osewalrus (osewalrus) wrote,

Why Does Austerity Sell Better? Or "Why I'm a Utiliterian When It Comes To Economics."

A hat tip to goldsquare for this link from 538.com on why austerity is likely to crash the economy rather than save it.

As Hale Stewart, the economist who did the 538 blog points out, countries that opted for austerity over stimulus in 2008-9 did poorly as compared to stimulus countries. Worse, despite bravely "taking the pain," they remain in worse shape economically than the countries that opted for stimulus. And I will add that this pattern is repeated. IMF and World Bank routinely required developing nations in the 1990s to get their debt under control with massive austerity programs. The result was always to plunge the country into massive unemployment and long-term recession. Arguably, this was worth it for countries suffering hyper-inflation, but it has become the cure-all for whatever ails ya (usually from the same folks arguing that tax cuts are the cure for what ails ya). The only South American country to reject this regimen was Brazil, which prioritized paying off IMF loans but rejected calls for the kind of austerity programs that bankrupted Argentina and Ecuador (it also relied on a huge stimulus plan in 2009).

Nevertheless, despite any objective evidence that government austerity is the path to prosperity, it remains the most popular economic program in the U.S. and abroad. The question becomes why.

I have a few theories. Start with the fact that most people don't understand macroeconomics and generally analogize from their personal experience. I often here "I have to live within my means, why shouldn't the government." While an interesting moral argument, it doesn't really mean anything economically. Governments do lots of things individuals cannot and should not do. I also do not check drugs for safety and efficacy, maintain an army, administer lengthy borders, collect taxes, or any of the long list of things government does. To say that the government should balance its budget because I, as an individual, need to do so makes as much sense as saying government should not maintain an army because I, as an individual, should not. Nevertheless, this moral argument masquerading as economic sensibility has enormous appeal.

This dovetails with the other moral argument masquerading as an economic argument: that it is somehow wrong for government to finance significant sectors of the economy. This ranges from Chicago School economics that maintains that government spending distorts the "real" economy (which is conveniently defined as 'everything except government') to a gut reaction against "socialism" and the idea of any sort of industrial policy (which is equated with central planning).

Here I confess to my horrible utilitarianism. When it comes to economics, I don't care whether the economics is "real" or propped up by government spending as long as it creates sustainable economic growth distributed throughout all social sectors. I don't demand it be distributed equally (nothing ever is), but everything I know about sustainability in economic growth tells me that if the benefits are spread too inequitably it eventually creates economy-stalling dynamics. Mass production is a critical element of economic growth. Concentrations of wealth in a relatively small percentage of the population frustrate the development of robust internal markets.

Which brings us back to Keynsianism and the current economic crisis. I am a believer in the government "pump priming," although I also maintain that the investment ought to be transformative of the economy as a whole and ought to follow an industrial policy of encouraging growth in key sectors in addition to simply creating short term jobs. In the short term, money is money and getting consumers to spend money and providing a basis for lending is critical. But in the longer term, we need an infrastructure that shifts job growth to the private sector (or to the public sector in a sustainable way, for example by having the government sell services or impose regulatory fees). That requires industrial policy -- which covers a wide range of policies from building broadband infrastructure to incentives to install solar panels to relieve our moderate our demand for fossil fuels ("which part of NON-RENEWABLE resource was unclear?")

The final justification given for austerity is to prevent the emergence of inflation. This usually comes from a rather simplistic view of inflation as being linked exclusively to money supply, which is supposedly measured by national debt. In fact, the relationship is much more complex. Yes, excessive debt can become a problem, as the Greek crisis indicated. But the problem occurs when debt becomes so massive that investors lose confidence in the ability of government to ever pay back the debt. But this inability to pay back debt is not merely a function of the size of debt. It is debt in relationship to expected GDP growth with consideration also for when the debt matures. Starving the country for economic growth produces a similar lack of confidence, which generally requires all resources to go to paying the debt to maintain solvency.

The other thing that determines inflation is the law of supply and demand. Where goods do not keep pace with demand, price goes up. Where production exceeds demand, the price drops. This is Econ 101, but folks do not generalize this from the microeconomic example of a single product to the larger macroeconomic process -- except for the idea that government debt somehow translates into "too much" money being available. While this can happen (one of the reasons many economists worry if cost of living allowances (COLAs) become too prevalent), the major problem of debt is that payment to service the debt is "non-productive" expenditure. Too much debt, means servicing too much debt, which means too little money going to productive (in economic terms) use.

Hence the concern of many economists with a deflationary cycle rather than an inflationary cycle. If people can't pay for goods and services, providers are forced to lower the price. This, in turn, means that providers must cut cost or accept lower profit margins -- or both. On a macroeconomic level, "cut costs" means lay offs or lower salaries, which means less money to buy goods and services. This contrasts with the problem of an "overheating" economy. An economy in rapid expansion can run into the problem that demand for goods exceeds the ability of market to produce the goods in the short term. Dump a ton of money into a geographic area -- for example as disaster relief -- and prices will rise dramatically because those with access to money will pay much more for the limited supply of goods, pushing the cost beyond the means of those who do not have access to the new supply of money. This is why economists like a GDP growth rate of between 3%-5% for a mature economy. This is considered enough growth to keep up demand/production, but not so much that a sudden influx of wealth causes demand to exceed to production capacity.

Finally, I will confess, we in the U.S. have a trick up our sleeve. We are too big to fail. Too much of the world's economy is valued in dollars -- a situation that persists despite all the abuse we gave our currency in 2007-08. This is why Treasuries continue to attract such demand, and why the world ought to worry about our getting into a deflationary cycle.

To conclude, I've skipped past the influence of political and media messaging as too complex. At heart, we remain prisoners of the most simplistic Chicago School economic theories, bolstered by poor understanding of macroeconomics and moral choices masquerading as economic theory. With the threat of economic collapse upon us, we briefly flirted with a return to the Keynsian idea that government plays an important role in the economy as an economic moderator/stabilizer, acting as the employer/consumer of last resort and pushing the economy in positive directions by overcoming certain collective action and investment problems. Alas, the American public and the political class regard this monetary return to sensibility as the economic and moral equivalent of an unfortunate wild weekend in Vegas, and seemed determined to show how thoroughly Reformed they are by returning to the Church of Austerity and the belief that government spending is not "real."

Unfortunately, the consequences of these decisions are very real. And, in good macroeconomic fashion, do not fall solely on those who make them.

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