Austerity Can Kill You
Domenico Mario Nuti
In 1962 the RCP (Royal College of Physicians) published a Report on Smoking and health in the UK. Using research by Sir Richard Doll and Sir Austin Bradford Hill, the Report established conclusively the link between smoking – including passive smoking – and lung cancer, other lung diseases, heart disease and gastrointestinal illnesses. It caused a sensation, and received an ambivalent, often hostile response from the media, governments and society. In 1962 tobacco “smoking was omnipresent, accepted, established.” “[In the UK] around 70% of men and 40% of women smoked”. It was “a world suffocated by the swirling clouds of tobacco” – “in pubs, cinemas, trains, buses, on the streets, and even in hospitals and schools.” [from the RCP-Royal College of Physicians report on Fifty years since Smoking and Health – progress, lessons and priorities for a smoke-free UK, 2012].
Gradually government action reduced this phenomenon. By 2012 “… smoking is no longer the norm. Our schools, hospitals, pubs, cinemas and public transport are subject to smoke-free legislation. [In the UK] Only 21% of the population smokes. Government, media and society have largely accepted the need to protect people, particularly children, from much of the harm associated with tobacco smoke.” Still, in the UK it took fifty years to achieve such a large reduction in smoking incidence. Smokers are still 21% of the population too many, they represent glaring evidence of either irrationality or addiction or both, and the persistence of vested interests by tobacco and cigarettes producers.
Austerity – aiming at a balanced government budget, reducing expenditure and raising taxation even in the middle of an economic recession – also has been the norm for a very long time, and still is enshrined in the statutory policies of EU and EMU, of IMF and ECB. Yet we have known at least since 1936 (with the publication of Keynes’ General Theory), indeed since 1933-35 (the dates of Michal Kalecki’s anticipations of Keynesian propositions, see Robinson 1976 and Nuti 2004) that austerity can cause unnecessary, involuntary unemployment of labour and irreversible losses of income and consumption.
In our time and age austerity is more incomprehensible than smoking, were it not for the irrational fear of inflation in the middle of a recession, the generalised addiction to hyper-liberal ideologies and the vested interests of those who think they benefit from labour unemployment keeping workers “in their place”. What is worse, austerity today is much more widespread than smoking, it is on the rise and is officially supported by our national and international authorities more than it ever was, while at least smoking is steadily declining not least because of progressive health policies worldwide.
Feasible full employment
In 1943 Michael Kalecki could write that “A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a government spending programme, provided there is in existence adequate plant to employ all existing labour power, and provided adequate supplies of necessary foreign raw-materials may be obtained in exchange for exports”. As long, of course, as such government spending programme is “financed by borrowing and not by taxation”. Kalecki even dealt with the case of highly indebted countries, which also could afford and attract loans to finance government expenditure as long as interest was paid out of a capital levy.
Opposition to such a policy of full (meaning high and stable) employment would be political: “(i) opposition in principle to government spending based on a budget deficit; (ii) opposition to this spending being directed either towards public investment – which may foreshadow the intrusion of the state into the new spheres of economic activity – or towards subsidizing mass consumption; iii) opposition to maintaining full employment and not merely preventing deep and prolongued slumps”. Such objections subside in the slump, and are revived in the boom, thus generating what Kalecki called a “political cycle” and a generally lower average degree of employment over such cycle than otherwise feasible.
But the feasibility of Kaleckian-Keynesian full employment policies soon ceased to enjoy the support of a “solid majority of economists”. The effectiveness of expansionary fiscal policy was challenged on an escalation of arguments.
From deficit spending to expansionary fiscal consolidation
First, it was argued that government expenditure would “crowd out” private investment. This idea neglects the possibility of private investment on the contrary “crowding in” additional expenditure due to the activation of its accelerator effect of higher primary demand. On the contrary, Dennis Robertson (in a talk given at Princeton in 1953) argued that at least some of the additional savings out of the income generated by government spending would not represent a leakage but would be channeled into additional investment, and called this “the Kalecki effect”.
Second, Ricardian equivalence was invoked, tentatively put forward by David Ricardo in the 1890s and re-discovered by Robert J. Barro in 1974. When government expenditure is raised, funded by borrowing, economic agents discount the future payments of higher taxes that they anticipate having to pay to service the higher debt. The effect is the same as it would be if expenditure was funded directly by an immediate higher tax: lower private consumption offsetting higher government expenditure. (The reader is invited to perform a mental experiment: is this how he/she responds to a fiscal stimulus by the government? I certainly don’t).
Third, in the early ‘seventies the theory of so-called rational expectations was introduced by Robert Lucas and others, which was a tendentious misnomer. They should have been called expectations successful by definition. The efficient utilization of all information available, by all economic agents, makes markets efficient. Nobody is ever surprised. Multipliers could then be lower than unity.
Fourth, in the 1990s and 2000s a series of empirical studies propounded the idea of “Expansionary Fiscal Contraction”. They argued that closing the budget deficit via higher taxes and/or lower expenditure can be and by and large is expansionary: see Giavazzi and Pagano (1990, 1996); Alesina and Perotti (1997); Alesina and Ardagna (2010). Blanchard (1990, then Professor at MIT, before joining the IMF as Chief Economist in 2008) explained how this was due to the promotion of private sector-led growth, for the reasons already mentioned above: Ricardian equivalence, increasing confidence, a favourable impact on expectations, declining borrowing costs, a weaker currency. This would hold also for “extreme” fiscal contraction or consolidation.
Growth in a Time of Debt
But the culmination of the expansionary fiscal consolidation thesis, supported by the so-called “austerians”‘ – “advocates of fiscal austerity, of immediate sharp cuts in government spending” (Krugman’s definition) – is a paper by Harvard economists Carmen Reinhart and Kenneth Rogoff, “Growth in a Time of Debt” (2010). On the basis of a new dataset of forty-four countries spanning about two hundred years, incorporating “over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances”, Reinhart and Rogoff find that “the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.”
The notion that government debt exceeding 90 percent of GDP has a significant negative effect on economic growth became a decisive supportive argument for austerity by national and international leaders, from ex-vice-presidential candidate Paul Ryan, chairman of the USA Congress budget committee, to EC Commissioner Olli Rehn, and authoritative commentators. Thus Keynes’s proposition that “the boom, not the slump, is the right time for austerity” was falsified, austerity becoming a good policy for all seasons in highly indebted countries.