Expansionary austerity: some shoddy scholarship

I’ve just read ‘Tales of Fiscal Adjustment’ by Alesina and Ardagna, which appears to be the founding text for the idea of expansionary austerity. The level of scholarship, at least as it applies to Australia (which is their first illustration) is exceptionally poor, to the extent that it requires a rescuscitation of the ancient Internet tradition of Fisking. I’m going to quote excerpts from their text (about 50 per cent of the total), and intersperse them with my comments.

In 1985, a single-party left-wing government took office and launched a stabilization plan to correct the internal and external imbalances (the current account deficit was 4.13% of GDP and the total deficit/GDP ratio was above 3% in 1984).

The Labor government was elected in 1983, not 1985, in the early stages of recovery from a deep recession. Their stabilization plan, introduced in 1984, and called the Trilogy, pledged to hold tax/GDP and expenditure/GDP ratios at or below their current levels while reducing the budget deficit. The current account deficit, a subject of continuous concern, remained high throughout the period in question

The government wage bill and transfer programmes accounted for the biggest share of the adjustment … The cuts in transfer programmes were mainly concentrated on unemployment insurance.

There were no cuts in unemployment benefits. Expenditure fell because unemployment was falling. Haven’t Alesina and Ardagna,heard of automatic stabilizers?

Capital taxation was rationalized.

OK, I guess, except that ‘rationalized’ in this context, typically means ‘reduced’. In fact, the government introduced a capital gains tax which more than offset the end of double taxation of dividends

From 1983 to 1986, wages were bargained at a centralized level. The system was based on full indexation with twice-yearly adjustment, but there was a departure from full indexation in 1984 and 1986. In the negotiation process, government used tax reductions previously described to induce the union movement to accept reductions and delays in wages increments.

Absolutely opposite to the story told here, the trade-off in 1984 was in return for the (re)introduction of a single-payer health insurance scheme, a major expansion in the role of government and one that has endured to this day. In subsequent rounds, tax cuts were sometimes part of the deal, but the big trade-off was the introduction of compulsory employer contributions to retirement income funds. These aren’t counted in measures of tax revenue and expenditure, but in functional terms they are the equivalent of a social security scheme (though a regressive and badly designed one, with lots of historical inequities and complexities locked in).

Between 1985 and 1986, the nominal effective exchange rate decreased by about 19%.

This is presented as if it were a goal of government policy. In fact, this depreciation, and the current account deficits that drove it led to Treasurer Paul Keating’s famous observation that Australia was in danger of becoming a “banana republic”

Australia is a clear case of an‘expansionary fiscal contraction’. GDP grew faster during and in the aftermath of the adjustment, both in absolute terms and relative to the G7 countries. A private investment boom was associated with profits and easier access to credit following the financial deregulation process that took place in 1985–6.

This is like the story of the guy who jumps off a tall building and says, as he passes the 25th floor “All good so far”. Writing in 1998, Alesina and Ardagna must surely have been aware that, almost immediately after their story ends, Australia entered the worst recession in its postwar history. The recession was triggered by contractionary monetary policy, but its severity was largely due to the collapse of speculative investment projects undertaken by so-called ‘entrepreneurs’ who took advantage of easy access to credit to build conglomerate empires that failed in the crisis, almost taking down the banking system with them. Unemployment reached double digits in the early 1990s, and didn’t fall below the pre-adjustment level of 8 per cent (itself disastrous) for nearly a decade.

In July 1987, the same government and the same prime minister in office were re-elected by popular vote. In the April 1990 elections, neither the winning government nor the prime minister changed.

This is true, though there was a huge amount of luck and ham-fisted opposition involved. When these factors ran out in 1996, the government suffered a thumping defeat, based primarily on the recession of the early 1990s. Labor was out of office for another decade.

Overall, the description of Australian macroeconomic experience given here is unrecognisable to someone who lived through the period. The government did lots of things that gained the approval of neoliberals (global sense) but these were almost entirely microeconomic in nature.

Although this piece is full of silly errors and spurious claims, the central problem (which starts with the dating error) is that the direction of causality is reversed. The strong expansion that began in 1983 drove much of the fiscal consolidation directly, and created the political-economic environment in which tight fiscal discipline was feasible without economic contraction, and politically salable. The severe recession that began just after the triumphant return to budget surplus (when Paul Keating went from bragging that “this is the one that brings home the bacon” to observing that “this is the recession we had to have”) wiped out all of the fiscal consolidation of the previous decade – balance wasn’t restored until years into the expansion with a consolidation that produced an increase (admittedly temporary) in unemployment, as Keynesian theory would predict.

As a final observation, Alesina and Ardagna would have had a much better picture of the events they described if they had taken a list of Keating’s most famous sayings and checked back to discover the context.

28 thoughts on “Expansionary austerity: some shoddy scholarship

  1. “The government did lots of things that gained the approval of neoliberals (global sense) but these were almost entirely macroeconomic in nature.”

    Presumably you mean microeconomic.

    “Their fiscal stance was either neutral or expansionary almost throughout their term in office.”

    Fiscal stance is hard to measure, since both expenditures revenues affected by the state of the economy (as well as vice versa) I don’t think that was true of the late 80s.

    Speaking of the late 80s, Alesina spent time (months) as a visitor at the RBA at that time, where he co-wrote papers on the Australian economic policy experience with (now) Treasury Deputy Secretary David Gruen. Alesina knows (or once knew) the facts. He is not usually sloppy like this. Maybe his co-author wrote the chapter on Australia.

  2. Actually, Professor, I’m pretty certain that Keating’s comments about the “banana republic” were not a response to the fall in the Australian dollar but a response specifically to the March 1986 balance of payments data.

    The current account deficit that month was much bigger than market economists had been forecasting – the early timing of Easter that year mucked up the seasonal adjustment – and the unexpectedly wide deficit prompted those remarks.

    The exchange rate had fallen immediately after the figures were released and before Keating was interviewed on radio (on the same day, I think) by John Laws, but before that it was actually a bit above its average for the 12 months leading up to that day, so there was no reason for Keating to be getting all huffy about the exchange rate on that day.

    Perhaps the fall in the exchange rate in the short time after the data release heightened Keating’s sense of urgency, but he wasn’t complaining about the lower exchange rate per se, he was arguing for economic reform and using the current account deficit in support of that argument.

    I take your point though, the lower $A was not a goal of economic policy. I mean, they did float the thing after all.

  3. JQ wrote; “Writing in 1998, Alesina and Ardagna must surely have been aware that, almost immediately after their story ends, Australia entered the worst recession in its postwar history.”

    I think “1998” is a typo and you meant “1989”. Also, does the early 1990s recession remain our worst when compared to the 2007 GFC in Australia? I don’t know the facts myself.

    The notion of “expansionary austerity” is absolute nonsense which is pushed by neoliberals and monetarists who have no idea how a modern economy works. I guess it’s the reverse of the “crowding out” thesis and so a kind of “making room” thesis. (Proper empirical work has refuted this thesis over and over. It is part of the loony world of fantasy that the right and neoliberals live in.) They assume reduced public expenditure makes room from private enterprise to expand and take the economy to full utilisation.

    (Irony alert beings) Hmmm, that must be the reason we had the GFC and still have something like 10% real unemployment in Australia, along with record private debt and the spectre of deleveraging and debt deflation hanging over our heads. It’s all because the real economy grows so well under neoliberal, monetarist presecriptions. (Irony alert ends)

    All reduced public expenditure plus depressed wages can achieve is to cause the need for private debt to go up if there is to be enough demand kept in the economy. Clearly private debt cannot expand indefinitely, as private income will not be sufficient to service the ever-rising private debt. Eventually, a debt crisis occurs and private debtors must deleverage. This depresses the economy. This is economics 101. Keynes, Minsky, Keen and Mitchell make this plainly and irrefutably clear in their work.

    The goals of economic management should be to do with real people and the real economy. Fiscal and monetary management should serve these goals. The goals of modern economic management should be to;

    1. Meet the legitimate needs and sensible aspirations of the people equitably.
    2. Maintain full employment with allowance for frictional unemployment.
    3. Achieve full utilisation of labour and fixed capital (physical assets) in the real economy.
    4. Achieve these goals in a manner that is sustainable indefinitely.
    5. Run the government budget, fiscal and monetary policy in a way to meet the above goals.

    Note that government budget and financial policy come last on the list. Government budget and policy must be tools to reach the real ends. The only limit on using tools is that they be not blunted or damaged irreparably. Deficits and surpluses have no meaning in and of themselves under a fiat currency. It cannot be a sensible goal to balance the budget or run a deficit or surplus for its own sake. Deficits and surpluses only have a meaning in relation to real economy needs. If the real econmy is depressed then a deficit must be run to inject money and thus demand into the economy. I know this is obvious Economy 101 but it has to be continually restated in the face of endless neoliberal lies.

  4. @Ikonoclast

    well,i think i’ve got that.

    but what is frictional employment?


    T,s o FA looks like agnotology in action?

    that bastard hangover word from the eighties?

    when malfaisants (murderers,torturers,rapists,liars,cheats,thieves,extortionists,etc) are caught,”rationalise” is the word used to describe their actions.

    just following orders.
    hard childhood.
    my hormones made me.
    it’s not my fault.
    god said i should.
    and on and on.

  5. @Ikonoclast

    I strongly agree with your comment. Especially “4. Achieve these goals in a manner that is sustainable indefinitely”.

    The neoliberals urge the government to give the market more freedom through lower tax and deregulations; but when market crisis happens they will throw away all the responsibilities and tell the government to fix it for them. It is common sense that responsibilities comes with freedom and power.

  6. Unfortunately shoddy scholarship, and even plagarism, are not career retardants they once were. Indeed, under the new managerial approach to academia, where it is all “don’t mind the quality, feel the width”, several shoddy publications can be worth considerably more than a few good ones (as long as the Stalinist ‘performance indicators’ say so). Recycling, to the extent that one is able, is encouraged. How very Green!

  7. I shall, hereafter, take stuff written about other countries with a pinch of salt. They may be taking advantage of my ignorance to convince me of things that aren’t true.

  8. @John Brookes

    Sensible response. And take at least some of the stuff written in the mainstream media, especially if it is written by ‘journalists’, with the same pinch of salt you might use when assessing material on blogs. Also shows that even Ivy league professors can turn out dross. (Even if their name is not Niall Ferguson.)

  9. If one enjoys reading ‘nonsense on stilts’ how about looking at “On the Origins of Gender Roles: Women and the Plough” by Alberto Alesina, Paola Giuliano and Nathan Nunn 2011.
    Considerable effort, ‘long bow’ inferences, and complex manipulation of a sizeable dataset provide results that suggest absolutely nothing. Well done.

    Maybe Wall Street is not the only location where resources are misallocated?

  10. @rog

    It might be official dead but it will not die off completely. I nearly fell off my chair laughing at the post of Paul Krugman where he said it’s less painful for the Euro to collapse on debt earlier than later; I wonder if he is thinking of his own country when he said that. It would be good if reputable “right” economist can think why this happened before posting things that makes people laugh at them.

  11. A lot of talk and analysis about the Euro could fall under the heading ‘wishful thinking’. The Euro has been a significant threat to the US dollar’s role as the reserve currency and the many many benefits the US has gained from the dollar’s role. Unsurprisingly, conscious or not, American and pro-American commentators have heaped nothing but scorn on the Euro even before it existed. There is no reason why the Euro ought to collapse, in the sense of component countries switching to their old or other currencies, simply due to debt. The argument for that happening is a tenuous as arguing that individual US states will leave the US dollar. Of course, in the end these things are driven by perceptions and politics and fuelled by both of those anything is possible. Krugman is mostly good but like us all is hardly immune to wishful thinking. If the US hadn’t damaged the Euro so much with its trash talk, and if the ECB had sensibly created Euro Bonds for the purpose, the Euro would be replacing the dollar as the reserve currency right now, and the US would be in even deeper do do than it is already. As it is, investors are groping for another reserve and trying to use the most unlikely vehicles as safe havens. Much to the chagrin and pain of the countries involved.

  12. @Freelander

    No doubt the Euro shouldn’t collapse; such a catastrophic event will cause long term recession/depression and will do significant harm to the society; whether if it’s financially(increase poverty), mentally (stress and mental illness) and physically (increase crime rate). I just wish that these “professionals” can be more humane and considerate, especially when the US itself doesn’t look so good either. As to the new election IF crazies like Perry is to be elected, the US government would be the next to fall under debt crisis.

  13. The US is already under a debt crisis; so far they have been successful by distracting attention from their own problems. The vast majority of states are bankrupt or close to. The Federal government has the Greek problem – massive debt and politicians and an electorate who seem very resistant to paying that debt off. So far the US has gotten away with very low interest rates on that debt, partly as a result of being the reserve currency, partly as a result of ridiculously high ratings by American rating agencies, but those benefits won’t last. If the US starts having to pay interest rates like every other grossly indebted nation, the unwillingness of congress to pay will quickly lead to the Greek disease. As it is there are many US citizens ready to riot in the streets about the economy designed to benefit one percent. Wait until things get tough. If anyone in the US thinks things can’t get worse they are extreme optimists!

  14. @Freelander

    Agreed, however if a party that thinks expansionary austerity would work in the sametime thinking it would be possible to pay of the public with the reduction in tax; that would be crazy.

  15. The title of Alesina and Ardagna’s publication in question does not promise a scholarly book. The title promises “tales”. And this is what they delivered, at least w.r.t. Australia.

  16. “Agreed, however if a party that thinks expansionary austerity would work in the sametime thinking it would be possible to pay of the public with the reduction in tax; that would be crazy.” Source: Tom @17

    I almost fell for it, Tom. Your point seemed to be so obvious until I realised I ignored the possibility of a categorisation error in the filing of books in a library or some other ‘knowledge management system’. Suppose, some fables are accidentally filed under economics and suppose these fables are read by members of a party that seek to educate themselves. Frightening, isn’t it, how easy it is to create an apparently crazy world.

  17. I shall, hereafter, take stuff written about other countries with a pinch of salt. They may be taking advantage of my ignorance to convince me of things that aren’t true.

  18. @Ernestine Gross

    America is already having a public debt crisis issue even with their current so called “high rate of tax”. What Freelander said is true; if the US currency is not a reserve currency the interest rate charged on the public debt would be much higher. Whoever is going to get elected to the next US government; if that person decides to use expansionary austerity (reduce tax and praying those money injected into the economy will stimulus growth fairy tale); it will be much harder to pay off the public debt it currently owes without cuttings some spending on transfers, infrastures or military spending etc.

  19. My apologies, it seems I have messed up my comment “Whoever is going to get elected to the next US government; if that person decides to use expansionary austerity (reduce tax and praying those money injected into the economy will stimulus growth fairy tale)” change to “Whoever is going to get elected to the next US government; if that person decides to use expansionary austerity in the sametime reduce tax and praying those money injected into the economy will stimulus growth fairy tale”.

    Austerity will already be contractionary policy, this reduction in public spending should not be reduced on the parts of government transfer. The people living on government transfers are living on their edges, further reduction in that area will cause public instability. The low flat tax rate as Perry suggested will not give much benefits the lower/middle class workers which makes up the majority of the population. Although their income gets a boost in the short run, the current problem will reoccur if the income of the lower/middle class worker’s wage fail to improve in the furture. By that time are the policitians going to cut the tax rate to 0%? Such a cut in public spending compensated with reduction in tax will be a crazy idea especially when the government is already having a public debt issue.

  20. Unfortunately the dynamics of ‘democracy’ in the US are that you need a pile of money to even stand a chance of being elected. Raising that money necessarily comes with strings attached. Lobbiest will never let their pet fiddle get cut. The so-called military-industrial-complex is the worst offender. The may, and have, allowed troop numbers to be reduced because there is poor profit yield on soldiers. The high yield is on ‘outsourcing’ and new high tech toys. Cutting expenditure on those will be a real problem. Food stamps? Other poor benefits? Easy to go. Probably not even one food stampl lobbiest to disappoint. In some ways, given the problems with their style of democracy, the US problems over the longer term, and not all that long term at that, are possibly more horrendeous that those of the Greeks. At least the Greek government can be dragged to a necessary survivial decision. Whether the US government can is an open question.

  21. @Freelander

    Agreed, it’s one of the main reason why I believe the current problem is unfixable because of their media and policitical system. I hope that the people of America will start realising the problem and try to fix it before it’s too late. I do not wish the American people to live in the state of extreme poverty after the collapse of their economy; I mean how much financial crisis will it need for the people to become exorcist and kill off the walking zombies?

  22. Yes, Tom, ‘their media’ is one form of knowledge management. Apologies for my tongue-in-cheek comment @19. I should have signalled the nature of its content.

  23. @Ernestine Gross

    No apologies needed, there will always be miscommunication of some sort (especially when my grammar isn’t that great). It only take 1 step from both sides to understand each other; but it looks like 1 step is too hard in politics in the US. If the left and the right parties of US can come to an “sensible” agreement in the policies to tackle the current US problems, there will be a much better future for the people of America.

  24. Interesting, just read “Alan Moran [Moron?] of IPA has a hot headed go at John Quiggin in today’s Fin Review “. The guy spent his time in the public service getting rid of those ‘bad’ regulations and food and food preparation inspectors that used to protect people from food poisoning. Remember that when you see some of the sloppy food handling that is now common, or the next time you get food poisoning. When he left the public service he was quoted in the newspapers as saying that various dangerous waste should just be dumped in the ocean. Well that has been happening off Somalia because their is no effective state to stop companies doing it, and that is why the Somalian pirates came into existence. They can’t fish anymore, because of the dumping and because with no state to protect the waters foreign trawlers moved in and fished it out. So they went into business for themselves. Can hardly blame them.

    Isn’t deregulation wonderful!

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