Tuesday, 24 December 2013

Ideology and economic thought

by Jaime Bravo

Brenna made a response to my article - see here. She wrote some arguments that were supposed to refute my theories on austerity and public spending. But there are, yet, arguments to be said. She tried to build a model mixing up economics and politics; she even quoted paragraphs of the American Constitution. This is not of my concern in here. But still, I have something to say about what she wrote.

We must say that there is a strong debate about balanced budgets and about the fact of balancing them. Austerity - balancing budgets - in depressions is a self-defeating move. Balancing budgets, now, does not follow any empirical evidence; as I said, it is moved by ideology. Here is the fact: if the budget is balanced, its effects should be notorious; the price of sovereign bonds will rise, government funding would be cheaper, credit would flow again etc. This is the scenario that has been presented to us in Brenna's article. But if we take a look at what really happened, we would be able to see that what was quoted here did not happen. Olli Rehn sometimes says that fiscal consolidation is a proper measure when countries have a 'debt addiction' - he uses Latvia as an example -, which basically means that, countries can only survive with more debt. But he does not say that the Welfare State is a victory for every citizen and for Europe. It is a victory for the economic thought, too. But, more empircally, austerity was not good for Latvia either. Quoting O'Brien on The Atlantic:

There are two things you need to know about that experience. First, Latvia had a massive bubble financed by massive foreign borrowing, with its current account deficit hitting a mind-blowing 22 percent of GDP in 2006-07 before the debt music stopped following Lehman's bankruptcy. And second, Latvia didn't do anything to cushion its subsequent crash. It didn't devalue its currency, and it didn't increase government spending. Instead, it kept its currency pegged to the euro, and actually gashed its budget. Now, it didn't have much of a choice when it came to austerity -- that was the condition for its €7.5 billion IMF-led bailout -- but it could have chosen depreciation over deflation. It did not. As Matthew Yglesias of Slate points out, Latvia chose so-called internal devaluation over actual devaluation, because it didn't want to derail its euro entry out of fear of Russia. This calculation may well have been in Latvia's best geopolitical interests, but certainly not its economic ones. The combination of tight money and tight budgets took Latvia's economy from "calamity" to "historical calamity"; its GDP fell by over 17 percent in 2009 alone. That's Great Depression territory.

She, he and every single 'austerian' - Paul Krugman calls them 'austeriacos' in Spanish, which is a mix between the Austrian School of Economics and Austerity - fail in their economic assumptions because they do not take into account many variables like, for example, how unemployment behaves when there is fiscal consolidation; a wider study on this topic will certainly help them to understand economics better.

Secondly, she makes a totally false statement. Yes, there are correlations. But they show the contrary. Thomas Herndon showed that there is NO correlation between higher government spending and GDP decline. Furthermore, she comes up with two questionable examples. She speaks about the stock market crash, and I am not going to say anything special about it, but everyone who knows economics should know that many stock market crashes are provoked by private hands. At that time,there was a lot of speculation, and therefore, bonds were overvalued. There was an increase [during the Arab Oil Embargo] in public spending but only because countries tend to increase public spending when they are going to have a war. Furthermore, there are empirical evidence about debt and growth: debt does not cause low growth, low growth causes low growth. There are, evidences on low growth and austerity. Figure 1 and 2 support my argument. (Source Financial Times, VOX).

I cannot believe someone compares the Keynesian Multiplier with the Ricardian Equivalence. I found it simply incomprehensible. The Ricardian Equivalence has shown to be false. It does not exist. What it says is that it does not matter whether the Government decides to finance themselves with taxes or with public spending because the effect on demand would be the same. The spending multiplier and keynesian economics has proven its existence within the years. The IMF, for example - and the way they solve problems is not the most 'keynesian' - accepted a failure in their calculus regarding the spending multiplier. How to calculate it, it is more difficult since you have to take into account a lot variables - unemployment, actual spending, debt etc. But, anyways, to compare both is a matter of ideology and not of reasonable economic analysis.

She speaks about incentives as if we knew everything about them. Truth is, nowadays, we know very little. She is exposing a big problem but from one point of view: the neoclassical one. She says that if, say, A gives a constant amount of money, even if he/she is not working, to X, X would not have incentives to look for a job. And I more or less accept it, But she shows that there is an addiction to welfare programs, which does not exist - it does, but it is not quite common, so we do not need to take it into count when writing a model like this one. Once again, she is assuming that those who support stimulus want money to be spent in anything. It is false. Stimulus could become, itself, in an incentive since it raises demand, which increases production, which may led to lower unemployment. Yes, there are many people who prefer not to work because they are receiving a monthly pay - provided by the Government. But there is already a very small protection in the American System, since its labour market is quite flexible. Of course there has been strong problems with the labour market here in Spain, or in Italy or even in France. Rigidity is, sometimes, a problem. But the allocation of workers is a quite complicated field of study. [Many] European and American workers have, at least, three things in common: firstly, they are not as flexible as employers would expect, they cannot move from one sector to another within a few days/months; secondly, there is a big difference between skilled and unskilled workers which means that they are not interchangeable within sectors; thirdly, unemployment is not the same in both areas, there are different reasons why people might be unemployed i.e some of them would like to take some time to learn so that they can improve the quality of the job they are applying for; others may want to take some time to rest, and, finally, other may have been fired and they cannot find a job - this last one may seem quite obvious, but it is not because it is important to analyse its unemployment level at the moment of designing policies to solve any problem that might happen inside its area. 

Now, she comes up with Greece by saying that the real problem is their political organization. I cannot end this response without saying that only mad people would agree that Greece was doing its job properly. But the answer to the problem -austerity- is self-defeating, and is, as has been argued before, useless. They needed reforms, yes, they needed to change things in order to keep the long term 'safe'. But austerity, evidently, wasn't the solution.

Finally, all this debate about whether austerity is or isn't good is a matter of ideology and is a matter of economic thought. Austerity in recessions is counterproductive. Austerity kills. Austerity is useless. The US should not reduce its budget. Not now, while the global sphere is going through one of the longest crises ever.


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