I have been a close reader of “austerity” versus economic stimulus arguments over the past couple of years in various magazines/websites of liberal and conservative/libertarian opinion as well as more traditional academic journals. This debate centers on whether prosperous, modern governments, especially those with large amounts of debt, should respond to recessions with stimulus measures or with measures of “austerity”. I put austerity in scare quotes because how it is defined is a key part of the argument as will become
So last week I was particularly interested to read latest missive from the liberal The New Republic on this subject written by a Brit named Robert Skidelsky whom the magazine describes as John Maynard Keynes’s biographer and a member of the British House of Lords. Lord Skidelsky begins his article as follows:
The last four years have created what economists call a “natural experiment” in economic policy. As a consequence of deregulation and globalization, Britain and the United States experienced the financial crisis of 2008 in much the same way. Large parts of the banking system collapsed and had to be rescued; the real economy went into a nosedive and had to be stimulated. But after 2010, the United States continued to stimulate its economy, while Britain chose the stonier path of austerity.
Now, to begin with it is amusing to read his confident appraisal of the causes of the U.S. and British financial crisis of 2008: deregulation and globalization. This by itself is nonsense on stilts, but is not the focus of his piece and is just an amusing example of bad opinion piece writing in general (examples of which you can find on the right and left). It is generally a bad idea to devote a throw-away sentence to a highly controversial and complicated historical topic as if there is a clear-cut answer that everyone and their brother knows as if recalling the date of the Battle of Waterloo.
Of more interest, is the next sentence in which he assumes like most liberals that government must respond to “problems”. Notice how he says “the real economy went into a nosedive and had to be stimulated.” Well, actually the real economy didn’t have to be stimulated and how governments should respond to recessions is a highly controversial and complicated topic that includes “nothing” as one solution to the question of “what should the government do when there is a recession.”
Be that as it may, Lord Skidelsky’s focus is on what he frames as the different responses of the United States and Great Britain – stimulus versus austerity. At first, Britain under Labor reacted in much the same way as Obama and the Democrats – their governments spent money they didn’t have:
In 2008–2009, Prime Minister Gordon Brown pumped an extra $41 billion into the British economy; in February of 2009, Obama signed into law a $787 billion fiscal stimulus package. Insolvent banks were bailed out and the central banks of both countries started “quantitative easing”—effectively, printing money—in an effort to expand the supply of credit by forcing down bank lending rates.
The activist policies had an immediate impact in both countries. A year after the onset of the crisis, GDP growth started to pick up. However, while stimulus measures prevented another Great Depression, they helped expand government debt. In 2007, both the British and U.S. government deficits were 2.7 percent of GDP; in 2010, the figures were 9.9 percent and 10.5 percent, respectively.
Then there was a change of government in Britain and the ‘bad’ Conservative/Liberal government led by Prime Minister Cameron led the “austerity” charge:
The government set out to slash public expenditure by £99 billion—or 7 percent of GDP—per year by the 2015–2016 fiscal year and increase taxes by another £29 billion per year. Two years later, the score card is in. Since May 2010, when U.S. and British fiscal policy diverged, the U.S. economy has grown—albeit slowly. The British economy is currently contracting. Unemployment in the United States has gone down by 1.4 percentage points; in Britain, it has gone up by 0.2 percentage points. And despite keeping up stimulus measures, the Obama administration has been more successful in reducing the government deficit—by 2.5 percentage points compared with Osborne’s 1.9 percentage points. Earlier this year, Paul Krugman wrote that “Britain . . . was supposed to be a showcase for ‘expansionary austerity,’ the notion that instead of increasing government spending to fight recessions, you should slash spending instead—and that this would lead to faster economic growth.” But, as Krugman wrote, “it turns out that . . . Britain is doing worse this time than it did during the Great Depression.”
For Keynesians, this is not surprising: By cutting its spending, the government is also cutting its income. Austerity policies have plunged most European economies (including Britain’s) into double-dip recessions. At last, opinion is starting to shift—but too slowly and too late to save the world from years of stagnation.
Well, there you have it – a clear cut case of the evidence pointing to liberal policies triumphing over the foolish ideas of conservatives (and Conservatives in the current British government) and to top it off, that great liberal hero John Maynard Keynes and his ideas are vindicated once again.
Except the case isn’t clear cut and the ideas of Keynes aren’t vindicated.
The first problem with Lord Skidelsky’s analysis is that he doesn’t define austerity for his readers. This is a common trope of liberal writers on this subject and it tends to confuse the average layman who would naturally associate the idea of “austerity” with the common dictionary definition and their own household budget – cutting back on all but the essentials and living with “strict economy” (or as Dictionary.com puts it, living the “austerities of monastery life”). But liberals ignore this common-sense definition, instead claiming that any government that uses either cuts in spending or efforts to enhance revenue (i.e., tax increases) is practicing austerity. So if a government raises taxes after a recession to deal with their budget deficit, but they don’t cut ANY spending, they would still be practicing “austerity” in this topsy-turvy liberal world because they are at least trying to reduce their overall deficit/debt levels.
Of course, the problem with this approach to thinking about austerity should be immediately apparent to anyone with passing familiarity with supply-side economics or even classical economics as practiced for years before Keynes showed up. People respond to incentives and plan for the future – if they are being taxed more and their governments continue to spend money on unsustainable welfare programs – they will react accordingly. This usually leads to lower spending, less investment in capital and fewer entrepreneurs starting businesses – in short the economy will suffer. On the other hand, if their government gets serious about cutting spending and only cutting spending (maybe even throwing in some tax cuts to help) then governments can help the economy grow and at the same time get public finances in order and on a sustainable path for the future. Here is how economist Matt Mitchell at George Mason University summarizes the economic literature on this question:
Lots and lots of papers have now studied this question and the evidence is rather clear: the types of austerity that are most-likely to a) cut the debt and b) not kill the economy are those that are heavily weighted toward spending reductions and not tax increases. I am aware of not one study that found the opposite. In fact, we know more. The most successful reforms are those that go after the most politically sensitive items: government employment and entitlement programs.
Mitchell then provides citations to 21 different papers and reports backing up the above claim and says:
Most of the following papers directly test the question of whether spending-cut-focused reforms or tax-cut-focused reforms are more successful and more expansionary. A few test related questions but provide corroborating evidence for this question. All of them suggest that spending-cut-focused reforms work better and are more likely to aid the economy.
One of the papers Mitchell doesn’t cite, which is odd because he includes an earlier work by these authors, is this 2009 paper by economists Alberto Alesina and Silvia Ardagna, whose abstract says the following:
Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.
Doing my own research I even found a recent book published by the IMF that studies the question of “fiscal adjustments” and comes to the same conclusions as all 22 papers listed above. However, I will note that I also came across one paper (ironically from the IMF) that casts some doubt on the methodology used in some of the above papers and hence the positive outcomes of austerity (although methodological problems plague all good macro-economic research). Nonetheless, there is still clearly ample evidence supporting the effectiveness of austerity via spending cuts.
Meanwhile, we know from Lord Skidelsky’s quote above that Britain planned to cut spending and raise taxes – what actually happened? It is curious that Skidelsky doesn’t quote any figures on the subject; he just provides statistics on the economic performance of the two countries, so we are left to do our own research to find out what actually happened over the past couple of years. Here the story gets particularly interesting.
The rate of government spending slowed, but total government spending was never cut (or “slashed” to use Lord Skidelsky’s dramatic phrase) by a single pound. The Cameron government did make good on the other half of its promise – to raise taxes as Veronique De Rugy details in this post from “The Corner”:
• a VAT hike from 17.5 percent to 20 percent (probably the main culprit of the U.K.’s current problems)
• a new 50 percent tax bracket, which will drop to 45 percent next year on incomes over £150,000
• an increase in air passenger duty to 8 percent
• “temporary” payroll tax of 50 percent on bonuses over £25,000
• a capital-gains tax hike
• a 0.088 percent levy on banks
• an increase to 7 percent in the stamp duty on the sale of properties worth more than £2 million and on properties bought through “non-natural persons.”
Now that we know Lord Skidelsky can’t bother to check whether or not his own government implemented its two-year old goals, should we trust him to get right his facts on the relative success of the U.S. versus Great Britain with respect to economic growth and deficit reduction? Of course not (remember he told us that “Since May 2010, when U.S. and British fiscal policy diverged, the U.S. economy has grown—albeit slowly. The British economy is currently contracting.) Yes the British economy contracted by 0.2% in the first quarter of this year, but it has just started to do so after a couple of years of slow growth since May 2010; basically just like the U.S. at a slower pace.
However, to use “Obama administration” and “successful deficit reduction” in a non-ironic manner in a sentence should basically banish you from polite company! The only way Skidelsky weasels his way out from this banishment is by using the phrase “despite keeping up stimulus measures.” I think what he means is that at the end of Bush’s last full year as President, since the federal deficit was almost $642 billion and then President Obama stimulated the deficit to a whopping $1.5 trillion by the end of 2009, Obama’s been able to reduce the deficit from that Olympic height since then. And yes, the U.S. has grown faster than Great Britain over the past couple of years, but then our Republican Congress has made sure that Obama and the Democrats have not gotten the tax increases they want and have been trying to impose more fiscal discipline on his administration since they’ve come to power in 2010.
So I have spent quite a bit of time taking apart a weak article by a British Keynesian scholar. Why bother? Because these types of articles influence our liberal friends and the broader public and are taken seriously by serious people. Lord Skidelsky might be a good biographer, and he might even upon reflection have corrected some of the points he made in this flawed article, but he shouldn’t get away with misleading readers and stating untruths. Those of us on the right who care about good public policy and the future of our country need to set the record straight and convince those who can still be persuaded that liberals do not have the answers to what ails the American economy.