GOVERNMENT AUSTERITY DEBUNKED

ABSTRACT: The argument for government austerity was largely built on two economic theories, both of which have been debunked recently by academia and reality. First was the theory that if government debt exceeded 90% of economic activity, then economic growth would be sharply lower. The second was that cutting spending in a depressed economy would create jobs.

 

The study the first was based on was dramatically discredited when an error was discovered in the Excel spreadsheet used to calculate its findings. Furthermore, the link highlighted between government debt and slow economic growth does not indicate that government debt causes slow growth; it could just as likely be the reverse.

The second theory was based on another academic study that was refuted by a 2010 study by the International Monetary Fund, which used better data. And finally, real life experiences in the US and Europe have not borne out what the austerity advocates predicted or promised.

Despite this debunking of the rationales for austerity, there hasn’t been any change in policies or political rhetoric in the US. The US austerity movement appears to be driven by small government ideologues who are using the economic crisis as an opportunity to push for cuts in social programs they’ve always opposed. There also appears to be an issue of class hiding behind austerity advocacy. While the years since the Great Depression and of austerity policies in Washington have been hard on the middle and lower classes, for the well off they’ve been pretty good. So, perhaps it shouldn’t be a surprise that the wealthy and political elites keep pushing austerity policies despite the lack of support from theory or reality.

FULL POST: The argument for government austerity – reducing the deficit by cutting spending and perhaps raising taxes – was largely built on two economic theories, both of which have been debunked recently by academia and reality. First was the theory that if government debt exceeded 90% of economic activity (measured by gross domestic product [GDP]), then economic growth would be sharply lower. The second was that cutting spending in a depressed economy would create jobs.

The first, on the danger of government debt, was based on a 2010 study by two Harvard economists, Reinhart and Rogoff, “Growth in a Time of Debt.” Despite significant controversy about it, its finding of a tipping point for reduced economic growth when government debt hit 90% of GDP was presented as fact by politicians and media arguing for the need for austerity. [1]

This study was dramatically discredited when an error was discovered by Thomas Herndon, a Ph.D. student at the University of Massachusetts, Amherst, in the Excel spreadsheet Reinhart and Rogoff used to calculate their findings. An error in one of their formulas had excluded data from Canada, New Zealand, and Australia, all of which had experienced strong economic growth in periods of high government debt. [2] (Reinhart and Rogoff have acknowledged the error.) This explained why other researchers, using similar data, hadn’t been able to replicate their findings. As Reinhart and Rogoff’s work was scrutinized, it was also criticized for omitting data and using questionable statistical procedures.

Furthermore, the link they highlighted between government debt and slow economic growth does not indicate that government debt causes slow growth; it could just as likely be the reverse, that slow growth leads to higher government debt. Indeed, the latter is clearly what happened in Japan in the early 1990s when government debt grew after the economy collapsed. [3]

The second theory, that cutting spending in a depressed economy would create jobs, was based on another academic study. It was refuted by a 2010 study by the International Monetary Fund (IMF), which used better data. The IMF study found that austerity reduced job growth instead of accelerating it as the original study and austerity promoters claimed. [4]

Finally, real life experiences in the US and Europe have not borne out what the austerity advocates predicted or promised. In the US, government debt and a bit of stimulus did not produce high interest rates and a shrinking economy. Most recently, the austerity measures adopted in March – namely the sequester’s budget cuts – are clearly causing jobs to be cut, with no signs of resultant job creation. Meanwhile, most of Europe is in recession despite consistent application of the austerity medicine for the last four years.

Despite this debunking of the rationales for austerity, there hasn’t been any change in policies or political rhetoric in the US, and little in Europe. This suggests that the austerity movement is not based on research and reality, but on ideology.

The US austerity movement appears to be driven by small government ideologues, given that the push for budget cuts continues unabated. These ideologues are using the economic crisis as an opportunity to push for cuts in social programs they’ve always opposed. They’ve seized on the austerity theories from academia as justification for their actions, and aren’t letting go of them even when they have been soundly discredited. [5]

There also appears to be an issue of class hiding behind austerity advocacy. The wealthy in the US regard the deficit as the most important problem we face and favor solving it by cutting spending on health care and Social Security. The middle and lower classes, although they see the deficit as a problem, view unemployment as a more important problem and want to see spending on health care and Social Security increase. [6] Given the political power of the wealthy elites, it’s not surprising to see policy bending to their preferences. While the years since the Great Depression and of austerity policies in Washington have been hard on the middle and lower classes (high unemployment, incomes that aren’t keeping up with inflation, home values that haven’t recovered to 2008 levels), for the well off they’ve been pretty good (incomes growing faster than inflation, corporate profits and stock prices surging). So, perhaps it shouldn’t be a surprise that the wealthy and political elites keep pushing austerity policies despite the lack of support from theory or reality.


 

[1]       Krugman, P., 4/18/13, “The Excel depression,” The New York Times

[2]       Roose, K., 4/18/13, “Meet the 28-year-old grad student who just shook the global austerity movement,” Daily Intelligencer

[3]       Krugman, P., 4/18/12, see above

[4]       Krugman, P., 5/3/13, “Playing whack-a-mole with expansionary austerity,” The New York Times

[5]       Editorial, 5/5/13, “Blame ideologues, not economists for failed ‘austerity’ policies,” The Boston Globe

[6]       Krugman, P., 4/15/13, “The 1 percent’s solution,” The New York Times

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2 comments

  1. rfleiss · · Reply

    Hi John,

    You might add Japan’s recent acceleration in economic growth to reasons for debunking the theory supporting our government austerity. Their government debt presently exceeds 200% of Japanese GDP while their fist quarter growth was 3.5%, far better than anticipated, reflecting Abenomics and a weaker yen. Their government debt is totally funded by domestic investors so it is not totally comparable to the US, but it does say something about the relationship between debt and growth.

    See you guys soon.

    Richard

    _____

    From: Lippitt’s Policy and Politics Blog [mailto:comment-reply@wordpress.com] Sent: Sunday, May 26, 2013 9:01 AM To: rfleiss@rcn.com Subject: [New post] GOVERNMENT AUSTERITY DEBUNKED

    John A. Lippitt posted: “ABSTRACT: The argument for government austerity was largely built on two economic theories, both of which have been debunked recently by academia and reality. First was the theory that if government debt exceeded 90% of economic activity, then economic gr”

    1. Rich,

      Thanks! Another great example of the austerity theory debunked by facts. Another that just came to my attention is an update from Portugal. The Financial Times reports that in Portugal, where an austerity program has been pursued “assiduously” for 2 years, unemployment is 19% (40% for those under 25) and the small businesses that are the core of the economy are closing at the rate of dozens per DAY! The promised recovery is nowhere in sight.

      See you soon.

      John

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