Something extraordinary happened in Europe this week. Enrico Letta, Italy’s Prime Minister nominee, upon being tapped to form the next government made a bold press conference announcement that his primary objective upon taking office will be to end Italy’s austerity program and join other leaders calling for an end to austerity across Europe. Presto! The bond markets did not go berserk. Contrary to wide expectations, instead of punishing Italy investors remained calm and did not proceed to increase its borrowing costs. And voila, the euro crisis has come to an end.
News also spread like wildfire this week about the notorious austerity paper scandal. An academic paper by the well regarded economists Kenneth Rogoff and Carmen Reinhart, which has been used by policymakers far and wide to justify their fiscal retrenchment, has been discredited. Among other high profile examples, EU Vice-President for Economic and Monetary Affairs Olli Rehn gave several prominent speeches in the early stages of the crisis explicitly basing European austerity programs on their work.
Their now infamous paper argues that once a given country reaches a 90% ratio of net public debt to GDP, economic growth will be sharply contracted. Reinhart/Rogoff touted their iron law widely, and policymakers from the Tea Party to the UK’s George Osborne were only too happy to take it to their policy hearts. But the results are in, in two senses. First, austerity itself has caused not only decreased growth but brought about even higher levels of debt compared to where countries were pre-crisis.
Second, Reinhart/Rogoff’s paper turns out to be an academic canard. The high profile economists cooked the books as it were, whether intentionally or not we don’t know. But using their data, a team at UMASS Amherst found coding errors, missing data, and the use of dates covering only a short period instead of a longer one: mistakes even grad students should not be making. With corrections however, their result essentially disappears. What is more, correlation is not causation. Even in the maligned paper itself, in lieu of an explicit causal mechanism there is only a putative association between the 90% debt level and GDP reduction. However, numerous mainstream economists argue the opposite: that sluggish growth causes ballooning debt levels.
To stip up this tempest in a teapot further, in the opening pages of the current issue of Foreign Affairs one finds an interview of Polish Foreign Minister Radoslaw Sikorski, who is tipped by many to take over when EU High Representative Ashton steps down. Sikorski talks at length about the need for continued austerity and gives great credit to Germany and Chancellor Merkel for their leadership. Sikorski has been quoted as fearing German inaction more than action. In a coup by Foreign Affairs, a few pages later Brown University professor Mark Blyth eviscerates that argument with a bevy of evidence. In the companion piece to his excellent new book, “Austerity: the History of a Dangerous Idea,” Blyth demonstrates that austerity has led everywhere to less growth and jobs and increased debt. Blyth labels the fact that normal citizens everywhere have had to pay dearly for the bailouts and other damaging policy decisions of elites as “the greatest bait and switch in history.”
Pro austerity types tend to hasten to put a spotlight on Latvia, the so-called austerity darling. But Latvia, which put in place an early austerity program, actually only started growing again when it ceased its fiscal retrenchment. Moreover, Latvia has a very small population and an atypical labor market compared to other long-standing capitalist countries.
While Keynes is turning over in his grave and the dismal science gets, well, more dismal, there is still time to in policy terms to right this wrong. We can leave the structural reform components in place, but governments everywhere need to engage in mildly expansionary fiscal and monetary policies. To its credit, oft maligned Japan is doing this very thing more successfully than any western government at present. It seems it will be left to economic historians to ponder a question that should be on all of our minds: in the face of considerable historical and recent evidence, how did this obsession with austerity ever occur in the first place?
(in case you missed Round 2 of Keynes vs. Hayek: https://www.youtube.com/watch?v=GTQnarzmTOc )
Interesting article. But to say austerity is dead based on the two instances you outline, Italy and RR, is a bit of an exaggeration in itself. In regards to the politics of fiscal retrenchment, the RR thing will blow over quickly, because it was never more than a post-hoc “scientific” justification. Fiscal retrenchment has little intellectual underpinning, because it doesn’t need it: the story of austerity works because it tells a simple narrative about the morality of debt and state overspending that, unfortunately, makes a lot of sense to a lot of people. That story, and the policies it logically leads to, are far from dead.
The post also makes too much of the R&R controversy in another regard. There is broad consensus among economists that high debt levels are a bad thing. Even Paul Krugman makes this point. High debt in and of itself is not something you want to have. Jeff Sachs notes that the costs of servicing debt eventually crowd out potentially productive discretionary spending. To read what happened as somehow vindicating a crude Keynesian mantra of spend spend spend is fallacious. People are mostly confirming their priors here. More disconcerting is the general state of modern macroeconomics. It is past time for a bit more self reflection on our ability to understand emergent orders in complex systems.
I think you need to read more of the Reinhart-Rogoff dispute before you start making claims that they “touted it as iron law” or “cooked the books”. Also, policy-makers are quick to cite whatever statistics suit their current agenda while ignoring academics the rest of the time. Unless R&R specifically advised the policy-maker, it is unfair to attribute significant influence on policy decisions to them. I’ll add links to what you should have read before making such imprudent claims:
https://www.cyniconomics.com/2013/04/22/hap-vs-rr-vs-the-pundits-scoring-the-reinhart-rogoff-dispute/
https://www.nytimes.com/2013/04/26/opinion/reinhart-and-rogoff-responding-to-our-critics.html?pagewanted=1&_r=2
You need to be careful too. R&R pushed their 90% idea, at least partly based on their heavily criticised research, in a series of high profile blog posts, Op-Eds and other “dissemination strategies”. While we can’t say whether this had any impact on the decisions of policy-makers, we can at the very least attribute some intentionality to R&R for attempting to – otherwise why would they be writing and doing these things?
Deets here: https://www.theatlantic.com/business/archive/2013/04/forget-excel-this-was-reinhart-and-rogoffs-biggest-mistake/275088/
That’s simple exaggeration for effect…what has actually happened is the pendulum has swung against austerity, which took hold as an idee fixe despite a mountain of evidence/history that it would not work and prove highly costly…the mea culpas have come in a torrent of late, the most notorious being the IMF…but this is no cri de coeur for crude Keynesian spending, as it is obviously true that high debt levels are bad all other things being equal…but things haven’t been equal, not even close…the correction course from here is continued structural reform but pulling back sharply from fiscal retrenchment…in fact Ollie Rehn and George Osborne have been far from the only high level policy makers who justified their decisions with direct references to R&R, two economists who were wild eyed about the influence they were but are no longer having
See yesterday’s FT for a major mea culpa by Rogoff and Reinhart…they even quote Keynes, at length no less
70 to 100 bodies, yes corpses – mostly children are being collected every single day from the streets of Athens and loaded onto trucks for burial. This is what austerity has done and the propaganda hysteria that Greece and its people were thieves and profilgate helped psychopaths like Merkel push through with her real agenda which is the destruction of Europe and eventual Totalitarianism.
It is Germany who ahs benefitted from the destruction of Europe and it is German companies who first helped to set up corrupt and deficient governments across the entire Mediterranean region. Last but not least, lest Germany and the Germans forget, Germany and the Germans have always been beaten which is why every 50-60 years or so they unleash armageddon and renew their quest for further bloodshed and suffering.