Why Does Austerity Fail?
Bureaucracies become influential through their expertise. A recent IMF working paper raises questions about the value of its expertise. Entitled “Assessing the Impact and Phasing of Multi-year Fiscal Adjustment: A General Framework” the paper develops a model of the effects of different approaches to fiscal adjustment to help Fund staff develop better lending programs. This paper also underscores the limits of the existing intellectual approach to austerity, which relies solely on economics to overcome what are essentially political problems.
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Undeniably, ascertaining the appropriate pace of fiscal adjustment is an important question. Given the high levels of debt in advanced economies, advice from Fund staffers is surely needed. For countries in economic crisis, this work can help the Fund design an appropriate pace of fiscal adjustment to help a country cope with its economic hardship. So the authors are to be commended for taking on a big question with important policy implications across the globe.
In the first part of the paper, the authors develop a model to sketch out some of the tradeoffs of different speeds of fiscal adjustment by looking at its effects on growth and debt. Because models have real value when they are field-tested, in the second part of the paper they test their findings against the experiences of advanced economies and emerging markets. The authors devote several pages to discussing the Greek experience, which underscores the limits of their approach.
By their logic, fiscal austerity is not painless, but should lead to growth in the long run. But simply put, their model cannot explain the collapse of the Greek economy, where unemployment approaches 28% and the economy is in recession for a sixth straight year. Scholars have claimed that the Greek collapse was due to underestimating the effects of the fiscal multiplier, so as spending fell, the economy shrank by more than expected. In contrast, these authors argue the shortcomings of the model can be accounted for by over-optimistic projections as well as a lack of program implementation. Both of these factors are of course political ones, not economic ones. Thus, in the hallmark case about the merits of austerity, the authors only put part of the blame on the IMF. As Maria Korologou smartly put it, “the IMF said its methods in calculating the effects of austerity were not wrong, although the result was.”
So how can we do better? The IMF’s excessive optimism does not stem from the rogue writings of giddy economists. It has deep political roots. The Fund is not as independent from its member states as it would wish to be. Research suggests that the Fund’s internal pressures to nudge markets to support borrowing countries lead to biases in forecasts, and we also know that clients of major powers also receive beneficial forecasts. Both of these dynamics have been at work, as these forecasting errors stem from the need to reassure other EU members and maintain market confidence.
We also need to realize that economic adjustment is a political process. There cannot be an optimal plan for fiscal consolidation that is based on the premise that it is implemented by a single decision maker who operates with regard for the national interest. No government on earth operates like this. Politicians bargain with each other to come to agreement, and they have partisan differences in how they view the world. We know that impending elections and coalition governments make implementing fiscal austerity difficult, and that countries with strong budget institutions can produce better results. The first two of these (and the absence of the third) have certainly hampered adjustment in Greece. Whether a Fund program is front-loaded or not misses the point: regardless of how the fiscal plan is devised, it is implementation that matters. Looking purely at a balance sheet, the IMF lacks the tools to assess whether an adjustment program will be fully adopted by a country. The Fund’s own after-action report notes that it overestimated the political commitment to adjustment in Greece. Front-loaded fiscal austerity may be economically optimal, but for leaders who rely on public support to remain in office, it is not politically optimal. Without a better understanding of the politics of adjustment, IMF policies will continue to underperform.
As we move toward a third bailout, it is time for an honest assessment of projections as well as a sober view of Greece’s capacity for implementing austerity. Bromides about resolve and toughness may play well with German voters, but they cannot help Greek citizens who are turning to extremists for answers. After six years of hardship aided by the Fund’s inability to see the political problem of austerity, it is time to do more than just rethink the math.