Policy errors like 2010 austerity – what can academics do?

                In this post I claimed that 2010 should be counted as one of the major errors of UK macroeconomic policy. In fact the claim is much more general, because 2010 was the year that the consensus among policymakers in the OECD area shifted from enacting stimulus to pursuing austerity, with damaging consequences in many countries. A number of comments and a couple of blogs added to my speculation on why this error might have occurred. Here I want to consider more generally what role academics and economists can play in preventing policy errors, and why this may depend on the reasons for those errors.

                Before coming to that, let me address one common objection to my view that 2010 was a major policy error at the time, and not just in hindsight. The objection is that the slowdown in 2011 was due to factors other than austerity that could not have been foreseen. There are two problems with this argument. First, the projected speed of recovery even before these adverse shocks occurred was pitifully slow. What the IMF described in late 2010 as ‘solid UK growth’ was actually 2.5% per annum into the medium term, which on their own admission only gradually closed the output gap. The OBR’s June 2010 post-budget forecast also had GDP growth of 1.2% in 2010, 2.3% in 2011, and never above 3% thereafter. Considering GDP was estimated to have fallen by 5% in 2009, this was a tepid recovery.

The second, and more important, flaw in this argument is that it ignores the fact that good policy should allow for risks. As I elaborated here, because of the zero bound for interest rates there was no insurance policy if bad shocks did occur (as they did). In contrast, if positive shocks had led to a recovery that was too rapid, monetary policy could have been used to cool it down. To put it more simply, austerity was a huge and unnecessary gamble, and the gamble did not pay off. Much the same could be said for many other countries.

                One class of explanation for this kind of policy error focuses on hidden agendas. The most obvious in the case of austerity is a desire to reduce the size of the state, as Chris Dillow suggested. As Mark Thoma put it: “The notion of "expansionary austerity" was the cover, but so long as government shrinks as a result of the policy, the expansionary part is secondary.” Chris has recently suggested even darker motives. I put forward another, more mundane, explanation that is specific to the UK: get the cuts out of the way well before an election, and hope the electorate have short memories. Perhaps an explanation specific to the US might be that it suited those opposed to the President that the economy failed.

                If this type of explanation is correct, is there anything that can be done to prevent or expose this kind of subterfuge? In this post, I was rather pessimistic. I suggested that it required near unanimity amongst academics before the media would begin to question the cover stories. Without unanimity, the cover story would just be described as controversial.

Brad DeLong has persistently railed against ‘opinions on shape of the Earth differ’ type reporting. All too often journalists appear to have only two categories - either something is objectively true or it is controversial. Anything controversial requires evenly balanced reporting. A tragic example from the UK would be the debate over the MMR vaccine. As Lewis and Spears document, a single paper in the Lancet suggesting a link with autism was hyped by the media, despite widespread scepticism among health experts and overwhelming scientific evidence that the vaccine was safe. As a consequence, take up of the vaccine declined and outbreaks of measles increased. (Here is a good account of this episode from a US perspective.)

Even with academic unanimity, there is the possibility that moneyed interests could manufacture controversy through think tanks, as has happened with aspects of climate change debate. [Update 20/2/12 - on this see George Monbiot.] Of course the debate is still worth having, but it is unlikely to change things very much or very quickly.

                This pessimism may be a little overdone, however, in the case of austerity. Politicians, above all, want to be re-elected. For that reason the cover story view does require a belief that the harmful impact of (early) austerity will not last long enough for it to matter at the next election. If that is not the case, academics might be able to convince politicians that it may not be in their own interests to undertake the policy.

                Which brings me to another class of explanation, which is policymakers fooling themselves. The hidden agenda may still be there, but the difference is that politicians convince themselves that the cover story is also true. In the case of austerity, there are a number of stories politicians can tell themselves. They can believe in expansionary austerity, of course. They could believe that Quantitative Easing will be enough, although I would hope any central banker would tell them that they had no idea what impact QE might have. They might have believed that the recovery was well under way, so any damage done by austerity would not be noticeable.

                Does this case also require near unanimity amongst academics to convince the policymaker they are fooling themselves? There are at least two reasons to suggest it might. First, (macro)economics is not held in the same regard as other sciences, for good reason. I would not go quite as far as one comment which said scientists proclaim facts while economists give out opinions – I think we are somewhere in between these two, but still. Second, the two way link between ideologies and economics makes it too easy for the politician to dismiss views they do not like by believing they are politically motivated, and it also makes it too easy for the politician to find academics who will tell them the stories they would like to hear.

                A third class of explanation for policy mistakes is that they are genuine mistakes. Events may arise which come as a surprise to most academics as well as policymakers, so there is genuine uncertainty. In terms of 2010, I think the probability of Greek default with possible Eurozone contagion was important at changing attitudes among those who might otherwise have been sympathetic to more fiscal stimulus/less austerity. In the case of the UK, it may have been crucial in persuading Nick Clegg and the LibDems to support greater austerity as part of the coalition. As I wrote here: “What finance minister can sleep easy when there is a chance that they too might be forced down the road being travelled by Greece, Ireland, Spain, Portugal and Italy?” Now I go on to argue, following Paul De Grauwe, that this crisis was a crisis of the Eurozone, and not the precursor to a generalised government debt panic. Although that view is gaining increasing acceptance as interest rates on government debt elsewhere continue to fall, at the time this proposition was neither obvious (governments with their own currencies default through inflation and depreciation, and lenders will fear that) nor widely argued.

In situations of this type, academics can in principle have much more influence. Furthermore, the blogosphere allows for an immediacy that might just be able to influence opinions before mistakes are made, and positions become entrenched. In the case of 2010 and austerity, I do not think it would have been enough. The political forces pushing for austerity, the hidden agendas, were too strong, and the panic induced by events in the Eurozone too great. But academics should never become so pessimistic about their potential influence that they give up trying.