Spending Other People's Money
Ex-IMF man and Nobel laureate Joseph Stiglitz is at it again. Austerity (i.e., lower deficit spending) is a terribly bad idea according to Stiglitz. He has frequently uttered this view over the past three years, without ever providing any proof for his assertion. What he is effectively advocating is that governments should spend other people's money more freely than they already do on his say-so. His stance serves as indirect proof that a Nobel prize for economics is often a bit of a contrary indicator. It doesn't tell us that the recipient is actually a good economist.
This is of course putting the cart before the horse. Jobs do not, repeat, not 'generate economic growth'. It is exactly the other way around – economic growth creates jobs.
|“Austerity is an experiment that has been tried before with the same results,” Stiglitz said today in a speech in Copenhagen. Cutting budgets in low-growth cycles leads to higher unemployment and hampers recovery, he said.”|
It is an all too rarely tried experiment, but the issue has been studied by other economists, and they have come to a different conclusion: it is deficit spending that hampers recovery, not 'austerity.'
E.g. Robert Barro, economics professor at Harvard, has concluded from his empirical studies of deficit spending that the so-called 'multiplier' is somewhere between 0.8 and lower. This is of course something everyone instinctively understands even without perusing the professor's studies – government spending is inefficient and generally does not generate economic profits, but losses. So how can it be 'good for the economy'? Professor Barro by the way is inter alia famous for his mid 1970s work on a concept we have mentioned before, namely that of 'Ricardian equivalence.' The argument goes basically: however much the government spends, this is what the private sector will neither spend nor invest, regardless of whether the spending is financed by borrowing or taxation. This is so because private economic actors know that they will eventually have to pay for the the borrowings – the taxation is merely postponed.
Moreover, the government does not possess any resources of its own. It can only spend what it takes in equal amounts from the private sector, whether by taxation or borrowing. This means that resources are merely shifted from a sector that employs them efficiently to one that does not. The government can not spend what does not exist after all. As Tim Harford once put it in the FT:
“Few things annoy me more than rhetoric that implies government spending is funded by the generosity of ministers rather than by taxpayers. (Alistair Darling’s pre-Budget report speech included lines such as, “Mr Speaker, we chose not to let people sink when they lost their jobs but to intervene to help them stay afloat.” No, Mr Darling, you didn’t – the taxpayer did.)”
In addition, once the government goes on a deficit spending spree, it tends to compete with the private sector for real resources – the so-called 'crowding out' effect. Stiglitz would likely argue that a 'large output gap' and 'idle resources/capacity' mean that there cannot be such a crowding out, but this is based on erroneous reasoning. After all, resources are idled for a reason during an economic bust. The reason is that the economy's structure of production has become misaligned with consumer demand during the boom, both intertemporally as well as in terms of what it actually produces. A lot of capacity may exist in lines of business that churn out a product for which there is no longer enough demand, whereas capital may be lacking in lines that would produce things people actually want. A good example for the former is the building industry. Whereas during the bubble it appeared to make sense to build 1.2 million homes per year, currently 250,000 seem a more reasonable number. Are there lots of 'idle resources' in the home building sector? You bet there are – the housing bubble represented one of the biggest misallocations of capital in human history. Would it make sense to 'un-idle' them? Obviously it would not, since what point would there be in producing even more homes nobody wants or can afford? This would only waste even more scarce capital. It is possible to keep some of the malinvestments of a boom alive past their due date – but this means only that their eventual liquidation will be postponed and that an even worse downturn may result when it finally occurs.
Stiglitz really goes off the rails when talking about Europe:
“Greece, Ireland and Portugal are under pressure to push through austerity measures that have sparked anti-government protests and general strikes as the three euro members struggle to comply with the terms of their bailout programs. The budget cuts have failed to persuade most investors the countries will avoid a default, a Bloomberg Global Poll published today showed.
Europe’s leaders are gripped by “deficit fetishism,” Stiglitz said. Austerity “doesn’t work, it does not lead to more efficient, faster growing economies,” said Stiglitz, a professor at Columbia University in New York who won the Nobel Prize for economics in 2001.”
Again, Stiglitz offers no proof that more efficient and faster growing economies will not result. It may well take a while – a giant boom-bust sequence has laid these economies to waste after all – but as an economist Stiglitz is surely familiar with short and long run effects and the concept of time lags. Generally, economies where government spending is a small share of GDP tend to do far better than those where it is a large share. But to accuse Europe's leaders of 'deficit fetishism' is really ridiculous. It may have escaped Stiglitz' notice, but Greece, Portugal and Ireland are effectively bankrupt. There can no longer even be a question of whether they should or shouldn't spend more. They simply have nothing left to spend.
If we follow Stiglitz' logic, then Greece with a total government debt of 160% of its economic output and nine times its annual tax revenue, figures that would rise to 800% of economic output and 45 times its tax revenue if its unfunded liabilities were included in the calculation, would be best served by increasing its deficit spending. Now, if Greece still had its own money printing press, this could probably be done, but at the likely cost of hyperinflation and complete destruction of the economy. Given that it does no longer have its own money printing press, it can not be done at all – the Rubicon has long ago been crossed into de facto default.
We will concede that due to the conventions of GDP accounting, which count government spending as 'contributing to economic growth,' such measures as GDP may decline when government spending falls. However, the idea that spending as such is always a 'good thing' is completely wrong. Spending does not create wealth, it consumes it. What creates wealth are saving, investments and production. The government may well by fiscal and monetary measures (i.e., deficit spending and inflation) give birth to certain jobs. It could, as Keynes famously opined, pay people to dig holes in the ground, bury things in them and then dig them up again (or alternatively build lots of empty apartments and skyscrapers like China, or pyramids like Egypt's pharaos). However, not one iota of wealth could be created that way – and since the government would have to take the funds for paying for such activities from the private sector, the private sector would have less funds available for market-oriented activities that would actually be likely to create wealth.
FDR's 'WPA' (Works Progress Administration) was an organization designed for creating such non-jobs (people joked that the acronym stood for 'we piddle around'). Of course, FDR presided over a period known today as the 'Great Depression' and not the 'quick recession he quickly deficit-spent to death.' Something must have gone wrong with all that spending, and the same appears to have happened in Japan. Oddly, Stiglitz never mentions Japan's failure to get anywhere by amassing the biggest debt load among industrialized countries. But somehow he just 'knows' that curtailing deficit spending 'is a mistake.'
We don't know how he would explain Japan's failure, but here is one educated guess: he would tell us 'they didn't spend enough.'
'Gimme that, I'll spend it for you'. Joseph Stiglitz thinks there's nothing better for restoring prosperity than deficit spending. He's as wrong this year as he was last, and the one before that.
(Photo credit: Bloomberg)