Adam Smith, godfather of austerity

Ed. note: This is the second post in a TP Ideas symposium on Mark Blyth’s Austerity: The History of a Dangerous Idea. The first installment is here and the third installment is forthcoming. You can read our previous book symposium here.

Mark Blyth’s intellectual history of austerity should be required reading for all progressives -– and in particular, the center-left policy elites who run the country.  There are many good books out there on the origins and aftermath of the financial crisis and the intellectual collapse of neoliberal thought (John Cassidy’s How Markets Fail: The Logic of Economic Calamaties, Justin Fox’s The Myth of the Rational Market, and John Quiggin’s Zombie Economics: How Dead Ideas Still Walk Among Us being standout examples.)  But few books today provide the political context for how a long discredited idea such as austerity gained institutional and political traction in the aftermath of the global financial crisis to become the preferred course of action among leaders despite its manifest failures in producing economic growth and reducing debt.

Blyth provides a clear and digestible historical tour of the ideas behind austerity, defined as “a form of voluntary deflation in which the economy adjusts through the reduction of wages, prices, and public spending to restore competitiveness, which is (supposedly) best achieved by cutting states’ budget, debts, and deficits,” from John Locke and David Hume to Joseph Schumpeter and contemporary advocates of austerity in Germany and the U.S. He also provides some much needed spice and anger when describing how it all works. It’s rare to read a book on economics that distills centuries of neoclassical economics into these choice words about the upside-down morality of those who believed markets could do no wrong prior to the financial collapse: “[Adam] Smith’s invisible hand had just given the public the finger.”

Most importantly, Blyth’s analysis implicitly raises critical points about how the progressive left failed to coalesce around a single solution to the financial collapse in 2007-2008, thus paving the way for the advocates of austerity to turn a private sector banking failure into a “crisis” of public debt and spending after nations such as the U.S. and U.K. intervened to save their banks.

How did this work? Blyth explains:

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Ed. note: This is the first post in a TP Ideas symposium on Mark Blyth’s Austerity: The History of a Dangerous Idea. A second and third installment are forthcoming. You can read our previous book symposium here.

Arguably, there is no greater obstacle to progressive change than the idea of austerity. Austerity dominates economic policy discussions in Europe, resulting in policies in country after country that ensure continued slow growth (or outright contraction) and high unemployment. These conditions have produced demoralized electorates that lack faith in all politicians, including those on the left, a cynicism that has only been deepened when left parties have attained power and failed to revive growth. In such an environment, progressive change is not possible and the left is reduced to purely defensive actions.

In the US, things are slightly better. Nevertheless, our economic policy discussions are still dominated by variants of austerity. The fiscal cliff deal at the beginning of this year slowed the economy and the sequestered spending cuts are slowing it more. Yet with unemployment still at 7.6 percent, growth projections for the year halved to 1.4 percent and the latest jobs report coming in at an anemic 88,000 jobs created, policy discussion continues to focus on the need to cut the deficit more (despite the fact it has already gone down dramatically) and solve a national debt “crisis” whose effects, if any, are many years away (and may never appear). Of course, such a focus precludes any progressive economic policies, including critically, spending programs that would help revive the economy and invest in our economic future.

How did we get into such a pickle?  Does the current mania for austerity make any sense whatsoever?  And could the recent discrediting of Carmen Reinhart’s and Kenneth Rogoff’s influential pro-austerity paper provide any hope for defusing this mania?  Mark Blyth’s timely new book, Austerity: The History of a Dangerous Idea, provides answers to these questions. They are not necessarily comforting ones.

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Over at the Huffington Post, Jared Bernstein points us to a recent pilot study examining the ideological and public policy preferences of the super wealthy. The findings might surprise you: the one percent, selfish as they are, endorse some sound economic ideas that Congress is afraid to touch.

The study, conducted by Benjamin Page and Jason Seawright at Northwestern University and Larry Bartels at Vanderbilt University, used a specialized database to identify members of the top one percent of American wealth-holders who might answer some basic questions about economic policy. Some of the results are not all that shocking. Compared to the public at large, the ultra rich are disproportionately conservative and Republican, far more active in politics, more obsessed with deficits and cuts to government programs, and more opposed to specific regulations and tax policies that cut into their bottom line.

Basically, they’re Mitt Romney and Paul Ryan rolled into one.

But unlike the 2012 GOP presidential ticket, the super-wealthy appear to broadly accept Keynesian economic policy ideas and even, in an abstract way, the idea that inequality is a problem (even though they aren’t all that willing to do something about it):

• Seventy-three percent of the wealthy in this study agreed that, “The government should run a deficit if necessary when the country is in a recession and is at war,” compared to the alternative idea that the “government should balance the budget even when the country is in a recession and is at war.” In contrast, only 31 percent of the general public agreed with this basic Keynesian idea.
• Sixty-five percent of the wealthy say they are “willing to pay more in taxes in order to reduce federal budget deficits,” compared to less than 4 in 10 regular Americans. However, as the study authors point out, there are limits to this openness to increased taxes: “Despite our wealthy respondents’ great concern about budget deficits, most did not favor increasing rates of the income tax or estate taxes even to the slightly higher levels that held during the Clinton administration.”  (Wealthy Americans are much more open to slashing Social Security, Medicare, and other social programs, however.)
• Roughly similar proportions of the wealthy and the general public agree that “differences in income in America are too large” (62 percent and 63 percent, respectively). But there are wide differences in opinion about government steps to redress this inequality. Americans overall are 3.5 times more likely than the wealthy to believe, “It is the responsibility of the government to reduce the differences in income between people with high incomes and those with low incomes” (46 percent vs. 13 percent). And while a majority of the general public (52 percent) believes, “Our government should redistribute wealth by heavy taxes on the rich,” less than one fifth of the wealthy (17 percent) hold similar views.

These data suggest that even though the wealthiest Americans remain strongly self-interested and averse to many progressive policy ideas, they may have more wisdom about macroeconomic policy and the effects of income stratification than the conservative leaders claiming to represent their interests in Congress.

Washington has spent much of the last three years focused on how to bring down the nation’s deficit, and that has extended into the ongoing debate about immigration reform. Conservative opponents have argued that immigration reform will be too costly for both the nation and domestic workers, despite studies showing that it will boost gross domestic product and workers’ wages.

The White House Office of Management and Budget (OMB), however, estimates that increasing the number of legal immigrants will itself reduce the deficit, as this chart highlighted by Quartz’s Tim Fernholz shows:

The OMB estimates (pdf, p. 56) that increasing immigration by 300,000 people a year, to 1.3 million, would be the equivalent of 0.6% of GDP in deficit reduction, or about $100 billion, each year between 2014 and 2088. Sounds like plan to tackle the debt to me.

Other studies have shown that immigration reform will have a net positive effect on the overall economy. The Center for American Progress, for instance, found that reform with a 10-year path to citizenship would lead to a $1.1 trillion increase in GDP over the next decade while boosting income, tax revenues, and jobs created over that period as well. Even a reform plan like the Gang of 8 proposal, which includes a 13-year path to citizenship, would boost the economy by $832 billion, growth that would naturally bring down deficits and debt with it.

Yesterday on TP Ideas Zack Beauchamp covered the release of new research showing that a key paper used to justify austerity in a time of economic crisis is so empirically flawed as to be rendered useless as a guide to policy.  That paper, by Carmen Reinhart and Kenneth Rogoff, purported to show that countries that cross a 90 percent debt to GDP ratio sustain a big hit to economic growth.  Turns out the data were analyzed incorrectly and the alleged relationship does not exist.  Out the window goes one of the main intellectual justifications for the current hysteria about bringing down the national debt.

Zack focused on exposing the foibles of journalists who take as gospel studies like Reinhart-Rogoff based on methodology they don’t understand and data they know nothing about.  That is indeed a problem and his post does a service by concentrating on it.

I’ll take a different tack here and focus on the idea of austerity.  The theory that slashing deficits can revive slumping economies has been a dominant economic theory since the late 18^th century and the rise of classical economics.  But its claim to be a policy elixir has never been grounded in strong empirical evidence. That is why, despite this serious hit to the academic case for austerity, we should not expect austerity’s vice grip on policy to weaken very soon or very easily.

The theory behind the austerity idea is as follows.  Classical economists believed that the overall economy tended toward a full employment equilibrium where all resources were productively employed.  While this equilibrium could be temporarily disturbed by wage and price rigidities, misguided monetary policies and other things that distorted the market, the economy would quickly return to a full employment equilibrium once these distortions were eased.  The role for government in responding to recession was therefore to do nothing, letting prices and wages fall to their natural levels or, even better, to do less, since government spending simply crowds out the private spending necessary to get the economy back into equilibrium.  That is why, prior to Keynes, the orthodox budgetary approach to recessions was to cut, not increase, government spending so as to create the proper business environment and hasten the arrival of a new equilibrium.

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Advocates for rapid deficit reduction have long used a study from economists Carmen Reinhart and Kenneth Rogoff, which argues that countries that carry debt burdens in excess of 90 percent of their total economy see slower economic growth, to prop up their argument. There were always problems with the study that kept other economists from taking it as gospel, but new research published this week found fundamental flaws in the study’s methodology.

That has blown a hole in the already-shaky argument that the U.S. is approaching a debt crisis and is thus in need of rapid fiscal consolidation. That means these 11 Republicans who have often cited Reinhart and Rogoff’s paper are going to need new evidence to support their austerity agenda:

Rep. Paul Ryan (R-WI): “Economists who have studied sovereign debt tell us that letting total debt rise above 90 percent of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis.” [6/23/2011]

Sen. Jeff Sessions (R-AL): “Four major academic studies have shown that gross debt in excess of 90 percent of GDP results in weaker economic growth.” [3/14/2013]

Rep. Dave Camp (R-MI): “Independent economists have found that debt loads greater than 90 percent of GDP could result in the loss of up to a million jobs.” [2/15/2012]

Sen. Tom Coburn (R-OK): “If you study [Carmen] Reinhart and [Kenneth] Rogoff and what they said, they know what’s coming. Every country that’s ever had a debt crisis and has printed money has ended up with an inflation problem.” [5/20/2012]

Sen. John Cornyn (R-TX): Well, I — let me ask you about Carmen Reinhart and Kenneth Rogoff have written a book covering 700 years — if I’m not mistaken — of fiscal crises and looked at the impact of — of large debt on economic growth. And they have opined that a debt that exceeds 20 percent — excuse me — 90 percent of the gross domestic product reduces economic growth by about 1 percent. Currently, our gross debt is 106 percent of GDP. And under the president’s proposal, gross debt would reach 97 percent of GDP in 2023. [4/12/2013]

Sen. Rob Portman (R-OH): “[RR] have shown that once a country’s debt burden reaches 90 percent of the economy, you have a significant downturn in economic growth.” [11/28/2011]

Sen. Orrin Hatch (R-UT): “Countries with debt above 90 percent of GDP have growth that is 1 percent below normal, resulting in a loss of 1 million jobs.” [6/29/2011]

Sen. John Thune (R-SD): “Carmen Reinhart and Kenneth Rogoff, have stated that debt in excess of 90 percent can cut our country’s economic growth rates in half. Washington’s policies of reckless spending have put America well beyond this point.” [1/6/2012]

Sen. Roger Wicker (R-MS): “[Reinhart and Rokoff] helps illustrate the lasting harm of high government debt. Their study of public debt in 44 countries revealed that debt levels exceeding 90 percent of GDP are associated with lower economic growth – declining by about 1 percent annually.” [9/10/2012]

Rep. Tom Price (R-GA): “I know from the Reinhart study that — that unless one gets below that 90 percent level and many of us believe it ought to be lower than that, but unless one gets below that, the economies don’t turn around.” [4/11/2013]

Rep. Jeb Hensarling (R-TX): If you look at the history of economies over the last 200 years when their debt exceeds 90 percent of GDP, they start to decline. That’s where we are in America today. [5/17/2012]

In the debate over government spending, the central data point wielded by fans of austerity is the claim that once a country reaches a debt load over 90 percent of its economy — a threshold the United States is approaching — economic growth goes into a tailspin. That argument came from a 2010 study by Carmen Reinhart and Kenneth Rogoff. After surveying a wide number of countries, they found that, on average, once the 90 percent mark is crossed, economic growth slows. Though the paper always had problems that kept many economists from embracing it, that didn’t stop it from becoming “the most influential article cited in public and policy debates about the importance of debt stabilization” as Slate’s Matt Yglesias put it.

There were already problems with the Reinhart-Rogoff study, but up until now, other researchers haven’t been able to replicate or pick through its numbers. A new paper finally has, and as Mike Konczal over at Next New Deal reports, it dug up some truly mortal flaws.

First, Reinhart and Rogoff excluded the post-war years for certain countries that enjoyed robust economic growth despite debt levels well over 90 percent. They also chose a skewed method of weighting the data: for example, New Zealand’s single year of terrible growth while over the 90 percent threshold wound up counting just as much as Britain’s 19 years of healthy growth. And they even incorrectly input at least one Excel spreadsheet formula, wrongly excluding several countries form their calculations.

In short, the central argument in support of austerity — cited by MSNBC’s Joe Scarborough, the New York Times’ David Brooks, and multiple times by House Budget Committee Chairman Rep. Paul Ryan (R-WI) — is now defunct. No one disputes that a country should avoid a big build-up in debt over the long-term. But every concrete signal we’re getting from the American economy — our high unemployment, our low inflation, our extraordinarily low interest rates, and our negative real interest rates — are a signal that more debt spending in the short term to fight the depression is perfectly appropriate. Thanks to the austerity drive that was heavily influenced by Reinhart and Rogoff’s study, American lawmakers ignored those signals (and plenty of others) and cut spending, delivering the most destructive fiscal policy we’ve had in any recession since at least 1980.

The President’s new budget recapitulates earlier fiscal negotiation strategies, going back to the debt limit fight of 2011, where he proposes bold action on deficit reduction and goes quite far in Republicans’ direction by including cuts to Medicare and Social Security benefits (the chained CPI).  The goal now, as then, was to somehow broker the elusive bipartisan Grand Bargain on debt reduction.  Based on previous experience, how much payoff can Obama expect to get from the current strategy?

Not much. If history can be a guide, there are three clear lessons from past deficit fights. First, the “adult in the room” theory is a fallacy. That’s the idea that the President, by appearing to be reasonable and willing to make big concessions to his opponents, will gain a commanding political position. But taking the high road didn’t work last time and it won’t work this time either. Back in 2011, the public did indeed perceive Obama as being more willing to compromise and blamed him less than Republicans for the difficulty of reaching an agreement. But his overall approval rating nevertheless plunged as the public got sick of teetering on the brink of disaster while the economy sputtered. In fact, his approval went down the most (16 points) among political independents, supposedly the audience most receptive to the adult in the room act.

Second lesson: Cutting popular programs is unpopular. Last time around, significant cuts to Medicare, Medicaid and Social Security made their way made their way into various “Grand Bargain” proposals floated by Obama in negotiations. These were ultimately spurned by Boehner and colleagues, but Obama might not be so lucky this time. Better to avoid the trap by remembering these findings from a July 2011 CNN poll on possible components of a debt ceiling deal. While two-thirds of the public supported, in the abstract, the idea of cutting spending to solve the deficit problem, the public opposed cutting spending on Medicaid by 77-22, cutting Social Security spending by 84-16 and cutting Medicare spending by 87-12. And nothing’s changed since then: in a late March CBS News poll, 80 and 79 percent, respectively, opposed cutting spending on Medicare or Social Security to reduce the budget deficit.

Third lesson: Economic growth is much more important than deficit reduction. Obama, by virtue of his temperament, pressure from elites and, of course, the priorities of Congressional Republicans, will be tempted to privilege debt reduction over economic growth as he reaches for that elusive Grand Bargain. But he should remember that, as far as the public is concerned, you can’t eat Grand Bargains. That is, no matter how much the public says it cares about deficit reduction, ordinary people, unlike elites and their pressure groups like Fix the Debt, care far more about the state of the economy and how it is progressing. That has not changed since 2011: in Democracy Corps’ post-election poll, voters, by a thumping 62-30 margin, said that our biggest priority after the election should be growing the economy, not a plan to reduce the deficit.  And just two weeks ago, in a Marist/Morning Joe poll, 62 percent chose creating jobs as the top priority for Congress and Obama, compared to just 35 percent who chose deficit reduction. Note that among independents — supposedly the key group that gets excited about Grand Bargains — sentiment for creating jobs over reducing the deficit was an almost-as-overwhelming 60-36.

These are the lessons of our past deficit battles. Will Obama heed them? Well, he’s already getting the predictable cold shoulder from the Republicans, to be followed shortly by ever-escalating demands for more cuts and increasing public disgust with the whole process.  Perhaps some of the truths I’ve outlined here will then start to sink in and he will turn away, as he did in the fall of 2011, from fruitless attempts to reason with the GOP and advocate instead for the policies this country really needs.

That means taking his case to the public.  As John Judis recently put it:

When Obama takes an issue to the country, as he did financial reform in the spring of 2010, or as he did during the debate over the fiscal cliff, conservative Republicans complain vociferously that he is degrading the office of the president — forgetting, of course, that Ronald Reagan and George W. Bush campaigned energetically for their policies. And lo and behold, the pressure works. Obama needs to get back out there and fight the budget battle. He has to make clear to the country that the cuts are threatening the recovery, and he has to make clear that what Republicans want to do is make further cuts to Medicare and Social Security. These are popular programs. These are not Solyndra or the Post Office. Obama can win this fight, but he has to get out of the White House and carry it on.

Exactly.  We can only hope that the day is not far off when he realizes that this approach, while not without risks, is considerably less risky than trying to strike a Grand Bargain with today’s Republican Party.

Deficit mania has officially taken over Washington—again. Both Republicans and Democrats, while they have different preferred approaches, are heavily focused on cutting budget deficits and relieving the long-term debt situation of the country. Yet unemployment remains at an unhealthy 7.6 percent, with declining labor force participation, and the modest economic recovery that’s underway has shown signs of sputtering — witness the latest jobs report which indicated only an anemic 88,000 jobs were created in March.

The simplest explanation for Washington’s monomaniacal focus on the deficit would be that politicians are responding to a shift in priorities among voters. The electorate, in other words, is now more worried about the budget deficit than the economy, so politicians have shifted their focus accordingly. But that explanation is simply not borne out by the facts.  The public’s concern for the deficit still lags far, far behind their concern for the economy and jobs: In a late March CBS poll, 41 percent of people in an open-ended question thought the economy/jobs was the most important issue facing the country, compared to just 9 percent who thought the deficit/debt was the top issue.  And in a late March Marist/Morning Joe poll, 62 percent chose creating jobs as the top priority for Congress and Obama, compared to just 35 percent who chose deficit reduction.

Another possibility that fits the “responsive politicians” explanation for current deficit mania is that voters, while perhaps not prioritizing deficit reduction, are particularly likely to punish politicians who do not take action on the issue. That is, even though deficit reduction is not the top concern for voters, voters will nonetheless turn against politicians who fail to make progress in this area. But this appears to get things backwards, especially when it comes to the incentives facing incumbent politicians. In reality, countless historical examples and empirical studies suggest that the surest route to getting booted out of office is poor economic performance — and this is the case regardless of whether politicians make progress on the deficit. Conversely, if the economy performs well, but little progress is made on the deficit, the incumbent party is still likely to benefit.

But if Washington’s deficit obsession is not simply a product of politicians responding to a shift in the public’s mood, where does it come from? The likeliest alternative is that, as political scientists Lawrence Jacobs and Robert Shapiro argue in their influential book, Politicians Don’t Pander, elected officials don’t so much seek to know public opinion in order to follow it, but rather so they can manipulate it to support their agenda and minimize any electoral damage that might result. This clearly fits the way Republicans are handling the deficit issue: Cutting spending on government programs is at the top of their policy agenda, so it follows that they wish to keep the political and media conversation focused as much as possible on deficits. Over time, they hope the incessant hysteria will move public opinion to their side, allowing them to pass more and more of their preferred legislation. Moreover, they are betting that their unresponsiveness to the jobs issue will not hurt them because the media will mostly cover the endless battles over deficits and spending, creating a news vacuum where the public is likely, lacking other information, to blame the party that holds the presidency for inaction on jobs.

Democratic complicity in today’s deficit-obsessed political climate is less easy to understand. Democrats, one might think, would place the jobs issue at the top of their agenda and exploit the clear public opinion preference for jobs to move their policies. But the assumption that jobs tops the agenda of all Democratic politicians is likely not warranted. There is a very significant section of the Democratic Party, including many moderates but also some liberals, that is not convinced by the standard Keynesian argument that deficits, even at their current levels or higher, are not a problem in the short run, while weak demand and slow job growth definitely are. These Democrats appear to be more impressed by arguments, retailed by the Bowles-Simpson Commission, the Committee for a Responsible Federal Budget, and a veritable army of editorial writers and pundits, that the country’s deficit and long-term debt problem is so severe that an immediate agreement to tackle the problem is necessary. Lacking an agreement on the debt, the argument runs, the U.S. will lose the confidence of its creditors and soon become an unstable, impoverished country. By this hysterical logic, an agreement on debt becomes far more urgent than dealing with the jobs situation.

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