Austerity and Living Standards

In my view one of the purposes of blogs by academics is to provide helpful information to economics journalists. I see this as a mutually beneficial trade: they get better information and those of us who read/hear economics journalists have a better experience. Sometimes that involves taking journalists to task for saying something silly. Personally I do this in exactly the same spirit: they get to make less mistakes and I have to squirm less often. Of course this may seem like we are just saying ‘how could you be so silly’. However being a good journalist is hard: you need to cover an area far greater than the scope of any single academic, and often under great pressure, so mistakes are inevitable

So by way of introduction to the main topic of this post, let me sound off about one silly thing which I have heard from good UK journalists recently, following the strong Q2 growth figures. I will not single anyone out, but here is a typical example: “The argument that fiscal austerity would lead to deep recession or permanent stagnation has proved false.” This is a classic rhetorical device: take one side of an existing argument, distort it so that it becomes much more extreme, and then claim that as this extreme version is obviously wrong the argument in general is false. The problem with the sentence above is that it can so easily be read as: recent growth shows critics of austerity were wrong.

As far as I know, no reputable economist has argued that austerity would mean the economy would never start growing again. In terms of basic theory, that would be a crazy thing to do. In a demand led recession, austerity reduces the level of output from what it otherwise might have been. In the simplest case, once we come out of recession output goes back to the level it would have been without austerity. (There is no long term impact on supply.) So austerity leads to some years where growth is less than it would have been otherwise, followed by later years where growth is more than it would have been otherwise.

As I have pointed out before in the context of discussing the Latvian experience, we could close down half the economy for a year. The next year economic growth would be fantastic. Only a fool would argue that this showed that closing down half the economy for a year was a great idea.

There is a quite powerful argument that austerity has additional longer term costs, besides the lost output during the recession, because of hysteresis effects. That argument would be disproved if the recession left no permanent scar, which we would only know if output returned to its pre-recession trend. Again rapid growth as we begin to come out of the recession gives us no information on this.

Unfortunately journalists live in the world of now, and so confusing levels and growth in this way is easy to do. Which brings me to a recent debate in the UK about whether the opposition is right to switch its criticism of the government to focus on the decline in living standards since the last election. It is generally accepted that complaining about fiscal consolidation being ‘too far, too fast’ has limited traction when the government has successfully implanted the false idea that austerity is required because the previous government was profligate. It could and should focus on the level of unemployment, but one of the features of the UK recession is that its impact has fallen on real wages as well as unemployment. So it seems to me both fair and logical that Labour should focus on living standards as a way of re-expressing the ‘too far, too fast’ idea.

Like Duncan Weldon here, I cannot really see why people like Hopi Sen or Chris Dillow have a problem with this. [1] It is just another way of saying that austerity in a recession is a bad idea, but with the advantage that it is one step removed from the Labour profligacy myth, and it provides an effective counter to the ‘look the economy is growing - didn’t we do well’ line.

One good way of knowing that you are on to a good thing is when the other side starts looking worried. So we are beginning to see the idea being discussed that slow growth in UK wages is all about the decline of the West in the face of the emergent East, or some inevitable decline in technical progress. Both are interesting ideas, but I do not think anyone would seriously argue that they explain more than a fragment of the recent stagnation in UK real wages. I’m not sure anybody has a complete explanation for this stagnation, but austerity has clearly played its part, so it is absolutely appropriate for the opposition to focus on low real wages. Indeed, they would be crazy not to.

[1] Hopi Sen also worries that Labour’s response to ‘what would you do about it’ is just a series of pretty small scale measures. At the rhetorical level I see the problem. However at the intellectual level I am a bit less concerned. The Conservative Party campaigned in the last election on a macro programme that promised to do great harm, and kept to that promise. So promising to do not very much would be an improvement! In addition, I suspect good policy is often made up of a large number of small measures. It would be nice, however, if there were some consistent themes that motivated those small measures, and I might have some more to say on this later.