Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 2 March 2016

Understanding the austerity obsession

It has often been argued, loosely following Keynes, that economists should be like doctors

Martin Wolf writes “The austerity obsession, even [sic] when borrowing costs are so low, is lunatic”. The IMF, the OECD and pretty much the whole of informed opinion agree. Yet those subject to this austerity obsession are in charge of levels of public investment in the the US, Germany and the UK. One interesting question that arises is whether they are all suffering from the same disease?

The diagnosis in the case of the Republican party in the US is reasonably clear. Judging from the remaining presidential candidates and the actions of Congress the main economic goal is to cut taxes, particularly for the very rich. That requires, sooner or later, less public spending. What about evidence that more public investment would help everyone in the economy, including the rich? The problem is that this group suffers from the delusion that the only way to help the economy is to tax the rich less and starve the beast that is the state. It is a clear case of the patient being infected by the neoliberal ideology virus.

The condition of the ruling class in Germany, however, is much more difficult to diagnose. Some local doctors have labelled it the Swabian syndrome: a belief that the economy is just like a household, and the imperative is to balance the books. This seems like a case of labelling rather than explaining a disease. There may be an allergy involved: an aversion to Keynesian economics, and anything that sounds vaguely Keynesian. But the microeconomic case for additional public investment in Germany is also strong: although German roads are not in such a bad state of repair as those in the US, the German public capital stock has been shrinking for over a decade. One possibility is that Swabian syndrome is being encouraged by an ageing population that worry about their pensions. It will be interesting to see how this is influenced by recent injections of the refugee vaccine.

The nature of the illness in Germany is therefore more of a mystery than in the US. Unfortunately as contacts between German officials and those in the rest of Europe are frequent, we have seen numerous cases of this disease - whatever it is - spreading elsewhere, and in one particular case (Greece) the patient remains in a critical condition. The disease also produces complications after accidents: here Finland - currently in intensive care - is a case in point.

The Conservative Party in the UK also seem to have the symptoms associated with Swabian syndrome. As with Germany, the outbreak reached a peak around 2010/11. For a time it was thought that UK cases might be in decline, but last year saw a renewed outbreak. There are some, however, who argue that in reality the party are feigning the symptoms as a means of winning elections, while still others claim that tests have revealed clear traces of the ideology virus.

What has become clear is that the traditional way of treating the austerity obsession, which involves occasional counselling with well trained economists, is having little effect. We also now know that the financial crisis shock treatment only makes the neoliberal virus more virulent. Extended therapy is the only known cure for this virus. As for Swabian syndrome, our best hope may be that the public gradually develop an immunity to the disease as its consequences become clear.  

42 comments:

  1. In the UK at least there is a heavy dose of Swabian syndrome, if the (frankly depressing) words of Lord Finkelstein, who is a friend of the chancellor, are anything to go by:

    "It is common to argue that there is nothing household budgeting has to say about state spending but (though an economics graduate well aware of the arguments) I don't accept this. In fact I think it is basically clever clever nonsense that is so sophisticated it ignores blindingly obvious common sense."

    ReplyDelete
    Replies
    1. Bravo for Lord Finkelstein! It is a sad fact that SWL's macroeconomics are beyond common sense.

      Delete
    2. And yet, in the UK, as in the U.S., households generally are heavily in debt all the time. Their mortgages, student loans, car loans, credit card bills and so forth collectively can be far higher than their average income. Households are rarely debt free.

      Delete
    3. goosh69:

      True. But all those households dislike their debt and try to get rid of it - not raise their debt.

      Delete
    4. The big difference, of course, is that households do not have the ability to print money and get people to accept it. At least, mine doesn't. (I met a guy who did issue his own currency, once. Very successful. His economics were like that of a government.)

      Delete
    5. Nathanael:

      Your comment shows a cultural lag. You don't seem to have noticed what has happened since the hineties.

      With an independent central bank, governments have lost the ability to print money.

      And there is a country where that happened much earlier:

      On orders of the Western Allies, Germany got an independent central bank in 1924 after the hyperinflation which the Reichsbank had produced at the German government's orders.

      Delete
  2. The US and UK seem pretty simple: the crisis is an excuse to reduce public spending in the long term. I doubt that the benefit of a stronger economy really swamp the downside of higher taxes (now or further down the road) for the top 20-30% of the population. Especially if you think the positional nature of many of the goods the wealthier part of the population consume. Public investment is investment: if the investment pays off, everybody is better off, but if it fails (and it can fail), it will be mostly wealthy people being damaged I think (either through much higher taxes or inflation)...

    Greece is a similar situation in a way: Northern Europeans might be better off if deficit spending pays off and Greeks definitely will be, but the downsides are mostly concentrated with the Northern European countries. You could argue that the downside for Northern Europeans are fairly low (a bit more inflation at the worst when inflation is too low anyway, since the debt is likely to be monetized anyway), but that's not what they perceive.

    Germany is more difficult to understand: why don't they want to spend more money on themselves? There seem to be lots of worthwhile investments they could do on themselves. Maybe it's again the wealthier sector of German societies which want to avoid running the risk of deficit spending failing (so basically the same situation as UK and US). This seems less clear a government priority then US and UK though... Maybe German elites are just better at disguising that desire.

    ReplyDelete
    Replies
    1. "Germany is more difficult to understand: why don't they want to spend more money on themselves?"

      Labour income is 60 to 62% of German National Income. That means that more than 60% of the value of all exports - including the trade surplus - goes to the labour force, which can spend or save it as it thinks fit (after taxes).
      And the majority voted for governments that would not raise the debt ceiling. That has nothing to do with the wealthier sector of society.

      What's so hard to understand?

      Delete
  3. I am a very occasional reader, and apologise for a possibly ignorant comment in advance; I think I have chosen a non-technical post where I may have some locus.

    Born 1960 in the UK, I grew up with a 'Swabian' affection for Thatcherism, and to some lesser extent Reaganism. I then saw it 'working' over a couple of decades, in a way that seemed better than the likely counterfactual.

    As political symbolism is most powerful when simple, we might try 'stopping the government share of GDP going upwards, which it will always do unless you keep cutting it back' as one central strand of that.

    To my generation, which is a lot of people born between 1950 and 1970 and hence currently running the show, this is a position that I would not call ideology, I would call it over-simplistic nurture. It's what we think we know, because it's how it seemed to be.

    There is certainly some selfishness in it, my take home pay rising nearly four-fold as tax rates fell from 84% to 40% did help.

    I don't mind being told times have changed and all that, or having economics explained patiently to me, but I do slightly mind being called an ideologue for simply having been formed at a time of 84% income tax rates, a winter of discontent, an IMF rescue, and the government share of GDP over 50%. It was a powerful nurturing cocktail which not even the great Roger Opie could prevent taking hold.

    I offer this to be helpful, not to argue with you. Perhaps looking at where our ruling class were and what was going on when they were between 15 and 25, taking a nurture rather than nature approach, might help your attempts to diagnose the lunatics?

    ReplyDelete
    Replies
    1. You don't expect SWL to take you seriously, do you?

      Delete
    2. I wonder how you're happy with over-simplistic and selfish, but get offended when by the thought that your empty understanding of the world could ever possibly be described as 'ideological'.

      Delete
    3. Well an ideologue is a producer of ideology, rather than a consumer - but the distinction is a sliding one. To the degree to which your opinions are based on your own self-interest in seeing your take-home pay increased, I suppose you're not a pure consumer. Though it's unclear how much further you want to see your tax rate cut.

      I do note that you are exceptional since apparently you were not only in the top income tax bracket, but so far into it that the top tax rate almost determined your overall tax liability. And all before the age of 19!

      The re-writing of the story of the oil shock, the Barber Bust, Con v Lab records on controlling inflation, the machinations behind the Winter of Discontent and the unnecessary IMF 'rescue' are interesting topics, but can't be addressed here - and in any case you do appear to have been a consumer rather than a producer of those particular bits of 'applied ideology'.

      Delete
  4. I've also heard in Finland the argument that pension liabilities are the reason VSP oppose debt financed infra spending (or any public investment). I really wonder if this argument holds scrutiny at all. I mean what's the alternative? To let roads break down, cut education, not build necessary public transport systems. Because this is what's happening in Finland right now.

    ReplyDelete
  5. I have never found the argument that public investment would benefit the rich entirely convincing, so if you could provide a link to that evidence it would be helpful.

    It is true that some forms of investment (roads, ports) would aid the flow of goods and hence boost profits but it’s hard to see how that applies to other forms such as public housing (construction firms aside). It’s also the case that the most advanced industrial sectors (IT, bio-medical) have fewer dependencies on public infrastructure than older industries, although they certainly rely on public funding for basic research. Finance is even less dependent, at least if we exclude periodic large hand-outs.

    ReplyDelete
    Replies
    1. I'm a wealthy American and your list is a good start but very incomplete summary of how public spending has benefited me. This would even include public housing and transportation if it existed. When I have to drive to the office it is annoying to see the roads clogged with those people who got gentrified out of their neighborhoods and have to drive. There would probably be a lot fewer pot holes if there was a train they could take.

      But our biggest welfare we hide in tax expenditures and other favorable laws. IP laws just enable my rent seeking behavior. What cost the US Government more, the mortgage deduction I have taken on two luxury homes or lifetime welfare benefits for *any* of my employees?

      Do you really think I used after tax dollars for the pair of first class tickets I bought last night to go visit my house in Italy? Nope. At least three trips a year with never taxed AmEx points. But since I do have to fly commercial I'm not really rich so maybe this is not a good example.

      We do make the rules and we do enjoy them.

      Delete
    2. The important reminder I take from this is that the composition of public spending is as important as its level. Your point on tax expenditures is also correct, as is your observation that the wealthy benefit from laws and regulations that might not directly cost public money but do so indirectly by encouraging rent seeking.

      There is a strong case for a radical review of all such exemptions and protections. Only a left 'anti-capitalist' government could attempt this, even though its result would be to make capitalism work more like its supporters claim it should.

      Delete
  6. In your second paragraph you've written "takes" instead of "taxes". Freudian slip maybe?

    ReplyDelete
  7. Typo "cut takes" -> "cut taxes" (2nd para)

    ReplyDelete
  8. Branding the Swabians as merely 'anti-Keynesian' is far too kind. Milton Friedman and his Chicago predecessors would be revving up the helicoptors right now. These folks are intellectual orphans. There are hardly any living economists in their corner, and no dead ones either. How do you explain the current condition of macroeconomics in Germany?

    ReplyDelete
    Replies
    1. What do you prefer - a flourishing economy with bad macroeconomists or a declining one with a macroeconomic mutual admiration society?

      Delete
    2. Is it so hard to understand that, in a currency union like the Eurozone, the Swabian way is the only way to go? The reason is that competitive beggar-thy neighbour devaluations have become impossible. That was the point all those highly intelligent, mainly English-speaking economists made against the Euro in the nineties - and they were right if you believe such devaluations to be legitimate policy measures. Oddly enough, those Southern European countries that rushed to join the Euro had practised that sort of devaluations regularly - and wanted to kick the habit. What they didn't realise was that they had to become Swabian to do so.

      Delete
  9. Lazy Commentor2 March 2016 at 09:56

    An additional point in the US is the determination to avoid anything that might cause or faclitate economic growth under the current president. I would suspect that if (god forbid) the repubs win the next election there will be massive debt-financed stimulus spending on infrastructure

    ReplyDelete
  10. I think we greatly underestimate how unconvincing our case for higher spending right now is to regular people, who might view Keynesian economics as clever obfuscation.

    You're also missing a HUGE elephant in the room: Austrian economics. Austrian economics is hugely influential in right and even centrist thinking, often without people even being aware of it. The problem is the situation is extremely easy for Austrian types to frame as extremely dire or dangerous: they can basically frame government finances as a massive ponzi scheme convincingly, they can tell you how we're borrowing alarming amounts of money *just to pay down previously borrowed sums of money* - they can make it seem like this whole situation is inherently unsustainable. It plays into the public's natural cynicism of government and their fear of impending collapse.

    What's worse, many Keynesians have ineffectual counters to this in a public debate - many umming and aahing with a few "well technically amortizing the debt is not a problem" or "but interest rates are so low it doesn't matter so..." - to which Austrians will immediately counter "ahah, but interest rates could go up at any minute, they can't stay at zero forever, and once they rise - then what?". No amount of "but there's no real reason that interest rates would rise any time soon" or "but increased spending will boost growth enough in the future enough that we can cope" will sit well with the public, who remember are naturally pessimistic. And finally the "well we can just print money and do helicopter drops" might sound even more scary, where Austrians can wax lyrical about hyperinflation.

    So basically, people will continue to push austerity until the Austrian narrative is rebuked, this is where Keynesians should be focusing.

    ReplyDelete
    Replies
    1. I agree with you except that I would argue that "Austrian" economics is just the way 99% of the public, pundits and politicians think. Same as the Swabian housewife. I've concluded that it's impossible to "refute" this "common sense." Fear of massive debt is practically instinctual. Thus I've come to argue for money-financed deficits as a way out of recessions, ala Adair Turner and (long before him) Abba Lerner. There is no reason for governments to borrow to finance their deficits when their central banks could just create the money and give it to them to spend (or return to the public as tax credits).

      Delete
  11. Germany's output gap is zero...zero! Unemployment is extremely low! There is no necessity for deficit spending. No illnes - no medicine! Instead, exercises and a diet that avoids supernutrition keeps the country fit. The next stochastic infection is on its way and if output gap becomes negative and unemployment rises the medical doctors (Schaeuble and Gabriel) will not hesitate to use antibiotics (fiscal policy) to fight the disease.

    ReplyDelete
    Replies
    1. At the expense of their neighbors: 8% of current account surplus and more than China in nominal term... I have not found good medical examples but alternatively astronomy can provide one: Germany is the big black hole of the world economy, just collapsing the world demand.

      Delete
    2. Bertrand:

      At the expense of their neighbours - how that? What prevented the neighbours from offering the same quality at comparable prices?

      Delete
  12. An excellent post, but it might be observed that it was the Neo-Keynesian doctors that by helping to innoculate the patient to the previous fiscal virus have left its immunity weakened to far more deadly supply side strains of disease.

    ReplyDelete
  13. "Obstinate ignorance is generally a sign of underlying political motivation." All is explained in Kalecki's article Political Aspects of Full Employment.

    ReplyDelete
  14. So, it seems that Angela Merkel (raised in a command economy, physics degree, PhD in quantum chemistry) is somewhat sceptical of what 'well-trained economists' claim.
    Maybe she cannot get her head around their rather advanced thinking.
    Or maybe she can see straight through the bunkum.
    Which do you think it is?

    ReplyDelete
    Replies
    1. I think "Anonymous 2 March 2016 at 23:04", immediately above your comment, has already provided a pointer to the correct explanation.

      But see also: http://boingboing.net/2011/03/15/an-expert-in-one-fie.html

      Delete
    2. True, the Germans often take a 'healthy and efficiency' approach to life.

      Delete
  15. Economists should emphasize more that some forms of spending are also forms of saving.

    Even if you think of economies as households, renovating when labour is cheap and available can build equity in the value of your house. Durable investment in infrastructure maintenance can save you from having to do it later. It's a physicalized form of saving that can have a long term payoff (on top of the payoff from helping solve aggregate demand issues)

    ReplyDelete
    Replies
    1. Agreed. One of the problems with the debt narrative is that it only looks at one side of the public balance sheet. The asset side also matters.

      This offers a way of arguing against the conclusion that 'living within our means' must imply reducing debt. Most people understand that both households and businesses often need to borrow either to fix problems that will only get worse if not dealt with, or to improve future life prospects.

      Delete
  16. "whether they are all suffering from the same disease?"

    its called "beholdin' to the billionaires"

    ReplyDelete
  17. William Peterson3 March 2016 at 07:28

    One reason why German economists suffer from the austerity virus (in its Swabian version) is that they are much less adversely affected by the symptoms than most other countries. Because the euro prevents the currency appreciation that they would experience with a floating national currency, they can maintain demand by running a persistent current account surplus. They can then proudly attribute their apparent immunity to economic difficulties to the fact that in some sense they are intrinsically 'healthier' than other economies. Unfortunately, since we cannot all run trade surpluses, it's not possible for all economies to become 'healthier' at the same time - this is where the analogy with medicine breaks down.

    ReplyDelete
  18. According to you, the US Republican approach seems logical (in whatever shortsighted way) but that omits the issue of US defence spending. It seems to me that for some sort of myopic wealth maximisation of the rich, cutting defence expenditure would be at least as useful as cutting public investment. Yet, no Republican president or congress likes to cut the defence budget. Ever.

    ReplyDelete
  19. As far as the UK is concerned, I would say the political presentation of macroeconomic economic policy (austerity in this case) is determined by;

    Firstly, given a choice between option 1 higher taxes and higher spending on public infrastructure or option 2 lower taxes and you spend the money on whatever crap you like. An impossible to ignore proportion of the great British public choose option 2.

    Secondly, you will never, ever, ever get beyond the basic household budget analogy for the overwhelming majority of people.

    Thirdly, you say what you need to say to get elected.

    Hence a lot of talk about austerity, but only some enactment of austerity.

    ReplyDelete
  20. I followed your link and read your article about the failure of the Knowledge Transmission Mechanism--the failure of politicians to recognize and follow the consensus advice of economists to avoid austerity in the middle of a recession. I love your work, but I suggest that all of you good economists fail to appreciate how powerful the Swabian housewife assumption is in forming the attitudes of ordinary people, including pundits and politicians. Yes, the R's in the U.S. always want to reduce government and have accordingly always hated deficit finance. But I am confident that even most liberals can't understand why a $19 trillion U.S. national debt is not a huge problem, or how a government can live way beyond its means year after year. 'Surely this is going to be a huge problem for our children?' they say, quite sincerely. Just look at Barack Obama's remarks, in the middle of a terrible recession, about how government needed to tighten its belt, just like families. You may disagree with me, but I think he was sincerely stating his understanding. When you and Krugman et al try to explain austerity, you need to start with the Swabian housewife syndrome. Then you can add general hostility to spending as a secondary reason, not the other way around.

    Incidentally, the impossibility of defusing concerns about the exploding national debt has lead me to conclude that money-financed deficits to get out of recessions are the only way to go because they don't raise the national debt. We need to get more and more of you high-profile economists to start explaining to the public why money-finance in a recession doesn't cause inflation. It will take years to make a dent, but I think it's our only hope for dealing with secular stagnation and/or the next big recession. Thanks.

    ReplyDelete
  21. I've always attributed this Schwabian tendency to a unique feature of modern German history and the need in adjusting to that particularly unpleasant history by pointing to external events and non-human agents as causal factors. Thus nazism did not arise from a defect in the German soul, blood or spirit (not that any of us are seriously suggesting it did), but from a failure of good Schwabian housekeeping. Sound domestic finances are therefore dictated to keep the dreaded hyperinflation at bay and the hyperinflation is a convenient, apparently non-human, scapegoat so it wasn't really anyone's fault. The inflation is as impersonal as the market an apparently non-human, objective, external force independent of the society and human actions which create it.

    ReplyDelete
  22. I think it is best explained in terms of POWER. The austerity obsession is simply a way for  Germany to maintain its economic – and hence political – domination.

    It may be contrary to Germany’s long-term interest (I personally find the lack of investment very worrying) but you can make the same argument about countries (and the world as a whole) delaying measures to fight climate change, it’s also not in their own interest…

     

    In the short run, Germany is the country that is effectively ruling Europe. See how the “socialist” government in France is currently trying to implement labour reforms that would have been politically impossible for the right to pass. I don’t think they seriously believe these reforms can boost growth in a depressed economy. But the goal is simply to please Berlin and the Eurocrats.

     

    Another aspect of this is that growth is not an end in itself. What matters is the corporate profits. And with low wages they are probably pretty decent. German wages are not going to increase significantly with an army of 1 Mio+ Syrians and other migrants - plus the young University graduates coming from European peripheral countries…

    ReplyDelete
  23. While it is interesting to speculate on the roots of austerity obsession (the Schwäbische hausfrau schtick is a little bit cutesy) in German political thinking we really do not have the time. As with climate change we need to take urgent action and not delve too deep into understanding why so many otherwise intelligent people deny that it is a problem. You are economists, not psychiatrists.

    As Wolfgang Munchau once remarked the German obsession with hard currency and market liberalism and the "fiscally retentive" behavior it produces would be basically harmless if only the Germans had it. The problem, as mentioned in the OP, is that in the EU and the Eurozone in particular ordoliberalism was able to metastasize through Europe through EMU and its various institutions. That transmission mechanism needs to be stopped before we can cure the illness, whether that means an end to EMU or a purge of EU institutions.

    As for the public believing in the equivalence of government and household economics that represents a real failing of education and the media (as with the coverage of climate change in the US), people do not end believing this nonsense by chance. It will not be an easy task to change public perceptions but (again as with climate change) it will sink in eventually if experts simply say that macroeconomics does not work like that.

    You can present historical data and theory afterwards but the work starts with explaining with conviction to people that they are wrong - in fact that they have been misled. Get to it.

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.