July 13th, 2014
in Op Ed
by William K. Black, New Economic Perspectives
Monday, July 7, 2014 provided another example of Paul Krugman explaining why austerity was an insane response to the Great Recession and the New York Times authoring another of its endless articles that assumes that austerity is essential to a eurozone recovery. I have no problem with the NYT reporters providing their rationale for why they concluded that Krugman was wrong and that austerity is the proper response to a recession. My problems are with the NYT reporters ignoring Krugman's views - views shared by the great bulk of economists - and with their failure to question whether austerity is the proper response to a recession.
Recessions occur when demand becomes seriously inadequate and industries fire workers and decrease production and investment. Austerity further reduces already inadequate demand by reducing public sector demand. Austerity is akin to bleeding the patient (the economy) to make him well. It would, therefore, be exceptionally strange if austerity were to be the optimal response to the Great Recession. We have a great deal of real world experience in dealing with recessions that confirms that austerity is self-destructive in such circumstances.
The U.S. Under the Automatic Stabilizers and Stimulus Program
Even the EU recognizes this fact by providing for (minor) fiscal stimulus (deficits are supposedly capped at 3% of GDP) when confronting a recession. There is no fixed definition of "austerity" or "stimulus." The U.S. initially responded to the Great Recession through its "automatic stabilizers" which automatically produce a significant budget deficit. Consider that sentence for a moment. There has been an overwhelming consensus among economists for over a half-century that "deficits" of this nature are "stabilizing" - they reduce the length and severity of recessions. The U.S. then added to the automatic stabilizers by adopting a "stimulus" program. Due to politics (including divisions among Democrats due to the "Blue Dog's" opposition) the stimulus program was far too small (it provided only a fraction of the lost private sector demand) and had design defects (far too much of it was in the form of tax reductions for the wealthy - the category that produces the weakest bang for the buck in stimulus terms). Despite these weaknesses it produced a far stronger recovery than the eurozone.
The U.S. Moves Toward Austerity
Unfortunately, Treasury Secretary Geithner, who has no economic expertise, increasingly became President Obama's dominant economic advisor. Geithner was a vitriolic foe of stimulus. As I have explained in prior columns, Obama became convinced that a budgetary "Grand Bargain" with the Republicans would be his legacy policy. That Grand Bargain embraced austerity. Obama and the Republicans have failed to reach the Grand Bargain, but their piecemeal bargains have pushed the U.S. steadily toward austerity, greatly slowing our recovery from the Great Recession. The U.S. fiscal deficit is now so small that the U.S. would comply with the EU's austerity regime. That means our deficit is far too small.
The Eurozone Recovers through the Automatic Stabilizers Until Germany Demands Austerity
The eurozone's initial response was also through its automatic stabilizers, which helped bring it out of recession. The EU's automatic stabilizers are weaker than those in the U.S. but still substantial. At that juncture, however, Germany and its allies demanded the imposition of austerity and the rejection of fiscal stimulus. This threw the eurozone back into recession and Spain, Greece, and Italy (with roughly one-third of the eurozone's total population) into Great Depression levels of unemployment. It became normal throughout the EU's periphery for university graduates to emigrate. Germany also demanded that the nations of the periphery slash their wages and make it far easier to fire workers. Inequality is surging in nations that were once far more egalitarian. Germany's political and economic hegemony over the EU is now blatant.
The Faux Morality of Government Budgetary Surpluses
A sovereign nation with a sovereign currency (such as the U.S.) is not "just like a household." We know households best so we have been conditioned throughout our lives to think of a budget deficit as unquestionably bad and a budget surplus as unambiguously good. We moralize these two states of accounting - a surplus is virtuous and a deficit indicates a moral failure. Interestingly, we have very different rules in the corporate sphere, where one of the best ways to be fired as CFO would be to pay off all corporate debt. But sovereign states are neither households nor corporations and their "deficit" is simply another sector's "surplus." That does not mean deficits are irrelevant - context is critical. It does mean that during a recession the effort to run a governmental budget surplus will, unless the Nation is a very strong net exporter, reduce growth and slow the recovery or even - as it did in the eurozone (and in the case of Spain, Greece, and Italy) - throw the economy back into a gratuitous second recession (or Great Depression).
The EU is about to Double Down on Austerity
Almost all eurozone governmental budgets are in deficit. That is as it should be, but size and context matter, and the eurozone deficits are far too small to spur rapid growth. Eurozone nations are still the beneficiaries of very modest stimulus via the automatic stabilizers. Germany, however, demanded that the infliction of much more severe austerity in the future. Given its domination of the EU, whatever Germany demands becomes EU rules. Over the next few years those rules will require the eurozone nations suffering from Great Depression levels of unemployment, the entire periphery, and core nations with weak growth to run increasingly large budgetary surpluses. That is a prescription for gratuitously forcing nations back into third recessions or depressions - and for long-term stagnation. Even the leading troika apologist for austerity, Olli Rehn, stated that under the troika's policies it would take Spain a decade to emerge from the "crisis" phase. 2024 is 16 years after the acute phase of the original crisis. Rehn gave no estimate of how long it would take Spain to fully recover under the troika's policies - and his estimate (implicitly) assumed there would be no further downturns for at least a decade. He also implicitly assumes an unbroken continuum of German austerity policies dominating the EU. I have written several columns explaining why austerity will cause extreme political changes in the EU. The NYT article I am about to discuss in more detail makes clear that Rehn's implicit assumptions are unlikely to prove correct.
The NYT's Inability to Write Coherently about the EU Crises
Roughly one-third of the eurozone's population is living in nations with Great Depression levels of unemployment because Germany demanded the infliction of austerity in response to the Great Recession. This is significantly crazed. It tells us that German hegemony over the EU is a disaster that is sowing the seeds of a future political crisis. It also tells us how bad economics and economists are. Any doctor that bled a patient (yes, I know there are a few specialized treatments that use leeches) to make them well would lose his or her license. But economists who engage in similar malpractice and bring misery to scores of millions of people have a very different fate in Europe (and Chicago). They are promoted and made finance ministers, the head of the ECB, and even the Prime Minister of Italy.
But perhaps the NYT believes that Krugman and most economists are wrong and austerity is the best response to the Great Recession. That could explain why they repeat endlessly and without any critical thought Prime Minister Angela Merkel's mantra: "there is no alternative" (TINA) to austerity. The latest exemplar of this is their July 6, 2014 story: "France Puts Euro Zone Recovery at Risk, Economists Warn."
"The economy has been hovering too long near stagnation, economists warned at an economics conference here on Sunday, saying that unless the government in Paris pushed more strenuously to improve growth alongside Germany, its performance threatened to weigh on the prospects for a wider recovery in the euro zone."
OK, so how would Paris "improve growth?" The conference was supposed to create this agenda.
"[T]op European policy makers and economists addressed what has become the most urgent concern about Europe: that for all the steps taken to put crisis-stricken countries on a path toward renewed growth, the recovery is still unfolding much too slowly."
It would be helpful for the reader to know the nature of "all the steps taken to put crisis-stricken countries on a path toward renewed growth." In prior columns I have explained why I believe that the troika's (the EU Commission, the ECB, and the IMF) "steps" (austerity and slashing wages) have been the greatest impediments to "renewed growth."
A Side Note about Why Germany can never be a Model of Recovery for the Eurozone
A nation can run a budgetary surplus in response to a recession and still grow if it is a very large net exporter - as is Germany. Germany positioned itself to be a very large net exporter a decade ago by reducing workers' wages. Germany's response to the plight of the periphery is: we took the bitter medicine and things are generally OK for us - you should do the same. That response, however, is untenable. First, we cannot all be net-exporters. My exports are your imports and if we all try to net exporters (1) we cannot succeed and (2) the result is a destructive neo-mercantilism race to the bottom that will crush European wages. Second, Germany's success as a net exporter makes it much harder - not easier - for the periphery to emulate its strategy because it is pretty close to a zero sum competition. Third, Germany's greater productivity means that nations of the periphery that try to follow its net-export model would have to inflict far greater reductions in workers' pay to compete. This would set off a race to the bottom among nations of the periphery to cut wages. Inequality, which is already surging in the EU, would explode. I call this dynamic the "Road to Bangladesh" strategy. It explains why German corporations are the greatest proponents of austerity.
The NYT Misses the EU Politics that Consumed the Conference Attendees
I return to the NYT's coverage of the conference that was supposed to address what policies the troika should adopt to prevent the eurozone's "lost decade" from becoming the "lost quarter-century." Recall that the context of the conference was the realization that several core nations, particularly France, are on the verge of being forced back into recession by austerity. France is a big problem because it is big (the EU's second largest economy and a large population) and because for decades it served as the fig leaf (barely) masking Germany's rule over the EU. As France's economy stagnates Merkel has moved ever more openly to rule the EU, which already poses political problems and may unravel the EU.
"'The weakness of France is visible,' Bertrand Badré, managing director and chief financial officer of the World Bank Group in Washington, said in an interview on the sidelines of the conference. 'It's not that France and Germany should dominate,' he added, 'but if we can't find a way together it might be an issue.'"
German dominance is far more than "an issue" in the periphery where that domination is often seen as throwing their nations into economic catastrophe for the benefit of German banks and corporations. The Germans and their closest Germanic allies also have an atrocious record of insulting the victims of austerity. If Germany throws the French under the bus and the Brits exit the EU the nakedness of German hegemony over the EU will be stark and it will gall more than the Gauls.
Even the IMF Knows that Austerity is Self-Destructive
IMF head Christine Lagarde explained that the IMF was cutting its growth forecasts for the EU. She explained that inadequate demand leads to inadequate production and investment - and that austerity made this worse.
"Investment in Europe is about 20 percent lower than it was before the crisis unspooled, while public investment - especially along Europe's southern rim - has been sharply tightened because of budget constraints."
Yes, austerity further weakens already inadequate demand, consumption, production, and investment.
Austerity Reduces Future Growth by Harming the Infrastructure
The article reports that the conferees also understood that austerity was harming the infrastructure. The context of this admission demonstrates that they knew that this would impair future growth and competitiveness.
"Two years after Germany urged European countries to cut government spending and raise taxes to mend national accounts, policy makers are now discussing the need for shock-and-awe public investment programs, especially infrastructure projects, to offset growth slowdowns that have been deepened by austerity measures.
'There are still post-crisis problems in the euro zone,' said Jacques Mistral, head of economic studies at the French Institute of International Relations. "There is a lot less spending today, so governments have to fill that hole."
According to a recent report by the consulting firm PwC, Europe will represent just 10 percent of global infrastructure spending by 2025, falling from around 20 percent a few years ago, while the Asia-Pacific region will represent nearly 60 percent of such spending."
There are a number of very strange aspects about how the NYT article is written. First, Germany did not "urge" austerity upon the eurozone - it demanded it.
Second, austerity does not "mend" "national accounts" - and national accounts (governmental deficits) generally did not need "mending." The exceptions are Greece and Ireland (solely because of its insane decision to guarantee that the failed Irish banks would pay back in full the unsecured foreign bank creditors (often German) of deeply insolvent Irish banks. Germany strongly backed that insane Irish action.
Even in Greece austerity was the wrong response to the recession for all the reasons (and there are many more) that the NYT reports in the passages I have just quoted. The automatic stabilizers "mend" an economy that is sinking into a recession by producing a governmental budget deficit. Reducing that deficit by tax increases and spending cuts constitutes bleeding the patient rather than "mend[ing]" the patient. The reporter should know that because the explanations of why austerity harms the economy in a recession that she presents begin in the same sentence in which she presents her "mend" metaphor. A Merkel "mend" is an oxymoron throughout the periphery and most of the core. The reporter's "mend" metaphor shows that she is so in thrall to TINA that she cannot escape it even when writing about why it is a self-destructive lie. The logical incoherence of the passage is marvelous to behold.
Third, stimulus is not a war against the economy, so the "shock and awe" metaphor is as bass-ackwards as the "mend" metaphor.
Fourth, the NYT could have informed its readers that Spain, Greece, and Italy are suffering from Great Depression levels of unemployment and reported on Rehn's admission that in the most optimistic scenario Spain will require a full decade just to emerge from the crisis. It could have informed its readers of the human pain and the destruction of growth potential inherent in the emigration of so many new college graduates from the periphery. Instead, the NYT felt its readers would best be informed by this gem: "There are still post-crisis problems in the euro zone." "Thank you Captain Obvious." It may well be that the conferees passed off the plight of 100 million Europeans (the combined population of Spain, Greece, and Italy) with such a vague phrase - that would make it all the more incumbent on the reporter to point those facts out.
So What Did the Conferees Offer the EU's "Southern Rim" and France?
Nothing, the article ends with a whimper, TINA today, TINA tomorrow, TINA always. After being told that government must "fill the hole" of inadequate demand and investment or the prospect is long-term stagnation it turns out that the article ends with this negation of that entire concept.
"Still, Ms. Lagarde warned countries seeking to spend their way out of a downturn not to add to already high national debts - a problem that has been at the heart of the euro zone's crisis. 'If you're not in a medium-term situation that assures sustainability,' she said, 'you can't undertake major infrastructure investments.'"
Note that the NYT presents Lagarde's TINA chant as indisputable fact. Krugman (and most economists) may consider austerity to be self-destructive in the eurozone, but their arguments are not even worthy of discussion. I will try to disassemble this stew in which the reporter mixes her economic myths with those propounded by the IMF. I'll begin by noting again that the IMF has found that stimulus was even more effective against the current crises than economists anticipated. When the IMF agrees that stimulus works you know the facts are overwhelming.
The reporter appears to be the source of the "facts" that "high national debts" are "at the heart of the euro zone's crisis." That is not accurate. Fraudulent and imprudent bank lending and investment (the EU's disastrous experience with "universal" banks is another proof of the urgent need for the U.S. to readopt Glass-Steagall) were at the heart of the crisis. Greece is the only nation that even arguably had a debt "crisis" prior to the financial crisis, and it is a story of fraud, corruption, and a broken political, ethical, and tax system. As I explained, Ireland's debt crisis was caused by the financial crisis and the insane attempt to prevent foreign banks from suffering losses that they had agreed to bear as unsecured creditors. Note that they got a premium interest rate for loaning on an unsecured basis (the premium was even greater for subordinated debt holders) and then got bailed out by Ireland. Prior to the crisis Ireland had particularly low levels of governmental debt.
The entire concept of "high" debt in the range of the EU debts is dubious, a point driven home by the demolition of Reinhart and Rogoff's mythical claim that there was some cliff after which nations fill into an abyss. The entire concept of "sustainability" is even more dubious. Note that Lagarde isn't worried about the sustainability of the planet or even humans. Pro-austerity economists typically disdain those concepts even though they relate to the most critical questions we face. No, Lagarde is floating the same discredited Reinhart and Rogoff myth about "sustainability" of deficits.
Her claim about "sustainability," which the reporter accepts as revealed truth, is nonsensical as a matter of economics and logic. Lagarde does not even try to provide a logical basis for her claim. It is a bare ipse dixit.
'If you're not in a medium-term situation that assures sustainability,' she said, 'you can't undertake major infrastructure investments.'"
The obvious response is "why?" As we still occasionally try to make clear to students and our children, "can" refers to capability while "may" refers to permission. Let's take a real case - the eurozone. I'll start with a hypothetical based on that real case. What if Russia threatened to invade Italy? Defending itself would require "major investments" not simply in arms, but infrastructure, and training far more of its citizens to function effectively as soldiers. Under Lagarde's "logic" Italy "can't undertake major ... investments" because it has "high" debts. So, is Italy's only choice to surrender and invite the Red Army to occupy Italy? The question of whether Italy "may" spend the funds necessary to defend itself depends on what budget rules German insists that the EU adopt.
Nations, including the U.S., have run far higher debt-to-GDP ratios than the EU periphery has now during World War II. It did not lead to hyper-inflation or "crippling" debt. Japan, today, in peacetime, has a dramatically higher debt-to-GDP ratio than the EU periphery - and is able to borrow money at a pittance and make very large infrastructure improvements. Indeed, Japan's struggle has been with deflation.
The real question is this: would spending money to develop the EU's seriously inadequate infrastructure in response to the Great Recession be a desirable policy? For all the reasons even the IMF admits, the answer is yes. Doing so would greatly improve growth, put people to work who want to do so, greatly reduce the "brain drain" of emigration of new university graduates, make the EU more competitive, and improve the quality of life. As nations grow the automatic stabilizers work to reduce government deficits (expenditures on the poor and unemployed fall while tax revenues increase). Those supposedly "unsustainable" U.S. deficits of World War II soon turned into modest deficits that aided growth without causing harmful inflation. The U.S. began its massive infrastructure improvements (the interstate highway system) while we were (not) "suffering" from the (non) "crippling" debt "burdens" of World War II.
The real restraint (the "can" concept) is resources in the real sector, not money. Every nation understands that truth when it is at war. No one surrendered to the Germans in World War II because they would have to take on debt or issue more money in order to fight for survival. The massive unemployment in the periphery proves that there are enormous amounts of unused real sector resources.
In human terms, that also means that over 10 million Europeans who want to work are denied that opportunity by Merkel's mantra of TINA. The "may" question is one of getting permission from Merkel to employ these peoples of the periphery. Because they made the grave error of surrendering their sovereign currencies the peoples of the periphery have the capacity to produce full employment but are denied the permission to do so by Berlin.
As Berlin throws over 100 million citizens of Spain, Greece, and Italy to the wolves - and alternates between ignoring and mocking their suffering - it brings closer the day when scores of millions of Europeans will revolt against their foreign rulers and the economic malpractice they insist on inflicting. Merkel's minions demean the peoples of the periphery on a daily basis. The Washington Consensus had its colonial arrogance, but it was not accompanied by constant insults about the character of the peoples of Latin America. The Brussels Consensus is defined by its withering contempt for the periphery.
I have suggested in the past that the NYT have its reporters that cover the eurozone meet Krugman for lunch and talk about economics. I have offered UMKC economics faculty to conduct an economics boot camp for the reporters. It would do them enormous good if they spent a week in the heartland. Of course, nothing came of either suggestion. I now ask Krugman to use his column to name and shame the NYT reporters that spread this economic malpractice that has caused so much human misery without an iota of critical thinking. They simply treat Merkel's mantra of TINA as gospel. I'd love it if the reporters ceased implicitly assuming the that TINA was revealed truth and instead presented their best substantive arguments about why austerity and slashing workers' wages are the eurozone's optimal strategy for responding to the Great Recession.