Austerity, the truth that dare not speak its name...

David McWilliams column in the SBP is well worth a read this week because he makes a case which has often only been heard on the left and is one that has an importance far beyond the present crisis. In it he discusses the IMF’s latest missal on the crisis, and he writes:

The nub of the issue is what economists call the size of the fiscal multiplier. This concept relates to how much a cut in government spending or increase in taxes affects the rest of the economy. If it doesn’t have much impact, this would be a small multiplier and mean that a country could cut government spending and not be affected so much because the private sector would take up the slack.

This is what the IMF believed up to now. But last Wednesday, it admitted that it may have been wrong. It admitted that the private sector, reeling with too much debt and no access to new funding, might not be taking up the slack at all.

Now if one thinks about it that’s the very core of orthodox thinking, a thinking that largely (though not exclusively) sees government as often something akin to an unnecessary evil. Cut government goes the thinking and not merely does one open up the space for the private sector to step inane fulfil functions that government hitherto has done but also government itself will become smaller, less intrusive, and from their standpoint less problematic – a sort of virtuous cycle.

But if government is the problem then the corollary of that is that the private sector is the solution. And yet a moments thought proves that to be almost absurd – and particularly so in the wake of the greatest market failure of most of our lifetimes. There are simply too many functions of state and government which the private sector is unable or unwilling to assume. Even in states which preach market orthodoxy to a degree that seems extreme even in this polity that is something of a truth – consider how great state (in the broad sense) funding of education and health remains in the United States despite the hotch potch system that has developed there in the latter case in particular. Simply put there are some things, social goods, services and provisions which require state heft.

And in societies like our own, and to a greater degree elsewhere in Europe, where the function of the state is considerably greater in many areas the primacy of the state is unarguable. So if the private sector cannot, will not and/or is too weak to function as the state has then – as ever – it remains for the state to ‘take up the slack’.

McWilliams notes that:

After pages of charts and numbers, and probing into what exactly happens in an economy like Ireland’s, when the government slashes spending, the IMF concludes: “These results suggest that actual fiscal multipliers were larger than forecasters assumed. But what did forecasters assume about fiscal multipliers? Answering this question is complicated by the fact that not all forecasters make these assumptions explicit. Nevertheless, a number of policy documents, including IMF staff reports, suggest that fiscal multipliers used in the forecasting process are about 0.5. In line with these assumptions, earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009.
“If the multipliers underlying the growth forecasts were about 0.5, as this informal evidence suggests, our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession.”
Wow! Just take this in for a moment.
This means that the IMF now admits that the impact of cutting government expenditure on economic growth, demand and unemployment is twice as much as it had thought – or maybe more.

But this is no surprise to most of us on the left. And it’s not as if the IMF’s figures weren’t challenged long long ago by those like Michael Taft. There’s more again. This information has ramifications for taxation and expenditure policies as well. One of the tropes of the era is the idea that expenditure cuts are always less destructive than tax increases. Yet even before the latest information there was evidence that that was a marginal effect at best - and I’ve long argued that if that was the case, that if it was marginal then for the benefit of societal and economic cohesion (and in that order too) it necessitated those on the left in particular, but also centrists and liberals, to argue for the latter over the former because that was an argument within orthodox thinking that could be won on its own merits. If however the negative effects of cuts are now considered to be greater again than once thought does that have yet further implications on the expenditure cuts/tax increase balance…

…but if so is any of this likely to be articulated by a government near you today? And that’s where all this begins to fall down. The IMF, for those watching it closely across the span of the crisis, been somewhat more engaged and reasonable in its utterings than the ECB or European leaders. But the manner in which the latter in particular have driven the political/economic response to the crisis has somewhat sidelined the IMF. The question remains how long they can continue to do so as evidence mounts up that their policy proscriptions are based on fundamentally flawed analytical thinking? The answer, unfortunately – to judge from the track record to date, is as long as it suits them.

And – a grimmer thought again – as Simon Kingsley in the same edition of the SBP notes;

Merkel and Schaeuble know their constituents and compatriots have their limits. It’s not about push coming to shove, not just yet anyway, although wait till Spain goes over the brink, but the message Germany is delivering is: “We’ve helped you, we are prepared to help you, but you have now really got to start helping yourselves.”
It’s harsh – brutal, even – and the problem with this, of course, is that the cure is also killing the patients.
It would be perhaps just a bit too cynical to propose it’s all part of a longer-term game, to do one’s best, to be seen to be doing it and then, when the whole edifice collapses, being able to say, “Hey! We tried, right?” Then again, that would also be a legitimate tactic.

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