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Richard Mellor

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Will reversing austerity end the depression?
« on: July 15, 2017, 06:00:49 AM »
Will reversing austerity end the depression?

by Michael Roberts

Were the policies of so-called austerity the cause of the Great  Recession?  If there had been no austerity would there have been no  ensuing depression or stagnation in the major capitalist economies?  If  so, does that mean the policies of ?Austerian? governments were just  madness, entirely based on ideology and bad economics?

For Keynesians, the answer is ?yes? to all these questions.  And it  is the Keynesians who dominate the thinking of the left and the labour  movement as the alternative to pro-capitalist policies.  If the  Keynesians are right, then the Great Recession and the ensuing Long  Depression could have been avoided with sufficient ?fiscal stimulus? to  the capitalist economy through more government spending and running  budget deficits (i.e. not balancing the government books and not  worrying about rising public debt levels).

That is certainly the conclusion of yet another article in the British centre-left paper, the Guardian.   The author Phil McDuff argues that holding down wages and cutting  government spending as adopted by the US and UK governments, among  others, was ?zombie economics? ?ideas that are constantly  discredited but insist on shambling back to life and lurching their way  through our public discourse.?  Austerity was absurd economically  and the article reels off a list of prominent Keynesians (Simon  Wren-Lewis, Paul Krugman, Joseph Stigltiz, John Quiggin) who argue that  ?austerity economics? was wrong (bad economics) and was really just  ideology. In contrast, the Keynesians reckon that ?the government  does everyone a service by running deficits and giving frustrated savers  a chance to put their money to work ? deficit spending that expands the  economy is, if anything, likely to lead to higher private investment  than would otherwise materialise? (Paul Krugman).

But is it right that austerity economics is just absurd and  ideological?  Would Keynesian-style fiscal stimulus have avoided the  Long Depression experienced by most capitalist economies since 2009?

Sure, ideology is involved.  Government spending in most capitalist  economies is spent not on meeting the needs of the people through  healthcare, education and pensions.  Much is devoted towards the needs  of big business: defence and security spending; grants and credits to  businesses; corporate tax reductions (while raising direct taxes on  households); road building and other subsidies.  So when ?austerity?  becomes necessary, the cuts in government spending are aimed at public  services (and jobs), welfare benefits etc ? as these are ?unnecessary?  costs for the capitalist sector.  And yes, keeping the state sector  small and reducing government intervention to the minimum is the  ideology of capital.  But even all this has an economic rationale.

It is an ideology that makes sense from the point of view of  capital.  The Keynesian analysis denies or ignores the class nature of  the capitalist economy and the law of value under which it operates by  creating profits from the exploitation of labour.  If government  spending goes into social transfers and welfare, that will cut  profitability as it is a cost to the capitalist sector and adds no new  value to the economy.  If it goes into public services like education  and health (human capital), it may help to raise the productivity of  labour over time, but it won?t help profitability.  If it goes into  government investment in infrastructure that may boost profitability for  those capitalist sectors getting the contracts, but if it is paid for  by higher taxes on profits, there is no gain overall.  If it is financed  by borrowing, profitability will be constrained eventually by a rising  cost of capital and higher debt.

Was austerity the cause of the Great Recession?  Clearly not.  Prior  to the global financial crash in 2008 and the subsequent global economic  slump, wages and household consumption were rising, not falling.  And  government spending growth was accelerating up to 2007 in many  countries.  As I have shown on many occasions on this blog, it was  business investment that slumped.

To be fair, the Keynesians have not really argued that the Great  Recession was a product of austerity policies.  That?s because Keynesian  economics never came up with a prediction before or explanation  afterwards for the Great Recession.  As Krugman put it in his book End the Depression Now! in 2012, there was no point in trying to analyse why the slump happened, except to say that ?we are suffering from a severe lack of overall demand? ? thus the slump in demand was ?caused? a slump in demand?.  For Krugman, there was nothing really wrong with the capitalist ?economic  engine, which is as powerful as ever.  Instead we are talking about  what is basically a technical problem, a problem of organisation and  coordination ? a ?colossal muddle? as Keynes described it.  Solve this  technical problem and the economy will roar back into life?.  If the problem is ?muddled thinking? and a lack of demand, create more demand.

This gets to the crux of the Keynesian argument on ?austerity?.  If  economies are suffering from a lack of demand, then cutting government  spending and balancing government books when capitalists are not  investing and households cannot spend is madness.  Even if the Great  Recession cannot be explained by Keynesian economics, it can explain the  Long Depression that has followed ? it?s been caused by austerity.

Now there is clearly something in the argument that when capitalist  production and investment has collapsed, driving up unemployment and  reducing consumer incomes, then cutting back on government spending will  make things worse.  And there is a growing body of empirical evidence  that austerity policies in various (but not all major economies) made  things worse.  One paper,  for example, shows that had countries not experienced ?austerity  shocks?, aggregate output in the EU10 would have been roughly equal to  its pre-crisis level, rather than showing a 3% loss. For the depressed  and weaker Eurozone economies of Ireland, Greece, Portugal etc, instead  of experiencing an output reduction of nearly 18% below trend, the  output losses would have been limited to 1%.

British Keynesian economist Simon Wren-Lewis has recently argued that  the Great Recession, combined with austerity fiscal policies in the US  and the UK, has had a permanent effect on output?A  long period of deficient demand can discourage workers. It can also  hold back investment: a new project may be profitable but if there is no  demand it will not get financed? The basic idea is that in a recession  innovation is less profitable, so firms do less of it, which leads to  less growth in productivity and hence supply?  This is called hysteresis by mainstream economics.

But is it this lack of demand that has affected productivity growth,  innovation and profitability in the Long Depression a result of  austerity, or just the failure of the capitalist sector to restore  profitability and investment?  The usual way of trying to answer that  question is to look at the multiplier effect in economics; namely the  likely rise or fall in economic growth achieved from a rise or fall in  fiscal spending?  The trouble is that the size of this multiplier has  been widely disputed.  For example, the EU Commission find that the  Keynesian multiplier was well below 1 in the post-Great Recession  period. The average output cost of a fiscal adjustment equal to 1% of  GDP is 0.5% of GDP for the EU as a whole, in line with the size of  multipliers assumed before the crisis, despite the fact that  approximately three-quarters of the consolidation episodes that  considered occurred after 2009.  So it is hardly decisive as an  explanation for the continuation of the Long Depression after 2009.

So Wren-Lewis has tried to get away from the multiplier argument.  Wren-Lewis defines austerity as ?all  about the negative aggregate impact on output that a fiscal  consolidation can have. As a result, the appropriate measure of  austerity is a measure of that impact. So it is not the level of  government spending or taxes that matter, but how they change.?  That seems a reasonable definition and yardstick to judge.

Looking at the US economy, Wren-Lewis relies on the Hutchins Center Fiscal Impact Model, which  purports to show the impact of government fiscal policy on real GDP  growth.  He admits that the measurement is difficult, but at least the  model compares changes in net government spending to growth. It shows  that there was a switch to austerity from 2011 up to 2015 and this, it  is argued, explains why the US economy had such slow growth and  ?recovery? after the end of the Great Recession.  If austerity had not  been followed, the US economy would have made a full recovery by 2013.

Well, what strikes me first about this graph is that, according to  the Hutchins Center, fiscal austerity in the US ended in 2015.  But  there has been no pick-up in US real GDP growth since.  Indeed, US real  GDP growth in 2016, at 1.6%, was the lowest annual rate since the end of  the Great Recession.  But maybe, Wren-Lewis would argue, is that  hysteresis is now operating to keep productivity and output growth  permanently low.  But even if that is right, fiscal stimulus is likely  to have little effect from here in getting these capitalist economies  going.

Moreover, there is plenty of evidence that fiscal stimulus will have  little effect on ending the depression.  Like Wren-Lewis, I have  compared changes in government spending to GDP against the average rate  of real GDP growth since 2009 for the OECD economies.  I found that  there was a very weak positive correlation and none if the  outlier Greece is removed.

Another case study is Japan since 1998. I compared the average budget  deficit to GDP for Japan, the US and the Euro area against real GDP  growth since 1998. 1998 is the date that most economists argue was the  point when the Japanese authorities went for broke with Keynesian-type  government spending policies designed to restore economic growth. Did it  work?

Between 1998 and 2007, Japan?s average budget deficit was 6.1% of  GDP, while real GDP growth averaged just 1%. In the same period, the US  budget deficit was just 2% of GDP, less than one-third of that of Japan,  but real GDP growth was 3% a year, or three times as fast as Japan. In  the Euro area, the budget deficit was even lower at 1.9% of GDP, but  real GDP growth still averaged 2.3% a year, or more than twice that of  Japan. So the Keynesian multiplier did not seem to do its job in Japan  over a ten-year period. Again, in the credit boom period of 2002-07,  Japan?s average real GDP growth was the lowest even though its budget  deficit was way higher than the US or the Eurozone.

Now specially for this post, I have compared government spending (as  defined by Wren-Lewis as government consumption plus investment, thus  excluding transfers) growth with real GDP growth in the major  economies.  From 2010 to 2016, the average real GDP growth rate in  Germany, the UK and the US was virtually the same, at about 2% a year,  but government spending growth varied considerably, from 3.4% a year in  (?non-austerity?) Germany to just 1.4% a year in austerity US.  The UK  applied as much austerity as France but grew faster.  Now it?s true that  both Italy and Spain cut government spending over the period and also  suffered non-existent growth, but I would venture to argue that this is more due to the failure of Eurozone fiscal integration.  The core Eurozone countries have refused to help out the weaker capitalist ?regions? of the Euro area.

Even more convincing is the work done by Jose Tapia in comparing government spending in the US economy since 1929 against  business investment and profits growth.  His sophisticated regression  analysis found no significant causal connection or correlation between  government spending and private investment and profits.  Indeed, Tapia  found that ?The Keynesian view that government expenditure may  pump-prime the economy by stimulating private investment is also  inconsistent with the finding that the net effect of lagged government  expending on private investment is rather null or even significantly  negative in recent decades.?

So, at the very best, the jury is out on whether Keynesian-style  stimulus would get capitalist economies out of this depression.  At  worst, it could delay recovery in a capitalist economy.

There is a much more convincing driver of investment and growth in a  capitalist-dominated economy, namely the profitability of capital,  something completely ignored by Keynesian theory. I have shown in the  past that real GDP growth is strongly correlated with changes in the  profitability of capital (the Marxist multiplier, if you like).  The Marxist multiplier was considerably higher than the Keynesian  government spending multiplier in three out of the five decades, and  particularly in the current post Great Recession period. And in the  other two decades, the Keynesian multiplier was only slightly higher and  failed to go above 1. Thus there was stronger evidence that the Marxist  multiplier is more relevant to economic recovery under capitalism than  the Keynesian multiplier.

Indeed, is the low productivity growth in this Long Depression caused  by a permanent lack of demand or hysteresis or to low profitability?  The recent annual report of the Bank for International Settlements (the research agency for global central banks) found that productivity growth had slowed down because of ?a  persistent misallocation of capital and labour, as reflected by the  growing share of unprofitable firms. Indeed, the share of zombie firms ?  whose interest expenses exceed earnings before interest and taxes ? has  increased significantly despite unusually low levels of interest  rates?.

The BIS economists come from the Austrian school that blames  ?excessive credit? and ?loose central bank monetary policy? for  credit-crunch slumps.  But they do recognise, from the point of view of  capital, that profitability is a factor behind investment, innovation  and growth, rather than a ?lack of demand?.

The policies of austerity do have an ideological motive: to weaken  the state and reduce its ?interference? with capital.  But the economic  foundation of austerity was not mad or bad economics, from the point of  view of capital.  It aimed to reduce costs of pubic services, interest  rates and corporate taxes in order to raise profitability.  The  Keynesian view ignores the movement of profitability as a cause of  crises.  And by relying on ?demand? as the measure of the health of a  capitalist economy, Keynesian policies of fiscal stimulus fall short of  solving the ?technical problem? of getting the economy to ?roar back into life?.
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