The Great Economic Malaise - the failure of austerity economics (Social Journal Europe)

The Great Malaise Drags On

06/01/2014 by Joseph Stiglitz 1 Comment

Joseph Stiglitz

There’s something dismal about writing year-end roundups in the half-decade since the eruption of the 2008 global financial crisis. Yes, we avoided a Great Depression II, but only to emerge into a Great Malaise, with barely increasing incomes for a large proportion of citizens in advanced economies. We can expect more of the same in 2014.

In the United States, median incomes have continued their seemingly relentless decline; for male workers, income has fallen to levels below those attained more than 40 years ago. Europe’s double-dip recession ended in 2013, but no one can responsibly claim that recovery has followed. More than 50% of young people in Spain and Greece remain unemployed. According to the International Monetary Fund, Spain can expect unemployment to be above 25% for years to come.

The real danger for Europe is that a sense of complacency may set in. As the year passed, one could feel the pace of vital institutional reforms in the eurozone slowing. For example, the monetary union needs a real banking union – including not just common supervision, but also common deposit insurance and a common resolution mechanism – and Eurobonds, or some similar vehicle for mutualizing debt. The eurozone is not much closer to implementing either measure than it was a year ago.

One could also sense a renewed commitment to the austerity policies that incited Europe’s double-dip recession. Europe’s continuing stagnation is bad enough; but there is still a significant risk of another crisis in yet another eurozone country, if not next year, in the not-too-distant future.

Matters are only slightly better in the US, where a growing economic divide – with more inequality than in any other advanced country – has been accompanied by severe political polarization. One can only hope that the lunatics in the Republican Party who forced a government shutdown and pushed the country to the brink of default will decide against a repeat performance.

But even if they do, the likely contraction from the next round of austerity – which already cost 1-2 percentage points of GDP growth in 2013 – means that growth will remain anemic, barely strong enough to generate jobs for new entrants into the labor force. A dynamic tax-avoiding Silicon Valley and a thriving hydrocarbon sector are not enough to offset austerity’s weight.

Thus, while there may be some reduction of the Federal Reserve’s purchases of long-term assets (so-called quantitative easing, or QE), a move away from rock-bottom interest rates is not expected until 2015 at the earliest.

Ending low-interest-rates now would not be sensible, though QE has probably benefited the US economy only slightly, and may have raised risks abroad. The tremors in global financial markets set off by discussions earlier in 2013 of tapering QE highlighted the extent of interdependence in the global economy.

Just as QE’s introduction fueled currency appreciation, announcing its eventual end triggered depreciation. The good news was that most major emerging countries had built up large foreign-exchange reserves and had sufficiently strong economies that they could withstand the shock.

Still, the growth slowdown in emerging economies was disappointing – all the more so because it is likely to continue through 2014. Each country produced its own story: India’s downturn, for example, was attributed to political problems in New Delhi and a central bank worried about price stability (though there was little reason to believe that raising interest rates would do much about the price of onions and the other items underlying Indian inflation).

Social unrest in Brazil made it clear that, despite remarkable progress in reducing poverty and inequality over the past decade, the country still has much to do to achieve broadly shared prosperity. At the same time, the wave of protest showed the growing political clout of the country’s expanding middle class.

China’s decelerating growth had a significant impact on commodity prices, and thus on commodity exporters around the world. But China’s slowdown needs to be put in perspective: even its lower growth rate is the envy of the rest of the world, and its move toward more sustainable growth, even if at a somewhat lower level, will serve it – and the world – well in the long run.

As in previous years, the fundamental problem haunting the global economy in 2013 remained a lack of global aggregate demand. This does not mean, of course, that there is an absence of real needs – for infrastructure, to take one example, or, more broadly, for retrofitting economies everywhere in response to the challenges of climate change. But the global private financial system seems incapable of recycling the world’s surpluses to meet these needs. And prevailing ideology prevents us from thinking about alternative arrangements.

We have a global market economy that is not working. We have unmet needs and underutilized resources. The system is not delivering benefits for large segments of our societies. And the prospect of significant improvement in 2014 – or in the foreseeable future – seems unrealistic. At both the national and global levels, political systems seem incapable of introducing the reforms that might create prospects for a brighter future.

Maybe the global economy will perform a little better in 2014 than it did in 2013, or maybe not. Seen in the broader context of the continuing Great Malaise, both years will come to be regarded as a time of wasted opportunities.

© Project Syndicate

Economic Fallacies of the Second Great Depression (Social Europe Journal) that under pin the present Government's policies

Four Fallacies Of The Second Great Depression

21/11/2013 by Robert Skidelsky 1 Comment

Robert Skidelsky

The period since 2008 has produced a plentiful crop of recycled economic fallacies, mostly falling from the lips of political leaders. Here are my four favorites.

The Swabian Housewife. (in NZ read "Waitakere Man" )“One should simply have asked the Swabian housewife,” said German Chancellor Angela Merkel after the collapse of Lehman Brothers in 2008. “She would have told us that you cannot live beyond your means.”

This sensible-sounding logic currently underpins austerity. The problem is that it ignores the effect of the housewife’s thrift on total demand. If all households curbed their expenditures, total consumption would fall, and so, too, would demand for labor. If the housewife’s husband loses his job, the household will be worse off than before.

The general case of this fallacy is the “fallacy of composition”: what makes sense for each household or company individually does not necessarily add up to the good of the whole. The particular case that John Maynard Keynes identified was the “paradox of thrift”: if everyone tries to save more in bad times, aggregate demand will fall, lowering total savings, because of the decrease in consumption and economic growth.

If the government tries to cut its deficit, households and firms will have to tighten their purse strings, resulting in less total spending. As a result, however much the government cuts its spending, its deficit will barely shrink. And if all countries pursue austerity simultaneously, lower demand for each country’s goods will lead to lower domestic and foreign consumption, leaving all worse off.

The government cannot spend money it does not have. This fallacy – often repeated by British Prime Minister David Cameron – treats governments as if they faced the same budget constraints as households or companies. (in NZ this is the favourite mantra of both Key (the gambler) and English (the "finance" minister) But governments are not like households or companies. They can always get the money they need by issuing bonds.

But won’t an increasingly indebted government have to pay ever-higher interest rates, so that debt-service costs eventually consume its entire revenue? The answer is no: the central bank can print enough extra money to hold down the cost of government debt. This is what so-called quantitative easing does. With near-zero interest rates, most Western governments cannot afford not to borrow.

This argument does not hold for a government without its own central bank, in which case it faces exactly the same budget constraint as the oft-cited Swabian housewife. That is why some eurozone member states got into so much trouble until the European Central Bank rescued them.

The national debt is deferred taxation. According to this oft-repeated fallacy, governments can raise money by issuing bonds, but, because bonds are loans, they will eventually have to be repaid, which can be done only by raising taxes. And, because taxpayers expect this, they will save now to pay their future tax bills. The more the government borrows to pay for its spending today, the more the public saves to pay future taxes, canceling out any stimulatory effect of the extra borrowing.

The problem with this argument is that governments are rarely faced with having to “pay off” their debts. They might choose to do so, but mostly they just roll them over by issuing new bonds. The longer the bonds’ maturities, the less frequently governments have to come to the market for new loans.

More important, when there are idle resources (for example, when unemployment is much higher than normal), the spending that results from the government’s borrowing brings these resources into use. The increased government revenue that this generates (plus the decreased spending on the unemployed) pays for the extra borrowing without having to raise taxes.

The national debt is a burden on future generations. This fallacy is repeated so often that it has entered the collective unconscious. The argument is that if the current generation spends more than it earns, the next generation will be forced to earn more than it spends to pay for it. (this is the favourite mantra of the disappearing ACT party and, on occassions, Key (the money dealer) )

But this ignores the fact that holders of the very same debt will be among the supposedly burdened future generations. Suppose my children have to pay off the debt to you that I incurred. They will be worse off. But you will be better off. This may be bad for the distribution of wealth and income, because it will enrich the creditor at the expense of the debtor, but there will be no net burden on future generations.

The principle is exactly the same when the holders of the national debt are foreigners (as with Greece), though the political opposition to repayment will be much greater.

Economics is luxuriant with fallacies, because it is not a natural science like physics or chemistry. Propositions in economics are rarely absolutely true or false. What is true in some circumstances may be false in others. Above all, the truth of many propositions depends on people’s expectations.

Consider the belief that the more the government borrows, the higher the future tax burden will be. If people act on this belief by saving every extra pound, dollar, or euro that the government puts in their pockets, the extra government spending will have no effect on economic activity, regardless of how many resources are idle. The government must then raise taxes – and the fallacy becomes a self-fulfilling prophecy.

So how are we to distinguish between true and false propositions in economics? Perhaps the dividing line should be drawn between propositions that hold only if people expect them to be true and those that are true irrespective of beliefs. The statement, “If we all saved more in a slump, we would all be better off,” is absolutely false. We would all be worse off. But the statement, “The more the government borrows, the more it has to pay for its borrowing,” is sometimes true and sometimes false.

Or perhaps the dividing line should be between propositions that depend on reasonable behavioral assumptions and those that depend on ludicrous ones. If people saved every extra penny of borrowed money that the government spent, the spending would have no stimulating effect. True. But such people exist only in economists’ models.

© Project Syndicate