The dead hand of austerity; left and right

Those who care to see know the real damage that austerity has had on people’s lives. From those needing care who now get so little, to those waiting longer for hospital treatment, and those whose homes might not have been flooded without the cuts from 2011. There is nothing unusual about the UK in this respect: austerity (cuts in spending that are either mistimed or unnecessary) causes harm, wherever it is imposed. But the political cost has also been huge.

This is true in the Eurozone, but in this post I want to focus on the UK. The cost on the left could not be greater. Austerity and the reaction to it were central to Labour losing the election. The Conservatives managed to pin the blame for Osborne’s austerity on Labour, and as the recent Beckett report acknowledges (rather tellingly): “Whether implicitly or explicitly (opinion and evidence differ somewhat), it was decided not to concentrate on countering the myth … ” It was also central in the revolution of the ranks that happened subsequently.

Austerity is a trap for the left as long as they refuse to challenge it. You cannot say that you will spend more doing worthwhile things, and when (inevitably) asked how you will pay for it try and change the subject. Voters may not be experts on economics, but they can sense weakness and vulnerability. If instead you restrict yourself to changes at the margin, you appear to be ‘just the same’.

I think many of those on the centre left still do not see this trap. There are some problems you cannot triangulate around, but have to tackle head on. Here is a recent example from Rachel Reeves. Much of what she proposes, when she talks about securing the necessary investment in flood defences for example, makes total sense, but it also tends to cost money. Rather than confront Osborne’s unnecessary cuts, she talks about a failure “to demonstrate that we understood that dealing with the deficit and controlling public spending are the precondition of effective progressive government.”

The urge to move on, and not talk about the dry subject of the public finances, is quite understandable and not confined to the parliamentary Labour party. Here is Mariana Mazzucato giving a brief summary of her excellent innovation agenda for Labour (or indeed any political party that is not hamstrung by a neoliberal romantic view that technical advance is all down to the entrepreneur and the state just gets in the way, a view completely destroyed by her excellent book). I was struck by the juxtaposition of the following two sentences:

“Likewise, it is time to move on from the debate over austerity to a new conversation about how to build smart, mutually beneficial public-private partnerships to fuel decades of growth.
For starters, we must invest in education, human capital, technology, and research.”

But of course it becomes so difficult to achieve that investment when the dead hand of austerity is demanding cuts from everything it touches.

That dead hand is not just left handed, but touches the reformist right just as it does the left. Some regard David Cameron’s speeches that talk about reducing the causes of poverty and social deprivation as just window dressing, but I agree with Raphael Bahr that these come from a genuine desire on his part to be remembered as a socially reforming prime minister. Yet as a result of austerity such speeches seem ridiculous now, and will only be disregarded by history: meaningless when set aside the reality of the poverty and harm caused by government actions. Here is a self explanatory chart from the IFS.

There were genuine hopes on all sides that Universal Credit (UC) might achieve the aim of simplifying the benefit system, and thereby reduce the number who fail to claim benefits they are entitled to and need. But as a result of austerity, and those cuts to tax credit that the Chancellor was forced to postpone, UC will now be seen as a way of cutting benefits and will be either extremely unpopular and/or be quickly killed. It would be useful to be able to assess what aspects of the health reform brought in by the coalition worked and which did not, but I suspect all that will be lost in the chaos caused by underfunding.

So the dead hand of austerity kills hope of reform from both left and right. The years of austerity will be seen as wasted years, when no new progress was achieved and plenty that had been achieved in the past setback. Recovery from recessions need not be like this, and indeed has not been like this in the past. They can be a time of renewal and reform: if not from a credit squeezed private sector then at least from government. And it could have been like that again, because there was absolutely no necessity to embark on austerity in the depth of a recession.

Those on the right may say well at least we are getting a smaller state. But attempts to force people to in effect spend less on health, education, justice and even a welfare state, are not durable for more than a decade or two. It will be a hollow victory.

In the US and most of Europe the obsession with austerity is coming to an end. It is still killing Greece and holding back Germany, but elsewhere deficit targets are either being achieved through growth or quietly ignored. Yet in the UK that dead hand continues, seen or unseen, to dominate policy and debate. And with its architect set to become Prince Minister and large parts of the opposition still too timid to challenge it, it looks like another five wasted years lie ahead for us.

The political right’s dangerous support for economic quackery

You may remember Niall Ferguson’s disastrous attempt to claim that George Osborne’s imagined success proved Keynesians and Keynes were wrong. That kind of nonsense makes it into a serious paper like the Financial Times because it is written by a famous history professor, or maybe on other occasions by a senior policy maker. But for those who only read this serious press, it is in fact one example of many. There is a little cottage industry out there of so called journalists and think tanks who peddle economic quackery to support right wing policies.

Take, for example, this recent piece by James Bartholomew in the Spectator. Deficit spending by the government never works, he claims. Presumably the opposite also holds, which is that fiscal consolidation (aka austerity) never hurt anyone. Mainstream economics has it all wrong. One of the skills writers like this have is to make very little evidence seem like a lot. Mr. Bartholomew has two bits of evidence.

1. Papers by Alesina et al. He is quite right they briefly gained a lot of influence in Europe in particular, among policy makers who wanted to cut deficits and liked to argue this would not reduce output. What Bartholomew does not tell you is that following this policy of cutting deficits, we had a second Eurozone recession. Nor does he tell you that subsequent analysis by the IMF and others explained why these authors got the results they did, because of countervailing influences that did not apply in the Eurozone in the years following 2010. Nor does he mention the huge number of past and recent studies that confirm fiscal policy does what Keynesians say it does. The only other authority he quotes is Tim Congdon.
   
   
2. Lots of historical examples where fiscal action did not, supposedly, have the expected impact. The thing is, anyone can write this kind of stuff about anything in macroeconomics, because in the economy there are lots of things going on. I’m sure I could come up with an equally impressive list to show you that monetary policy has no effect. Just look at 2009 and 2010: interest rates on the floor and the economy still crashed. That is why economists do econometric studies, the overwhelming (like 95%) majority of which show fiscal policy drives the economy in the expected direction.

To his credit Bartholomew does admit that logically Keynesian policies should work. But there is an awful lot he does not tell you. He does not tell you that the reason it should work is that additional private sector demand does increase output (except perhaps in booms), and that this, rather than fiscal stimulus, was the key insight that Keynes had. It is the insight that every central bank uses to guide monetary policy, using Keynesian models. Models that all say that without countervailing factors fiscal stimulus increases output and fiscal consolidation reduces it. There is no way that his article is a measured piece of journalism. It is designed to discredit the economics that is taught to every student the world over.

There is plenty of this on the left too: people who want to tell you mainstream economics is all wrong. Yet until very recently at least, the influence of this group on politicians on the mainstream left had been minimal, and this group has a far smaller public presence than their equivalent on the right. On the right they are ubiquitous.

Policy makers on the right might tell you that of course they are not influenced by this group, but instead consult serious economic analysis that you can find in mainstream universities. But how can we tell if they are telling the truth. When campaigning senior politicians on the right seem quite happy to talk about the government maxing out its credit card, the classic first year undergraduate ‘schoolboy’ error of treating the government like a household. In the UK, while the fiscal strategy of the Labour government was written up in Treasury documents that referenced the academic literature, there is nothing equivalent from the current government. Even the most technical of Osborne’s speeches just seemed horribly out of date in terms of its macroeconomics.

This is dangerous for two reasons. The first is that it can lead to major macroeconomic policy errors: in the UK think money supply targets, entering the ERM at an overvalued rate, and 2010 fiscal consolidation, in the Eurozone think of the Stability and Growth Pact and the 2011-13 recession. The second is that it encourages a lazy anti-science attitude, all too evident in climate change denial. If the political right in the UK and Europe want to see where this could lead, look across the Atlantic. With the left in disarray and flirting with non-mainstream economics, the right has an excellent opportunity (when a new Chancellor takes over in the UK, for example) to re-engage with mainstream economics, and cast off the quackery of the Ferguson and Bartholomew ilk.

Economics Rules by Dani Rodrik

I didn’t want to talk about this book before I had finished it: I somehow think Noah’s contrary approach has its shortcomings! The first and most important thing to say is this is a great book. Not because it gave me some huge new insight or knowledge, although I did learn quite a bit about other parts of economics, but because it had a way of putting things which was illuminating and eminently sensible. Illuminating is I think the right word: seeing my own subject in a new light, which is something that has not happened to me for a long time. There was nothing I could think of where I disagreed (which given the book’s wide scope is quite something), and plenty where the inner blogger in me said I wish I’d written that.

So who should read it? To be honest I cannot think of anyone who should not, as I think most of the material could be understood by interested non-economists. His writing style is enviable - it seems so effortless! (That’s me as blogger again.) The people who should especially read it are those who interact with economics or economists and are either unclear or distrustful about what economists are about (other social scientists particularly).

The first part of the book sets out a way of thinking about economics, and in particular to the models that economists could not live without. The key idea is that there are many valid models, and the goal is to know when they are applicable to the problem in hand. This idea has already attracted some attention, including Noah Smith’s post I linked to earlier.

I must admit when I first read it I thought well of course, doesn’t everyone understand that? I remember way back when I did my undergraduate degree, hearing a lecture from a young David Newbury I think, who said the days of big models (models of everything) were over in economics, and that today economists focused more on small but focused models, looking at particular problems or issues. But then as I read on I began to realise that I typically did not employ this knowledge into how I discuss the subject, which is exactly what Rodrik does. 

One area of economics that you might think this would not apply is macro, but it does. It is routine, for example, to split issues up by time: the famous short, medium and long run. A New Keynesian model is not going to tell you much about long run growth, but a Solow growth model does not tell you much about involuntary unemployment. The point here is not that an all encompassing model could not be built - it could, and sometimes individuals or institutions try to do that - but if it was it would be unwieldy, and we would want to break it up in our minds to understand how it works. (I used a related idea of ‘theoretical deconstruction’ in an EJ paper some time ago.) An important point that follows from that is that although we work with different models, it is important that we know how they interconnect, or at least how they relate to each other.  

Rodrik spends a good part of the book describing how you ‘navigate among models’. He warns that these methods are as much a craft as a science. Many have picked up on that, presuming that this is something that a proper science would not do. But as I have often said, the best analogies for economics are with medicine rather than physics. When a doctor diagnoses an illness based on symptoms, they could also be said to be using craft rather than science.

Let me give you a simple example from macro. How do we know if most economic cycles are described by Real Business Cycles (RBC) or Keynesian dynamics. One big clue is layoffs: if employment is falling because workers are choosing not to work we could have an RBC mechanism, but if workers are being laid off (and are deeply unhappy about it) this is more characteristic of a Keynesian downturn. This simple test beats any amount of formal econometric comparison. Craft maybe, but not a very difficult craft in this case.    

Lots of people get hung up on the assumptions behind models: are they true or false, etc. An analogy I had not seen before but which I think is very illuminating is with experiments. Models are like experiments. Experiments are designed to abstract from all kinds of features of the real world, to focus on a particular process or mechanism (or set of the same). The assumptions of models are designed to do the same thing.

Although I found that Rodrik’s discussion of how you select the right model familiar and sensible, it remains vague in the philosophical sense, as Emrah Aydinonat points out. But he also finds them instructive, so they are a work in progress that hopefully philosophers and economists can interact on. (It is worth passing on a point which Aydinonat makes, which is that unlike many economists who write about methodology, Rodrik has read the relevant literature!) Thinking about alternative models that differ in their applicability to particular problems is certainly a more insightful approach than the kind of Popperian stuff that most economists remember.

If this makes the book sound like a philosophical tome, that is quite wrong. It is a very readable account of how economists do what they do: the philosophical grounding is there but it is not intrusive, and instead the book focuses on practical examples. What Rodrik then does with this perspective of many models is to think about a lot of the issues outsiders have about economists: how ideological are they, for example. Towards the end he discusses what went wrong in the financial crisis. Once again the perspective is illuminating: there were for sure models that said a crisis should not happen, but also plenty of models around at the time that explained pretty well why it could. The mistake many economists made was to choose the wrong models, and he discusses why that might have happened. This perspective shows why a simple ‘the crisis shows economics must be flawed’ misses the point.

Hopefully that is enough to make you read this book.  

Heterodox economists and mainstream eclecticism

I knew when I wrote this post some economists would not like it. These are economists who locate themselves outside the mainstream: heterodox economists. They often claim that mainstream economics is this narrow discipline wedded to particular assumptions that are both implausible and ideological. So when I argue that in principle and practice it is not, they will not like it. Simply saying (as I do) that economists are often too reluctant (sometimes for good reason in terms of the sociology of economists) to explore this freedom is not enough for them. Some of them require mainstream economics to be beyond redemption.

Sure enough, Lars Syll attacks my post. He writes 

“And just as his colleagues, when it really counts, Wren-Lewis shows what he is — a mainstream neoclassical economist fanatically defending the insistence of using an axiomatic-deductive economic modeling strategy.” 

I can only think that reading my post got him so angry he temporarily lost his critical faculties. Because what he writes is completely false. I wrote a comment on his blog but it has not appeared, although fortunately Bruce Wilder makes my point in very gentle terms. As I have been here before with Syll (see the footnote to this post), I will be less gentle.

My post ended with the following sentence:

“Mainstream academic macro is very eclectic in the range of policy questions it can address, and conclusions it can arrive at, but in terms of methodology it is quite the opposite.”

I argue in the post that “this non-eclecticism in terms of excluding non-microfounded work is deeply problematic.” I then link to my many earlier posts where I have expanded on this theme. So how I can be a fanatic defender of insisting that this modelling strategy be used escapes me. Unless I have misunderstood what an ‘axiomatic-deductive’ strategy is. Perhaps for Syll not following this strategy means being able to completely (180 degrees completely) misrepresent what someone else says.

That out of the way, I wanted to say something more substantive. In macro, the insistence on using microfounded models also works as an exclusion device. (I am suggesting this as a fact, not a deliberate strategy.) You cannot just write down an aggregate macro model, based on other people’s work or empirical findings or whatever. You have to microfound it, and that requires a lot of skill and practice, as many a PhD student has found out.

If it also turns out when doing this that the issue you want to address or the innovation you want to make is ‘difficult’ in terms of finding an acceptable microfoundation, there are many wise supervisors who will suggest that the student tries something else. It is hardly surprising that this might put some people off mainstream macro.

I think some knowledge of these things is essential - the kind of knowledge to be able to read and understand a journal article. But the depth of knowledge required to be able to create your own microfounded model, if your own interests are more empirical but you nevertheless want to explore the implications of your empirical work for the economy as a whole? Here I think what Lars Syll says has validity. But his wish to tar even the critics of this aspect of mainstream macro with this brush is just bizarre. More generally heterodox economists misdirect their fire when they accuse mainstream macro of being inescapably narrow in its subject matter or assumptions, when their criticism should be directed at the limitations implied by microfoundations formalism.