/her views on microeconomics and macroeconomics? Do the citizen’s views (informed or uninformed) make any difference? For every citizen who becomes relatively informed, ninety-nine will remain relatively ignorant; what does this last contention imply for social and economic direction if it is true?

    Only a polymath genius who is all of orthodox-schooled, heterodox schooled and self-schooled in all of the main branches of the sciences and humanties (as implied by “polymath” of course), would have the slightest chance of “solving” just some of the questions embedded within political economy. This individual would have to thoroughly learn all the existing schools plus break new ground and then undertake a program of debunking and reconciling, refuting or confirming etc. When her/his mangum opus was released the likely outcomes are it would be;

    1. Ignored
    2. Suppressed
    3. Misinterpreted
    4. Misapplied
    5. Rendered obsolete by the passage of history introducing new unforeseen conditions.

    As an aside, IMO Karl Marx comes closest to the above delineation of the polymath genius and the fate of his work. Marxists might argue with point 5 but I would stick with it unless it was shown to me that Marx did deduce and fully understand the future implications of limits to growth, climate change, resource depletion, species extinction, resource exhaustion etc.

    I could write at length about my general thoughts on all this but I would get too prolix as usual. The disagreements of highly educated and intelligent economists on these issues (I am thinking in particular of John Quiggin, Ernestine Gross, Steve Keen and Bill Mitchell), illustrates to me that there is no settled consensus. The arguments of the more heterodox (Keen and Mitchell) seem to me (at least in significant part) to be as well grounded in empirical research and mathematical modelling (though from different starting assumptions) as the more orthodox but still “left” economics of Quiggin for example. As such, the former are not easily dismissed though their zeal and proslytising style may lead them into hyperbole and error at times.

    If I can organise my thoughts on this topic better, I might post in the idee fixee section some time.

  31. Dan
    March 3rd, 2012 at 09:09 | #31

    @Ikonoclast

    Hi,

    While I am sympathetic to your post, I think you have set the bar unreasonably – and needlessly – high.

    In fact we don’t need some economic messiah to be martyred in some configuration or another; a multiplicity of views should be welcomed, insofar as that as long as there is arguing it provides the impetus for iterative (and democratic) improvement, definitely a step up from the five options you list above. It’s true that there is iterative decline as well, but I’d rather be living now than at any previous point in history.

    As goes crisis, I just don’t think it tends to be the case that any magnum opus has all the answers at any particular point in history – which then loops us back to the iterative debate scenario above.

    Somewhat similarly, it’s easy to fall into thinking about how great it would be to have a bunch of Philosopher-Kings running the place, especially when you feel your side is unimpeachably correct but losing the battle (climate change, for instance). But that betrays democracy and the democratic process, and that’s something I’m not at all willing to jettison, because apart from anything else, history demonstrates that ultimately you arrive at the best solutions and the best societies in accountable, educated democracies (mediated, albeit, by education and accountable media).

    (And that’s why I’m a reformist.)

  32. Chris Warren
    March 3rd, 2012 at 09:10 | #32

    Steve Keen is a Minskyite capitalist. John Quiggin is a welfare state capitalist. Ernestine Gross is a bit lost.

    However for those who have benefited from the spoils of Eighteenth Century empire building and 2 world wars – that is for the world elites – it may appear that welfare state capitalism produces the best of all possible worlds. They forget that this is provided it receives benefits from outside the economy. This logic eventually must fail.

  33. Dan
    March 3rd, 2012 at 09:10 | #33

    ps. I agree that heterodox economists should be taught more about orthodox economics – and vice versa, of course.

  34. Dan
    March 3rd, 2012 at 09:13 | #34

    pps. In fact I jokingly suggested – trolled? – on Catallaxy a while back (after Greg Mankiw’s students walked out) that Economics 101 and 102 should be economic history courses. No response.

  35. Ikonoclast
    March 3rd, 2012 at 10:31 | #35

    To reply to Dan and Chris Warren…briefly, if possible.

    I have certainly set the bar unrealistically high. I was implying that every citizen needed to be a polymath genius (as well as being morally speaking a Christ-Buddha-like figure) for us to solve our problems. Your delineation of our best hope, genuine democracy, is one I agree with and you framed it well. We do have major problems in that area though as corporate oligarchy has seriously undermined democracy around the world. I think one of our major problems (as John Ralston Saul said) is that we are letting economics lead society rather than letting democracy lead.

    To refer to Chris Warren’s points. My view of Prof John Quiggin is that he is a social democrat and an advocate of a mixed economy and welfare state. Steve Keen is a “Minskyite” in a sense. I see him as trying to use appropriate advanced mathematic techniques and empirical research to better understand the financial economy of capitalism and macroeconomics under current conditions. I generally reserve the term “capitalist” for the owners of large amounts of capital who are clearly exploiting workers. (And in my opinion they are always exploiting workers.)

    Economists, including political economists, who work in the general field of “capitalist” economics may be;

    (a) simply trying to understand it and only afterwards humanise it (perhaps Keen’s position)
    (b) trying to find a genuinely humane, social-democratic and workable accomodation satisfactory to capitalists and workers alike (perhaps Quiggin’s position)
    (c) seeking to understand it and then supplant or overthrow it (perhaps the Marxist position).

    John Quiggin’s position might include the premise that a mixed economy is not only a good accomodation but in fact the best of all possible (realistic) systems in the world.

    I am interested in Chris Warren’s statement “They forget that this is provided (that) it (mixed economy welfare capitalism) receives benefits from outside the economy.”

    I assume Chris means both benefits from nature (which are plundered and wrecked in a once-only process of exploitation) and benefits from empire, colonialism, neocolonialism, globalisation colonialism etc. If Chris means this I agree with him. But there are two steps to this issue. At a personal level, in the West, initially one survives and finds an accomodation with (now globalised) capitalism. The system is all pervasive. There is hardly any way to be outside capitalism. At the second level one must work for or at least attempt to envisage a revolutionary change away from the failing and maladaptive system of capitalism.

  36. Chris Warren
    March 3rd, 2012 at 12:13 | #36

    @Ikonoclast

    Dealing with the environment is astonishingly difficult. All animals and plants exploit all of the environment according to their instincts and throw their waste back into the system at any opportunity. This is normal and natural, and is how humans themselves want to live and have done under primative conditions.

    If the population was a mere ten-thousandth of its present level, then possibly, carbon and methane emissions would not exceed the ecosystems capacity to reabsorb or otherwise respond.

    However the enormous size of the modern population and associated agriculture seems to be the real problem, and there is no solution. Abbott and his political kin-folk in other nations, including growth-mad socialists in Vietnam and China, will make sure that we do in fact destroy the planet in due course.

    If we cannot stop the Third World aspiring to the same standard of living as in Sydney or Melbourne, then the only possible policy to escape this dilemma is population decrease.

    But you need to get rid of capitalism first.

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