Sunday, 17 November 2013

No, Brenna, the US Should Not Reduce Government Spending

By Jaime Bravo

Brenna Fisher, a partner of mine in this blog, wrote today an article speaking about the possibility of reducing government spending and why it was necessary. Here is her take. After reading it - and I must say that I have been reading about austerity in Europe and in the US for a long time - I cannot agree with her thoughts. Austerity, as we know it in Europe and specially in Spain, has been intellectually defeated. Austerity has been widely used only for ideological and political purposes, that is, the implementation of austerity is good, but only if you are rich - which is exactly what Mark Blyth said a few days ago on The Guardian. So, if austerity has been defeated, why do we still support it in some ways? Because it keeps our political aims alive. Make no mistake, I really respect Brenna's work. I enjoyed her last article on music and recessions and I share my thoughts with her on Twitter - see here. It is just there are some failures on economic assumptions that we still consider as facts. It is not Brenna's problem, it is a problem of economic thought.

Do not follow the European path

Europe is one of the most complex economic experiments of all time. It is not my aim to write about it here but we have to work on a few facts. First, Europe is driving himself into a liquidity trap. I have worked widely on it - you can read my work here; it is in Spanish though. Mario Draghi said a few weeks ago that the ECB is going to low the interest rates at 0,30%. But Europe has a particularity:  members have not the control of their own currency; the US does. So it means that, devaluation is easier in the US than in Europe. Then, you cannot make a proper analysis withouth considering the job the ECB does. You have to assume that the ECB has not the same ideas than the FED: Janet Yellen is an economist who knows how to drive the economic scenario of the US while Draghi is limited by Germany. Austerity has been already used. And it had many effects on the economy. Let's take a look at the next graph, which shows a correlation between austerity and growth in many countries:

Even if you are not involved with economics you may see that those countries with low austerity experience more growth. Spain for example, implemented austerity and it led to a low growth. Similarly, the most bloody example is Greece, which implemented big austerity and, thus, had low growth. This is a fact: austerity promotes low growth. Here is why. Austerity only appears at particular moments. When countries enter in a recession, they tend to "call" austerity. There is no logic behind it, but they do it because they create a simple equation: if I low my spending, I will increase my benefits. Now the question is, where are this benefits? If this equation existed (which does not) these benefits should be reinvested in the economy. Now, here is what really happens. Brenna did not see an important fact when she wrote this:

"However, one tactic could solve a majority of the problems, though it wouldn't be the popular decision. Reduce government spending"

She missed one of the most important discoveries in economics: the Keynesian multiplier. She assumes (by writing this article) that debt is a problem and that therefore, we should cut it. But those who think like her do not realise that there are families and companies that depends on the Government to survive. And this dependence increases in recessions, since the private sector is depressed and people tend to save instead of spending. Let's apply this equation; let's say that the US reduce government spending - they adopt austerity. It will lead to a big increase on inequality. Inequality is not a secondary problem: it reflects the status of one country. The private sector is depressed on recessions. In this situation, Brenna and those who think like her propose to reduce government spending. But if it reduces it, then both the public and the private sector will be depressed which would lead to a "zombie" economy and, probably, to a lost decade - such as the one in Japan.

Another look at the article

The fifth paragraph of the article quoted above says:

"An even more basic example can be taken from an average American household. Say the family makes $50,000 per year, and then gives 5,000 per year in income taxes. Left with their disposable income, they spend half of that on necessities, such as food, clothes, electricity, and mortgage payments, and the remaining $22,500 can be spent on extraneous causes, such as extra activities for the children, a lavish house, and plenty of luxurious vacations. Contrastingly, they could save that money and put it towards retirement or college funds. Which would allow a stronger foundation for the future? Obviously, having the extra money saved, rather than spending it on necessities. Of course, a government is more complex, but the basic idea of smart spending is a common underlying theme"

And here is one the biggest failures in economics: there is no common underlying theme between a State - say, the US - and a family. Here is the wrong point of the article. A family is not a company. With this assumption, the article would be completely wrong because it is based on something false. You cannot make any comparison between a State and a family. Debt is not the same in a State than in a family. The spending necessary is not the same in a State than in a family. They do not have the same responsibilities nor the same obligations. It is simply, a mistake.

In the last paragraph, finally, she says:

"However, government spending is the main issue with our current economic state and reversing it is the simplest way to see real change"

And here we came back to the (wrong) equation. Economics are not that easy. If the Government stops spending it has some implications for the society. The economy is depressed and there is only one agent that can boost it: the State.  And later:

"reduced spending is the best way to produce steady, long-term growth, providing a sturdy economic foundation for the future."

Austerity does not produce that effects. Data can be presented. She is saying something that has been completely debunked in this article and in many others. Something that has been proved wrong. Something that is false.


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