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:

Tweets01

Tweets02

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

Fig01

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

Fig02

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
Fig03

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
Fig04

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
Fig05

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
Fig06

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
Fig07

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.

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.
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  • TruthIs­ThereIs­NoTruth

    This analy­sis could cer­tainly ben­e­fit from a broader and deeper com­par­i­son. The prob­lem for me isn’t the con­clu­sion itself (which may be right or wrong), but the pro­mo­tion of the idea that such analy­sis is suf­fi­cient to make an informed state­ment.

    Look­ing at a hand­ful of vari­ables between 2 coun­tries, where there are hun­dreds of vari­ables and a cou­ple of hun­dred coun­tries to choose from, one could poten­tially be accused of select­ing data to suit one’s argu­ment.

    There are notable instances where this approach has failed in the past: see Keen series of state­ments and arti­cles com­par­ing US, Japan and Aus­tralian real estate in the post-GFC period.

  • «Look­ing at a hand­ful of vari­ables between 2 coun­tries, where there are hun­dreds of vari­ables and a cou­ple of hun­dred coun­tries to choose from,»

    This is a bizarrely com­i­cal point because the dis­cus­sion is about gov­ern­ment aus­ter­ity in Bel­gium, and whether it hap­pened or not.

    Quite rea­son­ably look­ing at gov­ern­ment debt in Bel­gium is what is per­ti­nent for gov­ern­ment aus­ter­ity in Bel­gium. Steve Keen being a rason­able per­son also looks at *pri­vate* debt,

    Most right-wing or sell-side Econ­o­mists don’t look at pri­vate debt at all, because their main inter­est seems to be to reduce spend­ing on the poor, which they call “aus­ter­ity”, and they take reduc­tions in gov­ern­ment debt as a proxy for lower spend­ing on the poor.

  • «the change in pri­vate and pub­lic debt. They move in oppo­site direc­tions in the USA: ris­ing gov­ern­ment spend­ing»

    Ris­ing gov­ern­ment *indebt­ness* strictly speak­ing…

    «thus coun­tered delever­ag­ing by the pri­vate sec­tor.»

    That seems to me fairly a fairly absurd point with­out a vital addi­tional qual­i­fi­ca­tion.

    The large increase in gov­ern­ment debt caused largely by Bush and Paul­son was not due to anti-aus­ter­ity mea­sures, but sim­ply to mas­sive hand­outs (bal­ance-sheet wel­fare) to finan­cial com­pa­nies in order to pro­tect the jobs and wealth of very rich bankers and other high-income finan­cial sec­tor traders and exec­u­tives.

    But since the cri­sis gov­ern­ment employ­ment in the USA at both the fed­eral and state level have actu­ally shrunk, both per­centu­ally and IIRC in absolute terms.

    Gov­ern­ment pur­chases of goods and ser­vices at both the fed­eral and local level have gone largely side­ways, except per­haps on secu­rity.

    Gov­ern­ment trans­fers other than to large finan­cial com­pa­nies have actu­ally increased, but much less than those wel­fare hand­outs to banks and other cor­po­rates, which have been com­ple­mented by enor­mous mon­e­tary pol­icy hand­outs from the USA cen­tral bank.

    To char­ac­ter­ize a trans­fer of enor­mous spec­u­la­tive losses from finan­cial cor­po­ra­tion bal­ance sheets to the gov­ern­ment bal­ance sheet may be called “spend­ing” in the abstract, but that seems to be a bit out of place on a dis­cus­sion on “aus­ter­ity hawks” who seem to care only about lower cur­rent spend­ing on the poor.

    Over­all the USA pol­icy has been like the one in the UK, which has been char­ac­ter­ized by its author as «fis­cally con­ser­v­a­tive but mon­e­tar­ily active».

  • striped-pad

    Argu­ments of fal­lacy of com­po­si­tion are use­ful, but need to be care­ful and should not over­state what they have suc­ceeded in debunk­ing. Con­sider the Dal­las Cow­boys exam­ple:

    1. If Dal­las Cow­boys improve their defence, ceteris paribus, they will win more games.
    2. But if all teams improve their defence, it is not true that they will all win more games.

    So the fal­lacy of com­po­si­tion argu­ment shows that the extreme claim of win­ning more games can­not be gen­er­alised. How­ever, this does not mean that Dal­las Cow­boys should not try to improve their defence.

    Another exam­ple:

    1. If Fred leaves for work 30 min­utes ear­lier, he will miss the rush hour and get to work much quicker.
    2. But if every­one leaves for work 30 min­utes ear­lier, it is not true that they will all miss the rush hour get to work much quicker.

    How­ever, even though they don’t all get to work quicker, they still all get to work 30 min­utes ear­lier, so again the fal­lacy of com­po­si­tion argu­ment doesn’t mean that peo­ple should just con­tinue to leave at the same time that they did orig­i­nally. It depends on whether they are get­ting to work when they need to.

    Then there’s the sav­ing argu­ment above:

    1. If one per­son saves money as an indi­vid­ual, that person’s bank bal­ance will grow.
    2. But if every­one tries to save more, they will earn less income. (With the impli­ca­tion that we end up sav­ing less).

    Note that this form of argu­ment is dif­fer­ent from the oth­ers. The straight­for­ward use of the fal­lacy of com­po­si­tion argu­ment here would be:

    2(a). But if every­one tries to save more, then it is not true that everyone’s bank bal­ance will grow.

    I think that 2(a) is actu­ally false. The rate at which the bank bal­ances are increas­ing will slow down, ceteris paribus, but the total sav­ings will still increase.

    In response to the topic as a whole, it’s clear that pri­vate debt can’t sim­ply be ignored. But just because pub­lic debt is smaller, it doesn’t mean that it can be ignored, in the same way that car loans can’t be ignored because they are smaller than the rest of the debt. All the promises to repay bor­rowed money, which have been made through­out both pub­lic and pri­vate sec­tor, need to be tested to see if they are plau­si­ble. If they are not, it would be bet­ter to be hon­est about it now, force the lenders to write them off, take the con­se­quences (which were inevitable fol­low­ing a period of over-con­sump­tion), and resume at a lower level of GDP but with a sus­tain­able econ­omy.

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  • TruthIs­ThereIs­NoTruth

    Appre­ci­ate your com­ment Blis­sex. I took the con­text of the post to be whether or not aus­ter­ity will work rather than whether aus­ter­ity did or did not hap­pen in Bel­gium.

    Agree that the deci­sions are polit­i­cal rather than the­o­ret­i­cal. How­ever from a the­o­ret­i­cal point of view which Steve Keen is tak­ing, a very nar­row analy­sis of one par­tic­u­lar coun­try is not only insuf­fi­cient to prove any­thing, it is pro­mot­ing an inad­e­quate approach to prov­ing one’s point.

  • TruthIs­ThereIs­NoTruth

    One of the main fac­tors not con­sid­ered is the cost of debt and this really dif­fers across coun­tries and is where the US has a sig­nif­i­cant advan­tage. While the US can con­tinue to spawn cheap money, I’m not entirely cer­tain Bel­gium could get away with that.

    Increas­ing pub­lic debt means sell­ing more bonds, which forces bond prices down which increases rates for every­one. It’s an exam­ple of how a sim­ple argu­ment can present a con­flict­ing per­spec­tive with­out tak­ing any the­o­ret­i­cal point of view. 

    From what I have observed in fol­low­ing this blog the the­o­ret­i­cal point of view is a hand­i­cap in assess­ing real­ity. The hand­i­cap is two fold. Firstly eco­nomic real­ity doesn’t fol­low any the­ory. There­fore try­ing to under­stand real­ity within the prism of a the­ory inevitably leaves out essen­tial details. No good say­ing I would have been right if this or that, the “this or that” are the real­ity which should have been under­stood in the first place. Real­ity is not meant to fol­low the­ory, the­ory is meant to explain real­ity! The sec­ond aspect of the hand­i­cap is the ego fac­tor. The­ory is espe­cially blind­ing if there is a sense of per­sonal attach­ment to the the­ory. The con­se­quence of this aspect is obser­va­tional bias and poor analy­sis seem­ingly based on the notion of pos­sess­ing a supe­rior the­o­ret­i­cal point of view reduc­ing the require­ment for a more rig­or­ous approach.

  • Zojo

    @striped=pad
    I think that 2(a) is actu­ally false. The rate at which the bank bal­ances are increas­ing will slow down, ceteris paribus, but the total sav­ings will still increase. 

    Not nec­es­sar­ily. Some peo­ples sav­ings will increase, but oth­ers will decrease as they lose their income and so have to spend their sav­ings. It is per­fectly pos­si­ble that if we all try to save over­all the total sav­ings could go down.

    As for the argu­ment about leav­ing 30 min­utes early to miss the rush hour. Clearly if every­one does it the rush hour will start 30 min­utes ear­lier. Thus it will not be missed. That is the fal­lacy. No one was argu­ing that peo­ple would or would not arrive ear­lier so the point you make is mean­ing­less.

    Finally How­ever, this does not mean that Dal­las Cow­boys should not try to improve their defence No one is sug­gest­ing this. The point is that EVERYONE can­not ben­e­fit if EVERYONE improves their defence. That is the fal­lacy of com­po­si­tion.