Not my core professional competence, but I’m increasingly exasperated by our politicians’ handling of the economic crisis. So I guess I’ll keep updating and expanding this post here as my personal go-to place.
There’ve recently been two studies published on the devastating impact austerity is having on public health, a book and an article in the prestigious medical journal Lancet (links to news articles here and here). While access to care and medication are going down, mental illness, suicide rates and epidemics are on the rise. So cutting back public health spending is leading to a deterioration of public health. Who could have guessed?!?
Unemployment rates in the crisis countries are also just horrifying, especially youth unemployment. Essentially, a whole generation is being destroyed in terms of its job prospects. Youth unemployment in Greece is now above 60% and also at similarly devastating levels in the other crisis countries.
And all this pain isn’t even doing what it’s supposed to do, helping to balance public budgets. No wonder, since a lot of people are starting from a wrong diagnosis. Especially Germans like to think that the crisis was caused by profligate public spending in the Southern European countries. Actually, except Greece, all the crisis countries ran pretty solid public budgets before the crisis hit, the BBC has a nice chart here. Spain for instance decreased its debt-to-GDP ratio from about 60% to below 40% in the decade before the crisis.
What actually caused the crisis was an unsustainable economic boom in the private sector, especially the housing sector, in the USA and Southern Europe. Now that the bubble has burst, everybody is sitting on a pile of debt and is forced to pay down that debt, leaving no money for spending or investments. The interest rate would have to be negative to bring desired spending and desired savings into balance. But it is already close to zero and obviously can’t get below. In such a situation, public spending doesn’t crowd out private spending, instead it utilises resources that otherwise would lie idle. Even the IMF’s chief economist now says that under current conditions it’s counterproductive to cut back government spending. Under current conditions, each euro of public spending cut leads to a decrease of GDP of more than one euro. Austerity therefore just further depresses GDP and thus the tax base and thus worsens the debt position instead of improving it. As has been amply borne out by the experience over the recent years, the sharper the austerity has been in a country, the sharper the drop in its GDP.
Paul Krugman just had a long essay laying out the fallacies of the austerians, in particular how austerity has been promoted on the basis of two studies that have now been thoroughly debunked.
But policy-makers seem determined to repeat all the mistakes their predecessors made during the Great Depression, which had the same basic structure as the current crisis: widespread deleveraging after the bubble of the Roaring Twenties had burst. A little refresher: The German Brüning government in 1930-32 reacted to the crisis by imposing draconian austerity that would probably have made it the darling of the IMF (before its recent Damascus event), if there had been an IMF at the time. The result: A collapsing economy, unemployment shooting up above 30%, which led to a desperate population turning to anyone who seemed to offer an alternative, which led to the combined election results of the anti-democrats on the right and left shooting up above 50%, which led to Hitler becoming chancellor. So especially we Germans really ought to know better than lecturing the rest of Europe on the supposed benefits of austerity. Against that background, the near-collapse of the political centre in the latest Italian and Greek elections came us no surprise to me, nor does the current surge of the UK Independence Party. The current UK government has elegantly engineered a double-dip recession with its harsh austerity policy, for which it is now reaping its just reward.
The worry about public debt also doesn’t make sense to me in general terms, even if we were not in a depression. The Washington Post recently had a nice rundown of the arguments and counter-arguments. The basic problem seems to be that many people think of public debt as if it worked like private household debt, so government should in their view act like a “good Scottish housewife”.
There’s a big bogeyman of each German being thousands of dollars in debt due to the government’s debts. This perspective totally ignores the other side of the equation, the corresponding claims the creditors have on the German government. In the German case, the public debt is overwhelmingly held by Germans, so it’s basically money we owe to ourselves, the economy doesn’t get one cent poorer by it. And as noted, in the current situation government spending also doesn’t crowd out private spending.
A related argument is that we shouldn’t saddle our children and grandchildren with all that debt. The counter-argument is just the same. The payments government will make on the interest and principal of its debt is going to go to exactly those same children and grandchildren.
Public debt is also very different from private debt insofar as governments don’t really need to pay back their debt. They can indefinitely roll it forward, taking out new loans to pay off the old ones, especially if they have their own currency, in which case the central bank can always act as lender of last resort. Governments probably ought to make sure that the debt doesn’t rise faster than the tax base, i.e., the size of the economy. But even that is not an ironclad rule, one may note that the interest Japan currently has to pay for new loans is close to zero even though its debt is close to 200% of its GDP. And the argument that high levels of public debt will be a drag on the economy is exploded by Paul Krugman in the essay referenced above. So saying that government should behave like a “good Scottish housewife” is comparing apples and oranges.
The problem of the Southern European countries is of course that they no longer have their own currency, so the risk premium on their loans shot up when it seemed that they might be forced into default. But once the European Central Bank made clear that it would do whatever took to save the euro, the premium immediately came down sharply.
So the only argument for budget discipline I see is that going into a crisis with low debt makes it easier to deal with the crisis. But as Keynes said, the boom, not the slump, is the time for austerity. And as shown by most euro countries in the decade before the crisis, the often-heard argument that governments aren’t going to exercise restraint in good times either is just another bogeyman.
In the above-mentioned essay and a recent blog post, Paul Krugman suggests a couple of reasons for why so many people are nevertheless in love with austerity. One is that many people see economics and economic policy as a morality play. The Southern Europeans have sinned, and in the minds of many Germans are anyway lazy do-no-gooders, so now they must atone for their sins. Never mind that the Greeks are outdone only by the South Koreans in terms of annual working hours, way ahead of Germany, as are the other Southern European countries.
And with any kind of political advice one should always asks who profits. So another possible reason for the turn from stimulus to austerity is that it implies “giving creditors priority over workers. Inflation and low interest rates are bad for creditors even if they promote job creation; slashing government deficits in the face of mass unemployment may deepen a depression, but it increases the certainty of bondholders that they’ll be repaid in full.”
Another hypothesis is that elites “see economic distress as an opportunity to push through “reforms” — which basically means changes they want, which may or may not actually serve the interest of promoting economic growth — and oppose any policies that might mitigate crisis without the need for these changes”. It’s basically Naomi Klein’s Shock Doctrine, “with its argument that elites systematically exploit disasters to push through neoliberal policies even if these policies are essentially irrelevant to the sources of disaster.”
Business interests may in particular dislike Keynesian economics because they mean that politicians don’t “have to abase themselves before businessmen in the name of preserving confidence” in order to make recovery possible.