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. @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.

  2. 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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