What Austerity Hawks Ignore

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My fel­low Post Key­ne­sian and good mate Pro­fes­sor John Har­vey pub­lished an excel­lent piece on his Forbes blog today, point­ing out the fal­la­cy of com­po­si­tion in the pro-aus­ter­i­ty. He took his cue from anti-aus­ter­i­ty riots in Bel­gium:

Riot police have fired tear gas and water can­non dur­ing clash­es with demon­stra­tors as at least 100,000 peo­ple marched through Brus­sels in the first mass protests against gov­ern­ment aus­ter­i­ty mea­sures. (“Bel­gian pro­test­ers clash with police over pen­sions and pay”, BBC News Europe)

Then he point­ed out that the pro-aus­ter­i­ty argu­ment is fal­la­cy of com­po­si­tion. That’s a hard con­cept to get through—especially, it turns out, to con­ven­tion­al­ly trained econ­o­mists. So John used a bril­liant exam­ple from Amer­i­can foot­ball:

Micro Propo­si­tion: If the Dal­las Cow­boys improve their defense, they will win more foot­ball games.

Macro Corol­lary: If every team in the Nation­al Foot­ball League improves their defense, they will all win more games.

The micro propo­si­tion is true; but the macro propo­si­tion is false because, as John put it:

Since every game gen­er­ates one win and one loss, the aver­age win­ning per­cent­age in the Nation­al Foot­ball League must always be 50%. It is a zero-sum game. Thus, in this case, the log­ic of the micro does not extend to the macro and believ­ing oth­er­wise is a fal­la­cy of com­po­si­tion.

That’s a bril­liant and easy to under­stand anal­o­gy to the more com­pli­cat­ed eco­nom­ic fal­la­cy of com­po­si­tion. At the micro lev­el, if one per­son saves mon­ey as an indi­vid­ual, that person’s bank bal­ance will grow. But at the macro lev­el, if we all try to save more, we’ll earn less income.

I thought it was a great post (and he’d come up with the anal­o­gy the night before when we shared din­ner after estab­lish­ing an exchange agree­ment between our two uni­ver­si­ties, TCU and Kingston). So I tweet­ed it and thought noth­ing more of it.

But then my work on a pre­sen­ta­tion defend­ing math­e­mat­ics in eco­nom­ics that I‘m giv­ing at Cam­bridge Uni­ver­si­ty on Mon­day was dis­turbed by a series of aggres­sive tweets [by which I mean putting his case aggressively–not being aggres­sive towards me. That appears to be how Geert inter­pret­ed this word when he read this post and on this word alone decid­ed to end the dis­cus­sion. So for the record, Geert was not aggres­sive towards me per­son­al­ly at all–so let’s talk] from Geert Noels, the author of Econoshock, who argued that Bel­gium wasn’t in fact prac­tic­ing aus­ter­i­ty:



So here’s a quick com­par­i­son of Bel­gium and the USA on the issue of aus­ter­i­ty ver­sus stimulus—even if the Amer­i­can stim­u­lus was large­ly the result of polit­i­cal grid­lock in Wash­ing­ton. First­ly, as I not­ed in one tweet, aus­ter­i­ty pro­po­nents see the entire prob­lem as gov­ern­ment debt, and ignore pri­vate debt. So Fig­ure 1 cor­rects for that bias. And sure enough, pri­vate debt in Bel­gium is far high­er than gov­ern­ment debt. It went through the roof over the ear­ly 2000s but was com­plete­ly ignored by Euro­pean pol­i­cy mak­ers because, in com­mon with all con­ven­tion­al Neo­clas­si­cal econ­o­mists, they wrong­ly believe that pri­vate debt has no macro­eco­nom­ic sig­nif­i­cance.

Fig­ure 1:Private debt in Bel­gium is far high­er than gov­ern­ment


Fig­ure 2 shows that gov­ern­ment debt was basi­cal­ly sta­t­ic until the cri­sis began, and only rose once it had com­menced. Notice also that for the last cou­ple of years, the change in pri­vate and gov­ern­ment debt have both been falling as a per­cent­age of GDP.

Fig­ure 2: Change in pri­vate and gov­ern­ment debt


Now com­pare Belgium’s data to the USA’s. The same pat­tern of pri­vate debt exceed­ing gov­ern­ment debt, and gov­ern­ment debt being con­stant (as a ratio to GDP) pri­or to the cri­sis and only ris­ing after it applies there too.

Fig­ure 3

But the dif­fer­ences are obvi­ous when you com­pare the change in pri­vate and pub­lic debt. They move in oppo­site direc­tions in the USA: ris­ing gov­ern­ment spend­ing thus coun­tered delever­ag­ing by the pri­vate sec­tor.
Fig­ure 4

Now let’s com­pare Bel­gium and USA gov­ern­ment deficits (or rather the change in gov­ern­ment debt per year) side by side. The Maas­tricht Treaty and the “Sta­bil­i­ty and Growth Pact” made a big song and dance about how impor­tant it was to keep the deficit below 3% of GDP. Notice that the USA’s deficit almost hit 15% after the crisis—surely that would lead to eco­nom­ic calami­ty, accord­ing to pro­po­nents of aus­ter­i­ty?
Fig­ure 5

No: in fact it helped revive the pri­vate sec­tor, and unem­ploy­ment in the USA is now well below cri­sis lev­els (see Fig­ure 6). I am a cyn­ic about how long that will last, since the growth is pred­i­cat­ed on anoth­er debt boom and nowhere near enough delever­ag­ing actu­al­ly took place, but that’s an issue for anoth­er post.
Fig­ure 6

The out­come is that not only is unem­ploy­ment falling in Amer­i­ca and well below the ris­ing lev­el in Bel­gium, but gov­ern­ment debt is falling in the USA while it’s still on an upward tra­jec­to­ry in Bel­gium (see Fig­ure 7).
Fig­ure 7

So aus­ter­i­ty is not only bad for the well-being of Bel­gians, it is bad for achiev­ing its own ends. The riot­ers are right. Europe should over­turn the “Sta­bil­i­ty and Growth Pact” and end this mad exper­i­ment with aus­ter­i­ty.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.