An end to the Broken Window fallacy
Austerity is under attack. Last weeks news that the UK has slipped back into recession was blamed on the government’s ‘austerity’ program. This weekends election of Francois Hollande to the French presidency, electoral gains in Italy for anti austerity parties, and chaos in Greece strengthen the hand of the so called ‘growth bloc’ which looks at the withering economies on Europe’s fringes and seeks an alternative to the tax rises and spending cuts of the austerity they hold responsible.
Across Europe it is being said that ‘austerity’ is not the answer. The choice is being as framed as austerity versus growth, as though riches are just a choice away. Sadly, and not surprisingly, it is not that simple.
When people say ‘growth’ what they really mean is increased government spending. But there is no connection between government spending and economic growth, if there were the Soviet Union may still be with us.
Indeed, for all the controversy about austerity across the west we see government’s borrowing and spending sums utterly unprecedented in peacetime.
Greece, with a national debt officially approaching 150 percent of GDP is going to run a deficit of 7 percent of GDP this year. The governments of Spain, Portugal, and France will all borrow around 5 percent of GDP this year. Britain, though, tops the lot. The British government will borrow over £120 billion this year, nearly 8 percent of GDP. The ‘cruel’ and ‘ideological’ cuts actually come in at a distinctly unaustere couple of percent.
In short, we are seeing massive borrowing and spending and our economies are still tanking. The argument that government spending = growth is plainly false. And with that the idea that there is a simple choice between growth and austerity disappears.
Anyone who after all this still clings to the idea that we can generate growth through increased government spending is suffering from some sort of hyper Keynesian psychosis; that we must push our deficits to 10, 15 or 20 percent of GDP, our debts to 150 or 200 percent of GDP. You could call this economic or suicide. If you were Monsieur Hollande you could call it an economic policy.
The ground upon which the ‘growth vs austerity’ plant has taken root was sown, to some extent, by those economists who pushed the idea of the expansionary fiscal contraction – the idea that the very act of cutting spending itself it would spur growth. But while budgetary balance might not be sufficient on its own for economic growth it is a necessary condition.
As countries borrow more and lenders come to doubt their ability to pay it back, the costs of borrowing increase. We’ve seen this with spikes on bond yields for governments in Greece, Italy, Spain, and Portugal during the euro crisis. These governments have had to pay more and more to borrow necessitating further spending cuts in other areas of government spending.
One alternative is to have the central bank buy the governments bonds with newly printed money. The European Central Bank has been doing as much of this as it can within its anti inflationary remit and seeks the power to do more. The Bank of England and Federal Reserve have been doing it lots and calling it Quantitative Easing. This has held down borrowing costs in both countries at the price, in Britain, of high inflation.
Inflation has been less of a problem in the US (on official figures anyway) but only due to the dollars status as global reserve currency which means that other nations will absorb almost any amount of dollars. Almost. The Federal Reserve’s monetizing of the debt is placing great strain on the dollar. The consequencesof a collapse would be catastrophic.
Either way, whatever people lose in austerity they will lose also with the inflation of the alternative, the decline in the purchasing power of their money. There really is no painless way out; no box to tick or lever to pull labelled ‘growth’ or anything else which will return us to the debt fuelled boom times before the credit crunch. As I’ve said before, as bad as it is, is as good as it gets.
The worrying thing about the anti-austerity backlash is that it indicates that voters still don’t really accept this. When asked if spending should be cut, taxes raised, and debt brought under control they generally agree in the abstract. But it seems they flinch from the reality of what this actually entails.
On official calculations, the debts of western countries are huge and growing. Unofficial calculations paint a much grimmer but probably more accurate picture. If even moderate attempts to slow the increase in debt – all austerity really promises in the short term – prove electorally unpalatable then western voters will be faced not with the bumpy landing of austerity but with the fatal crash of economic collapse. That, not debt fuelled growth vs austerity, is the real choice.
This article originally appeared at The Commentator