The New Deal for Europe: More Reform, Less Austerity

My Comments: There has been a disconnect in this country, typically along partisan lines, whether or not austerity is the way to solve the so called debt crisis at the federal level. As an economist, and a Democrat, my instinct has been to set the stage for growth, and as growth and increased economic activity increase, revenue will increase and resolve the debt crisis. Starting with George Bush, and the bailout of the big banks in 2008, we have largely stayed away from pure austerity.

Europe, on the other hand, has largely gone the austerity route, and it’s not working. The rules that apply to a household with a finite time horizon, thought of as “micro economics”, are not applicable to a dynamic society such as the US, where “macro economic” rules apply. This article suggests that Europe is moving in our direction.

By Philip Stephens for the Financial Times April 26, 2013

The War of the Coding Error is a reminder that the economy is too vital to be left to economists

Britain and Spain once went to war over the severed ear of a ship’s captain. The annals of unusual conflicts will surely record that the 18th-century War of Jenkins’ Ear was a pretty unremarkable affair when set against today’s War of the Spreadsheet Coding Error.

Economists have taken up arms. One side has long claimed proof that high public debt suffocates growth. European governments have fallen in behind, rampaging across the continent under the flag of austerity. Now a rival army of academics says the statistical books were spiked. As things turn out, the causality may flow in the opposite direction: it is low growth that drives up debt.

The Harvard economists Carmen Reinhart and Kenneth Rogoff had posited that debt above 90 per cent of national income was almost always associated with significantly reduced growth. The implication was that deep retrenchment was the only route back to prosperity. Now, economists at the University of Massachusetts Amherst say the results reflected a data “coding error” and some questionable aggregation. The assumption that high debt always equals low growth is not sustained by the evidence.

I know whose side I am on, but, after the dismal experience of recent years (remember economists proclaiming liberal financial capitalism to be the philosopher’s stone?), it is tempting to shrug one’s shoulders. That would be a big mistake. This particular fight merits more than a knowing sigh. It is another salutary reminder that the economy is too important to be left to economists. More importantly, it presents policy makers with a chance to escape a flawed orthodoxy.

Excessive austerity has seen much of Europe mired in depression. In spite of swinging spending cuts and tax rises, debt is increasing. The crisis of the euro may be over, in the sense that the existential threat to the currency has been lifted. But the crisis within the euro is extinguishing political consent for European integration. The continent badly needs to reset its course.

The answer is not a new fiscal splurge. A heavy price must be paid for the unchecked spending and credit booms that ended in the global financial crash. But timing and pace matter. Governments with a demonstrable determination to raise long-term economic growth with supply-side reforms should be given more time to cut deficits.

During the past couple of years politicians have prized credibility with markets above real economic performance. It hasn’t worked. Bond traders such as Pimco’s Bill Gross now attack austerity, calling for measures to rekindle growth. Bond markets, like economists, are rarely known for their consistency. In this instance, though, Mr Gross is right.

The present confusion – visible in open debates at the International Monetary Fund – gives politicians and central bankers a chance to think again. The response should be a calibrated policy shift to combine accelerated supply-side reforms with flexible fiscal timetables and increased investment. To the extent fiscal restraint weighs on demand, it should be offset by policies to expand productive potential.

Britain is in as much trouble as the eurozone. After three years of austerity, the economy and borrowing are flatlining. Policies framed to win over financial markets have been rewarded by rating agency downgrades. Inexplicably, the Treasury has slashed growth-enhancing capital investment while increasing transfer payments to the over-65s. Britain’s borrowing will soon be higher than that of Greece.

Elsewhere, there are one or two encouraging straws in the wind. True, Germany is not about to sanction a big stimulus in peripheral eurozone nations; Chancellor Angela Merkel will keep a firm grip on her cheque book before and after the German election in September.

That said, German policy has become more nuanced. The most closely watched statistics in Berlin are measures of competitiveness. Of course, you hear German officials say, Spain, Portugal and others must cut borrowing and debt. But the indicators that matter most are relative unit costs, productivity and exports. Here Germany acknowledges tangible progress.

This leaves room for the new bargain between creditors and debtors. The advantage of an explicit trade-off between more aggressive reform and looser fiscal timetables is that it would at once offer a more palatable political message to voters and buy credibility in markets. Both would be assured that tough reforms offered a route out of the debt trap to the economic growth needed for sustainable public finances.

High unemployment in Europe is not just a reflection of recession. It often mirrors ossified labour markets that lock out young people and discourage investment and innovation. Raising the pension age generates not only more growth but also confidence in markets about fiscal sustainability – and promotes equity between generations.

Cutting taxes on labour encourages business expansion and jobs. Education and skills training are vital elements in competitiveness. Modernising essential infrastructure can secure a long-term income stream from a one-off expense.

What circumstance now demands of politicians is the confidence to break free of the defunct, and debunked, economic theorising. Economists are not always wrong; nor does the real problem lie with dodgy data. The mistake comes when policy makers invest the findings of a faith-based discipline with the certainties of science. They would do better to rely on common sense and observed behaviour. By underscoring this fairly simple lesson, the War of the Spreadsheet Coding Error may yet do Europe a huge service.

Advertisements