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Keynesians on austerity – predictably wrong

I have lost count of the number of opinion pieces written by finance commentators and journalists who complain that the austerity programmes of Europe are doomed to fail, because they cause perpetual economic contraction, resulting in shrinking government revenues, curtailing the ability to pay down debt – which was why the austerity programmes were embarked upon in the first place. And this will go hand-in-hand with a widespread, precipitous and neverending decline in living standards, which raises the spectre of social and/or political collapse. The alternative solution they generally propose comes from our good friend Baron Keynes. Naturally.

This is utterly wrong-headed. Naturally. I do not take much issue with the consequences of European austerity that have been identified, however austerity is not the cause of these. Austerity works just fine if governments do not implement it alongside tax increases. Which is what pretty much every austerity programme (either real or imagined) in Europe is either proposing or enacting. It’s the tax increases that will cause the vicious cycle mentioned above – not the austerity, stupid. Austerity alone redirects capital from government programmes to more productive areas of the economy, resulting in growth. But austerity plus tax hikes decreases the size of one part of the economy (the public sector, and this on its own is of course a good thing), whilst putting a yoke on the private sector by preventing individuals and companies from stepping into the breach, with punitive taxes discouraging investment or making it unaffordable. Of course this is a recipe for limitless economic contraction and social misery.

Citizens of a nation that requires a genuine period of austerity must be aware that there will be pain as structural adjustments take place whilst private sector investment slowly and surely crowds out a throttled and atrophying civil service. But pain is and was always going to be inevitable when the almighty spending binge so many governments have embarked upon over the last couple of decades unavoidably draws to a close, either through substantial policy shifts or sovereign default. The former is much less painful than the latter, but more politically difficult, so it seems. And, in dealing with the current debt crisis, Keynesians have never seen a can they haven’t wanted to kick down the road.

17 comments to Keynesians on austerity – predictably wrong

  • “Which is what pretty much every austerity programme (either real or imagined) in Europe is either proposing or enacting”

    The operative term here is “imagined”.

  • RRS

    What is Austerity?

    Does it ever involve a revision of the functions of governments?

    Well, until it does, can a “definition” ever be met?

  • Jordan

    I have lost count of the number of opinion pieces written by finance commentators and journalists who complain that the austerity programmes of Europe are doomed to fail, because they cause perpetual economic contraction

    This type of prediction always amuses me, as do the similar ones about the “deflationary death spiral.” As if people will stop demanding goods and services either because some useless parasites lost their cushy government jobs or the central bank finally stopped punishing them for saving.

  • Alisa

    The reasons for austerity measures (if they are indeed real, which I also doubt) are real and practical, the reasons for raising taxes are purely political. The reasoning goes something like: we’ll stop giving money to the “poor”, because there’s none left to give. But to placate those “poor” we’ll also take money from the “rich”, consequences be damned.

  • @Jordan:

    The issue here is unlike the “deflationary death spiral” (which I personally disbelieve), but rather the simple fact that with wage stagnation, tax rises and price inflation, less and less money will be available for spending in the productive side of the economy (i.e. the market bit).

    Given that there is genuine fear about job security, working people will be more reluctant to spend money on non-essentials, although they will be spending a larger proportion of their available money on both taxes and essentials due to said tax rises and price inflation.

    The net result is that at best growth stagnates, but at worst you get a gradual contraction caused by marginal businesses in the premium sector going bust and resultant job losses affecting consumer confidence.

  • Paul Marks

    Actually things are not as complex as this – because the claims of “austerity” are a LIE.

    An obvious example would be Paul Krugman of the New York Times (seeking to play the role that Keynes played in the New York Times back in the 1930s – although in those days there was also Henry Hazlitt which, of course, there is not now).

    Prof Krugman declares that the economic problems of the United Kingrdom are due to cuts in government spending – “austerity” (if the word has a meaning then “cuts in government spending” is what it means).

    Check TOTAL government spending in Britain every year since the present crises started.

    “Real terms”, money terms, percentage of GDP….. use any method you like.

    In every year government spending has gone UP not down.

    So debating the effects of “austerity” is a waste of time – as it is a great big LIE.

    And (before someone mentions it to me) who wants to bet that the government spending in 2012 will not be HIGHER than it was in 2011?

    Remember the spending on the absurd London games (shock, horror, it is “unexpectedly” many times higher than it was supposed to be) and all the IMF

    And, please, no banker “off the books” trick with the IMF spending. You might as well say that Ireland has “cut governmenrt spending”, by leaving out all the money spent on bank bailouts (just how stupid are people supposed to be?).

    Of course governments can cut government spending – government spending in the United States was dramatically cut after World War II (compare government spending in 1947-1948 to government spending in 1944-1945) and the real economy BOOMED (so much for the negative effects of “austerity”).

    “But that was war spending Paul”.

    O.K. Warren Harding became President of the United States in 1921 – and was at once hit by the credit bubble bust of 1921 (the one the history books gloss over – because how government reacted to it was totally different to how Herbert The Forgotten Progressive Hoover reacted in 1929 – with his desperate efforts to PREVENT wages falling and so on).

    The Harding Administration cut government spending by 25% from a PEACETIME (1920) total, and in the face of a massive bust.

    Within six months the economy was in recovery.

    There is a big (a basic) difference between REAL “austerity” (acutally cutting total government spending), and “austerity” as a contentless word in the media.

    What the present government has actually done is INCREASE TAXES (as have so many governments in Europe).

    But if that is the new definition of “austerity” then the media should say so – and stop talking B.S. about “the cuts”.

  • Paul Marks

    As for “deflation”.

    The Bank of England (like the Federal Reserve and the European Central Bank) has been creating money (from NOTHING) at an incrediable rate (for example the ECB gave the banks a Christmas present of 485 billion Euros, created from NOTHING, just a few weeks ago – and the Bank of England has been playing such games for years).

    To call monetary policy “restrictive” or “deflationary” (or whatever other word the Keynesians wish to use) is just another lie.

    I am getting rather irritated by this stream of lies from the establishment.

  • James Waterton

    I think many of the comments above are rather UK-centred. In several European countries, there have been genuine cuts in government spending. I remember reading that pensions there have been cut by 25% – imagine that in the UK! As a less significant, but more amusing, example of Greek cuts, I noticed their embassy in Hanoi recently relocated from a couple of floors in a plush waterside serviced apartment building (I guess the equivalent of permanently renting out a few levels of the Four Seasons), to a few rooms above a furniture shop on a rather ugly main road.

    There have been genuine cuts in public spending in several European countries, as well as tax hikes. This is what I’m referring to in my piece, not David Cameron’s phoney austerity.

  • James Waterton

    I remember reading that pensions there have been cut by 25%

    Oops, that should say “pensions in Greece”

  • Johnathan Pearce

    I sometimes think that Keynesianism, inasmuch as it makes any sense, is a sort of collective confidence trick. The populace need to be persuaded that they are better off, so their “animal spirits” need to be manipulated by the illusion of their being better off, hence spend money on X, encouraging growth, etc. The problem is that the ability of governments to more or less fool the public is not what it was since the public is, by and large, more cynical these days.

    Another thing is that inasmuch as the “multiplier effect” – a key part of Keynesianism – had any credibility, it has dwindled as the size of government relative to the rest of the economy has grown. When government takes, say, only 25 per cent of GDP, the impact of government spending increases will be marginally much bigger than when it takes 50 per cent. And now that governments are at or above the limit of any sustainable spending, the positive effects of fiscal stimuli such as spending on infrastructure are negligible. This is something that the Paul Krugmans of this world either refuse to accept, or are too dishonest and ideologically motivated to openly state.

  • RRS

    J P:

    Come on now, don’t use “GDP,” please.

    Further, to paraphrase what good old Milt said, “don’t look at the “take” of governments, look at what they spend.”

    And say, it would not take a lot more to make me think that “Paul Marks” is really the name taken by an organization of readers and thinkers, rather than one guy!

  • Paul Marks

    I should have made the point more clearly.

    I am NOT discussing cuts in individual deparments – I mean TOTAL government spending.

  • Fiend's Brave Victim

    I understand Austerity in its current guise to be strictly spending cuts alongside tax rises, at least notionally if not in practice. If it was spending cuts and tax cuts it would be called something else. A smart idea, maybe.

  • Stephen

    Not sure I quite agree here. Cutting government spending does not in the short term redirect capital from government programmes to more productive areas of the economy if the national finances are deep in debt. It redirects money to pay off the debt. I’m not qubbling with the general thrust of opinion on the silliness of Keynesian thinking, and imagining that governments spending money might be good for the economy. It is clearly a weakening factor, and in the longer term austerity is the right thing.

  • Laird

    My turn to disagree, Stephen, on several levels. First, cutting government spending would “redirect money to pay off the debt” only if the resultant spending level were sufficiently low to generate a budgetary surplus. But given the level of deficits most western governments are running that result seems highly unlikely, so the actual effect would merely be a lessening of the rate at which the debt level increases.

    Second, even if the resultant spending level did generate a surplus, one has to look deeper to determine the effect. In the US (I believe the UK is similar), a significant portion of the national debt is in the form of Treasury bonds held by the Federal Reserve. This is the result of “quantitative easing”. That money was merely printed (electronically) by the Fed; it wasn’t “borrowed” from anyone. Eliminating the faux dollars represented by those bonds wouldn’t be paying off “debt” in any meaningful sense; it’s just cancelling offsetting debits and credits.

    And finally, even if (mirabile dictu) there were a budgetary surplus, and it were actually used to pay off some of the privately-held national debt, what precisely do you think the (former) holders of that debt would do with the cash? They would find some other use for it; not many would stuff it under the mattress or bury it in the back yard.* Which means that such debt repayment would, even in the short term, “redirect capital from government programmes to more productive areas of the economy.” Governmental austerity is an unalloyed good.

    * Some might buy gold, but given the facts of our (admittedly unrealistic) hypothetical the government would be acting so rationally that the principal reason for buying gold would have disappeared.

  • Stephen

    There was me thinking if we stopped spending money we didn’t have on one thing, then we still wouldn’t have it to spend on anything else…
    There you are, this is why I’ve never been any good with money!