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.
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.
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?
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.
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).
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.