Tuesday, 8 May 2012

Is Europe's austerity a bad idea?

Kalypso Nikolaidis - EU
Photo by openDemocracy
So CNN has an article entitled European voters revolt against austerity, cuts. Here's a telling sentence from it:
The French turfed out the president who wanted to make them more competitive and less indebted — and voted for a candidate pledged to reversing the recent rise in the retirement age.
Hmm, "turfed out"? Actually, both candidates want to make France more competitive and less indebted, but they have radically different ideas about how to do this and painting Hollande, the new President of France, as simply being about for raising the retirement age, is a grotesque oversimplification. Of course, Hollande hasn't been forthcoming in how he's going to pay for many of his ideas and this has been one of the strongest criticisms against him.

Now think about political campaigns: how often do you find politicians say how they're going to pay for their programs? They generally don't because it turns out that people like when politicians provide services and "turf out" politicians who take away those services. Thus, as soon as a candidate says "I'm going to pay for X by taking money from Y", if Y is insignificant, he's not taken seriously. If Y is significant, he's just lost a huge block of voters! Keep telling people up front on how you plan to pay for things (vague promises of "cutting the pork" or "eliminating inefficiencies" don't count) and you lose an election. Better to take criticism for vague promises than specific threats.

But what is Hollande about? What are many Europeans about when they reject austerity? (Note that austerity, as it's typically preached, focuses on cutting spending and ignores the possibility of raising taxes). On its surface, if you blame the financial crisis on governments run amok and overspending, austerity sound great. Except that it's worth asking what an economic downturn is.

In an economic downturn, people are obviously spending less money. What money? Where did it go? It didn't disappear, but you might be forgiven for thinking that. Instead, the money is still there, but people aren't spending it. Paul Krugman (love him or hate him) actually gives a great explanation of this in his Baby-Sitting the Economy article on Slate.com.

If the money is not gone, why are people spending it less? Because they're afraid that with the downturn, they won't have a chance to earn it back. Small business owners have been skeptical of receiving tax breaks in the US because, as they've pointed out, there's no reason for them to reinvest this money to produce more output that people are not buying. Companies don't hire more employees during a recession. Businesses don't start ordering more raw supplies. Many argue that lower interest rates make borrowing more attractive and will help the economy recover, but the Fed slashed interest rates to an all-time low back in 2009 and the US economy is still struggling badly.

What happens is that when an economy turns down enough, the individual actors in the private sector cannot take the risk to increase spending and it takes aggregate behavior to change this. This aggregate behavior won't come from the private sector any more than the private sector would provide the US interstate highway system (which was a huge financial success, but not in a way that a private company could manage it). Thus, there's a clear role for government to step in and get the economy going again.

Which gets back to why people hate austerity. They hate it because it means they're getting fewer services for their taxes. However, more and more economists hate it because an economic downturn means fewer people are spending money and austerity reinforces the lack of spending. Get that? What needs to happen when the economy is so moribund is to jump-start the spending. You don't want to do this forever, though, because when times are good, you need to stop jump-starting and start cleaning up. When times are good is when it's good to save. When times are bad you rely on those savings. However, when the economy recovers, politicians will again find themselves with the dilemma of cutting services being very unpopular. Intelligently managing an economy is very difficult in the face of a democracy (note: this is not an attack on democracy, it's an observation of one of its problems).

In his new book, End this Depression Now!, Paul Krugman argues forcefully that austerity in an economic downturn only exacerbates the problem. Unfortunately for his critics, he has a host of both current and historical examples to back him up. Sadly, religionomics guarantees that people will sooner follow their beliefs than look at the facts and since Krugman has been labeled a socialist but since many Americans have no idea what socialism is but nonetheless hate it fiercely, getting tarred with that brush means many people simply won't listen to you.

The world is going to have to experience a lot more pain before they get beyond where they are now and, sadly, they're probably going to forget this lesson soon. For now, though, the people have spoken and are looking for growth opportunities instead of mindless and painful austerity programs.


  1. Very nice post. Austerity sounds lovely (and very high-minded) until folks start figuring out that their favorite ox is about to be gored. Then begins the unseemly battle to separate the "deserving" from the "undeserving" and the "indispensable" from the "frivolous." And I agree with both you and Krugman (Krugman who is a *brilliant* economist who was not given his Nobel prize because he has pretty thighs and shapely ankles), it's no way to get an economy going again.

    My .02 :-)

  2. The problem with people needing to feel pain to make changes is that, so far, the ones feeling the pain are marginalized and ignored. The ones who are in a position to make decisions about public policy are not feeling the pain because they have offloaded it onto the rest of us.