Finance in the 21st Century
Does Austerity Promote Economic Growth?
Robert J. Shiller
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NEW HAVEN – In his classic Fable of the Bees: or, Private Vices, Publick Benefits (1724), Bernard Mandeville, the Dutch-born British philosopher and satirist, described – in verse – a prosperous society (of bees) that suddenly chose to make a virtue of austerity, dropping all excess expenditure and extravagant consumption. What then happened?
The Price of Land and Houses falls;
Mirac’lous Palaces, whose Walls,
Like those of Thebes, were rais’d by Play
Are to be let; . . . .
The building Trade is quite destroy’d
Artificers are not employ’d; . . .
Those, that remain’d, grown temp’rate strive
Not how to spend, but how to live . . .
That sounds a lot like what many advanced countries have been going through, after financial-crisis-induced austerity plans were launched, doesn’t it? Is Mandeville a genuine prophet for our times?
Fable of the Bees developed a wide following, and generated substantial controversy, which continues to this day. The austerity plans being adopted by governments in much of Europe and elsewhere around the world, and the curtailment of consumption expenditure by individuals as well, threaten to produce a global recession.
But how do we know if Mandeville is right about austerity? His research method – a long poem about his theory – is hardly convincing to modern ears.
Harvard economist Alberto Alesina recently summarized evidence concerning whether government deficit reduction – that is, expenditure cuts and/or tax increases – always induces such negative effects: “The answer to this question is a loud no.” Sometimes, even often, economies prosper nicely after the government’s deficit is sharply reduced. Sometimes, just maybe, the austerity program boosts confidence in such a way as to ignite a recovery.
We have to examine the issue with some care, understanding that the issue that Mandeville raised is really a statistical one: the outcome of government deficit reduction is never entirely predictable, so we can ask only how likely such a plan is to succeed in restoring economic prosperity. And the biggest problem here is accounting for possible reverse causality.
For example, if evidence of future economic strength makes a government worry about economic overheating and inflation, it might try to cool domestic demand by raising taxes and lowering government spending. If the government is only partly successful in preventing economic overheating, it might nonetheless appear to casual observers that austerity actually strengthened the economy.
Likewise, the government’s deficit might fall not because of austerity, but because the stock market’s anticipation of economic growth fuels higher revenues from capital-gains tax. Once again, we would see what might appear, from looking at the government deficit, to be an austerity-to-prosperity scenario.
Jaime Guajardo, Daniel Leigh, and Andrea Pescatori of the International Monetary Fund recently studied austerity plans implemented by governments in 17 countries in the last 30 years. But their approach differed from that of previous researchers. They focused on the government’s intent, and looked at what officials actually said, not just at the pattern of public debt. They read budget speeches, reviewed stability programs, and even watched news interviews with government figures. They identified as austerity plans only those cases in which governments imposed tax hikes or spending cuts because they viewed it as a prudent policy with potential long-term benefits, not because they were responding to the short-term economic outlook and sought to reduce the risk of overheating.
Their analysis found a clear tendency for austerity programs to reduce consumption expenditure and weaken the economy. That conclusion, if valid, stands as a stern warning to policymakers today.
But critics, such as Valerie Ramey of the University of California at San Diego, think that Guajardo, Leigh, and Pescatori have not completely proven their case. It is possible, Ramey argues, that their results could reflect a different sort of reverse causality if governments are more likely to respond to high public-debt levels with austerity programs when they have reason to believe that economic conditions could make the debt burden especially worrisome.
That may seem unlikely – one would think that a bad economic outlook would incline governments to postpone, rather than accelerate, austerity measures. And, in response to her comments, the authors did try to account for the severity of the government’s debt problem as perceived by the markets at the time that the plans were implemented, finding very similar results. But Ramey could be right. One would then find that government spending cuts or tax hikes tend to be followed by bad economic times, even if the causality runs the other way.
Ultimately, the problem of judging austerity programs is that economists cannot run fully controlled experiments. When researchers tested Prozac on depressed patients, they divided their subjects randomly into control and experimental groups, and conducted many trials. We cannot do that with national debt.
So do we have to conclude that historical analysis teaches us no useful lessons? Do we have to return to the abstract reasoning of Mandeville and some of his successors, including John Maynard Keynes, who thought that there were reasons to expect that austerity would produce depressions?
There is no abstract theory that can predict how people will react to an austerity program. We have no alternative but to look at the historical evidence. And the evidence of Guajardo and his co-authors does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.
Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all. But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.
Robert Shiller, Professor of Economics at Yale University, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.
Copyright: Project Syndicate, 2012.
www.project-syndicate.org
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groovologist 09:13 18 Jan 12
I'm very pleased that capitalism finishing his life on my eyes )))
GrahamWilliamsKinsale 09:52 18 Jan 12
It is worth going back a few centuries beyond Mandeville.
Plutarch recorded Pericles ideas on government expenditure - which Keynes encountered while taking classics at Eton:
Pericles, on the other hand, informed the people, that they were in no way obliged to give any account of those moneys to their allies ....."which money," said he, "is not theirs that give it, but theirs that receive it, if so be they perform the conditions upon which they receive it." .....they should convert the overplus of its wealth to such undertakings as would hereafter, when completed, give them eternal honour, and, for the present, while in process, freely supply all the inhabitants with plenty. With their variety of workmanship and of occasions for service, which summon all arts and trades and require all hands to be employed about them, they do actually put the whole city, in a manner, into state-pay; while at the same time she is both beautiful and maintained by herself. For as those who are of age and strength for war are provided for and maintained in the armaments abroad by their pay out of the public stock, so, it being his desire and design that the undisciplined mechanic multitude that stayed at home should not go without their share of public salaries, and yet should not have them given them for sitting still and doing nothing, to that end he thought fit to bring in among them, with the approbation of the people, these vast projects of buildings and designs of work, that would be of some continuance before they were finished, and would give employment to numerous arts, so that the part of the people that stayed at home might, no less than those that were at sea or in garrisons or on expeditions, have a fair and just occasion of receiving the benefit and having their share of the public moneys.
.....Thus, to say all in a word, the occasions and services of these public works distributed plenty through every age and condition.
janelasdedeus 10:04 18 Jan 12
I admit that I can't follow all the economic logic here... but I do have fairly simple question: how can a society prosper if an ever increasing majority of its citizens are living off the production of an ever decreaing minority?
Zsolt 11:03 18 Jan 12
I think whenever we talk about austerity there is a huge question: what is normal consumption and what should we consider austerity?
At the moment through the hyped up constant growth, increasing production system we forced ourselves into elevated consumption to such levels, that is unsustainable for multiple reasons, and this is why today we are in a general, global crisis, or more precisely in a system failure as this is not a simple economical or financial crisis that could be overturned by superficial economical adjustments, the whole lifestyle and the inflated bubbles created by it have reached their end.
Over 90% of our present production and consumption is unneccessary, creating unneccesary and harmful products harming ourselves and our environment. The Internet is full of statistics and clips on different peak capacities, environmental and health effects explaining the above through objective and reproducable data.
Despite the multitude of material, physical possessions we can accumulate today people are unhappier than ever, especially in the richest countries in the richest social layers.
It turns out that austerity, even a significant reduction of this constant growth model, and a return to resource and necessity based consumption would liberate us from the slavery of consumerism and make us healthier, happier, and free up our capability to deal with what a human being mostly should be dealing with: social connection with other human beings.
Of course it comes with a different political and economical model which we will need to build based on evaluating the global, interconnected, mutual system around us that system is only viable through the same natural laws as any other interconnected natural system around us.
cowanmr 11:22 18 Jan 12
I think that there needs to be some subdividing of the analysis of austerity. As the famous Keynesian example goes, if spending gets the economy going, why don't we hire people to dig large holes with spoons and then refill them? Without delving into the numbers, common sense tells us that we're essentially taking people that could work on productive projects and paying them to do something unproductive. Even worse, we have to tax productive businesses to pay for the unproductive activities, so we're also taking money away from businesses that could be reinvested in the productive enterprise and drive further growth.
To date, it appears that the argument hovers around the austerity or no-austerity decision. I think that the question of whether a government should impose austerity or not is too broad. The focus should sift to a line item by line item analysis of individual expenditures, the benefits they provide to society, and whether the government can afford to keep the program based on the underlying ability to produce tax revenues.
If we back off the ideological battle of austerity pitted against no austerity, we can make some meaningful progress on the issue. How do we eliminate unnecessary government employees without dragging on the economy (e.g. paying them half their salary to search for another job or develop skills in high demand in the private sector)? How can we leverage the government's unique role to add more value to society without adding cost, employees, etc.? And other questions.
I hope we can cross the ideological divide and get under the hood to make government more efficient, more effective and fiscally sustainable.
ehlow 10:01 19 Jan 12
We need to specify a time frame when we ask the question, “Does Austerity Promote Economic Growth?”. Is “…a clear tendency for austerity programs to reduce consumption expenditure and weaken the economy” in the short term or long term? A more meaningful question to ask is: Does an austerity program cause a country’s long term trend growth to improve or deteriorate?
Perhaps more importantly, austerity measures are often primarily targeted at debt reduction with the expectation that its effect on short term growth will be negative. Intuitively, it is very hard to justify how austerity can stimulate short term growth, if that was ever the intention.
superb 05:50 19 Jan 12
I love this debate! My view is that it depends on the economic multiplier effects. Is the economy part of a highly competitive environment and is it industrial or services focused? The manufacturing-based economy adopting austerity programs would impact employment, income levels and trading deficits/surpluses on a different level than would a services-based economy. The influence on competitiveness is also important, is the austerity program tremendously decreasing your ability to compete in a growing global economic environment? Point here is, an austerity program in the U.S. would probably negatively impact overall economic activity but the same program might substantially strengthen the economic outlook of a country like...say...Malta...
mikerobe 06:49 19 Jan 12
The Prozac metaphor is apt. Eli Lilley failed to report a range of effects associated with the drug, from psychotic episodes to suicides, during testing. Subsequent to approval millions of users reported adverse side-effects, unsurprisingly. Most severe are the reported cases of discontinuation syndrome.
Economics is a subset of politics. To adopt capitalist economics, in whatever variant, is a political decision. The political decision to allow a more de-regulated form of capitalism invariably leads to bubbles, corruption, highly speculative investments, poor judgments in lending, etc. When all of this crashes then yet another political decision must be made: who loses?
In the current case, given the extraordinary level of political influence of the financial sector, especially, Wall St., bankers win and everyone else pays vis-a-vis austerity. The Prozac must be understood both as austerity for middle class and working class people AND in the form of bailouts, Fed actions, and weak regulations that the politician/banking class enacts. As with Prozac there are many ill side effects, and discontinuation is dangerous.
But people begin using Prozac to treat psychological disorders. Capitlaism should be seen in the same light as a mild form of psychosis with potentially disastrous consequences if untreated. The healthier course would be to never allow the irrational capitalist genie entirely out of the bottle. This would involve stringent state regulations, especially of the riskiest types of capitalist activity, as well as considerable public investments in all the things that make for a healthy social body--universal health care, parks, education, a healthy environment, ample leisure time, museums, cultural festivals, and so on.
Of course, no one ever accused humans of being rational. Greed and the promise of endless luxuries is enough to send any budding capitalist or hapless consumer straight over the edge and into the psychiatrist's office. This tension between lucidity and schizophrenia is the stuff of the actual political workings of civilized society, especially in its modern capitalist form.
gamesmith94134 03:46 20 Jan 12
Gamesmith94134: Does Austerity Promote Economic Growth?
In answering the question of “Does austerity promote growth? Of course, it does not. There is no abstract theory that can predict how people will react to an austerity program; and I agree with Guarjardo and others on the results that governments adopted the austerity program tended to be followed by hard times. What does the austerity program mean? It is only the atmospheric perception on the search of the bottom of what or how people lives; it does not promote growth but it show more of the competitiveness in mere opened grounds.
When the story my friend told me of the donation to a college was a bad idea, because the college would engage programs available for its infrastructures, students and professors. It demands perpetuity to fit their budgets in growing. Often, the crisis situation arrives after the expansion of the donor’s buildings or library, or if the donors stopped their offerings; the fee will go up and a budget crisis will arise, especially more of the millionaire professors arrive with their BMW, and the student are going the other way with heavy debts. It is all psychological and economical under the spells of human behavior since most of the administrators and the budgets are not seasonally adjusted or commercially leveraged. It is why most our politicians are reluctant to follow well with the austerity program or obey to cutting the budget because they are not disciplined with the business cycle based on the competitiveness to growth; and they may not understand how the zigzags make the world goes around.
I can understand Mr. Robert J. Shiller may scales the growth on the projective on the economy; since the present austerity programs are not servicing the growth. However, the austerity program enforced to search the bottom line of productivity, the reactions of the politicians and its populace will make a distinguished level of tolerance for the excessiveness and suffering within the system or its governance allows. In addition, such deleverage reestablishes the essences of the missing elements on normalcy of the business cycle or risk factors like interest rates, currency exchanges. When the sovereignty debts created the imbalance crisis by liquidity and solvency; and they indicate the budgetary measures is derailing from the business cycle and becoming political at a sovereignty level. Economy may not grow under the budgetary enhancement as much of the Keynesians believe. It is because growth comes after the business cycle and not even at the level of monetary liquidity or solvency that ECB or FED can project at its continuance of growth. Zigzag make a better search on the bottom line, and growth only comes after.
May the Buddha bless you?
Amincd 09:00 20 Jan 12
Even if it's found that it reduces consumption in the short run, it doesn't mean spending cuts are a net economic negative in the long run.
Given a large private sector relative to government sector is generally associated with better long term economic performance, it's pretty reasonable to assume spending cuts in nations with high levels of government spending would lead to improved long term economic growth.
RodgerMitchell 09:47 24 Jan 12
Two great surprises:
1. Bleeding a patient does not cure anemia
2. Austerity does not grow an economy.
My book, FREE MONEY, revealed these "amazing" facts more than 10 years ago. Most economists still don't get it.
The U.S. is Monetarily Sovereign. It has the unlimited ability to create its sovereign currency. It needs neither to tax, nor to borrow nor to reduce spending. By contrast, the euro nations are monetarily non-sovereign. They will continue to suffer until they do one of two things:
1. Return to Monetary Sovereignty by re-adopting their own sovereign currencies, or
2. Become a quasi "United States of Europe," in which the EU gives (not lends) euros to member nations. There are no other long-term solutions. None.
Rodger Malcolm Mitchell
jsmith23 07:16 08 Feb 12
We have to be cautiously optimistic about today's growth estimate. The right attitude to have is that it could have been worse regarding the last year's overall economic activity. Although it appears the U.S. is not headed towards another recession, it doesn't mean that the nation's troubles are completely behind it. custom t-shirts
pshakkottai 07:02 15 Feb 12
Re: GrahmWilliamsKinsale 09:52:18 Jan 12
I quote from Operational design arising from modern monetary theory | Bill Mitchell – billy blog
"Role of the national government
Before we establish specific arrangements in the financial markets etc, we need a clear statement of purpose for any national government. I think some of the erroneous reasoning in the media and within the broader debate stems from a lack of clarity about what it is that the national government should be doing on our behalf.
From the perspective of modern monetary theory, the national government which issues the currency as a monopolist has a charter to advance public purpose (welfare) at all times even if, in doing this, specific private interests are impeded. In general, the advancement of public interest will provide a sound basis for private benefit also. But at times this will not be the case.
From that broad charter, full employment, poverty alleviation and environmental sustainability become the most significant expressions of public purpose although in choosing those policy targets I am expressing my values rather than making an economic statement.
However, it is highly unlikely that an economy will perform to potential if these policy targets are compromised in any way so I think there is a good case for making them the starting points in the pursuit of public purpose."
similar to Perecles' ideas.
Gulmar 07:29 18 Jan 12
Gulmar
Blinders on eyes have that kind of economists - blind to the fact that the great civilizations - Easter Island - Maya - Mesopotamia - was destroyed from over-exploitation of ecological environmentThe contemporary crisis gets not from hunger, but from over-consumption - and just rationalizing production and consumption can be overcome