The Austerity Experiment

If we cannot adequately diagnose our problems it will be even harder to fix them.

Bruce Bartlett’s latest NYT column explores An Experiment in Austerity.

The experiment in question is how fiscal contraction (austerity) will influence the broader economy.

The most ominous passage was the following:

once in a while economists get to observe a natural experiment where policy is changed in a way that allows a theory to be tested by real-world results. We are about to run just such an experiment by tightening fiscal policy and cutting spending significantly below baseline projections at a time when the economy is weak. As I pointed out in a July 12 post, we performed this experiment once before, in 1937. The budget deficit was sharply reduced and a recession immediately followed.

So, we are about to add a new data point.

The column is mostly an overview of various recent studies on this topic and is worth reading.

One thought that comes to mind:  there are two major issues at hand in these conversations, although they tend to be conflated in the popular discourse.

There is a) the question of government taxing and spending (i.e., fiscal policy) and its immediate impact on the economy, and b) the question of deficits and debt over the medium to long term.

The main arguments for austerity are focused on b and not a (although some argue that the two are linked).   However, a is actually the immediate issue, i.e., the question of growth now and therefore jobs now.

Indeed, most of the conservations about even b conflate deficit issues that are short-term in nature (i.e., TARP, stimulus, and the contraction of revenue due to the recession) with the longer-term problems (entitlements, specifically Medicare).  A lot of the arguments being made, for example, about deficits in the first two years of the Obama administration (and the last year of the Bush administration, for that matter) seem to largely ignore the distinction between which portions of those deficits are due to short-term policies (or even one-shot policies, like TARP) and how much are part of longer-term issues.

If we cannot adequately diagnose our problems it will be even harder to fix them.

As I reflect back on the debt ceiling debate, it is remarkable the degree to which claims were made about spending cuts linked to short term economic fixes.  I am just not seeing it.  While I agree that we have long-term fiscal problems that are going to need to be addressed, I have a hard time accepting the notion that we are going to fix them by primarily making cuts to discretionary, non-defense spending.

I am especially vexed by the GOP/Tea Party line on immediate cuts.  Their mantra has been that uncertainty in the economy is holding business back (where “uncertainty” means taxes and regulations).  While I certainly understand that businesses have to take taxes and regulations into account, it is quite unclear as to why the current environment is any more uncertain in those terms than in previous eras.  Indeed, given the divided nature of the Congress (not to mention the anti-tax position of the House GOP), surely we can be pretty certain that there are not going to be a lot of new regulations or taxes.  Yes, the Bush tax cuts (as extended by Obama) are set to expire.  However, that is a relatively predictable process.

The “uncertainty” argument lost, to my mind at least, a lot of force (not that it had all that much as per the above paragraph) after the House GOP (and especially the Tea Party faction) helped created massive amounts of uncertainty by the way they conducted the debt ceiling debate (and even the solution create uncertainty because we don’t know how the next round of cuts will proceed).  Indeed, the S&P downgrade was, by S&P’s own account, driven by the way that debate was conducted.  For a group of actors who claim that what we need is “certainty” the Tea Party in particular doesn’t seem all that dedicated to creating it.  Indeed, Representative Jason Chaffetz (R-UT) was on This Week on Sunday still using the “we need certainty” line.   I just don’t understand how one can make that claim after participating in a process that did the exact opposite.

Still, to sum up the central point of these musings:  there are two different fiscal issues facing us, one that is short term and another that is long term and we need to stop conflating the two.  Further, to get back to Bartlett’s point, we are about to see how policy aimed at one problem (the longer-term set) affects another (the shorter term, economic growth issue).

FILED UNDER: Congress, Deficit and Debt, US Politics
Steven L. Taylor
About Steven L. Taylor
Steven L. Taylor is a Professor of Political Science and a College of Arts and Sciences Dean. His main areas of expertise include parties, elections, and the institutional design of democracies. His most recent book is the co-authored A Different Democracy: American Government in a 31-Country Perspective. He earned his Ph.D. from the University of Texas and his BA from the University of California, Irvine. He has been blogging since 2003 (originally at the now defunct Poliblog). Follow Steven on Twitter

Comments

  1. James Joyner says:

    Interestingly, we’re seeing the austerity vs. stimulus debate play out in Europe, too. The Germans are the kings of austerity and it’s working out pretty well for them, except for the anchor that comes with having the PIIGS on the same currency.

  2. @James Joyner: This is true. No matter how all of this turns out, there is s going to be a lot of data for economists of the future to play with.

  3. hey norm says:

    Yup.
    Shorter version…”Ya know – there are a lot of freakin’ idiots driving the economic conversation – and we’re making some monsterously bad decisions because of that.”

  4. john personna says:

    @James Joyner:

    The Financial Times has an “austerity in Europe” page, which doesn’t talk about Germany at all. I was actually surprised by your suggestion. I’d think Britain, which has been piloting austerity for a year or more, a better model.

  5. Tsar Nicholas II says:

    The recent goings on in London and Athens provide a visual clue for how austerity probably would be received here in the good ol’ US of A.

    If the Feds impose austerity here you’ll be wise to steer quite clear of the big Democrat cities, e.g., Philly, Chicago, Detroit, L.A., NOLA, Baltimore, Cleveland, Boston, Seattle, Newark, etc. Mob rules is a great song and even a better album, but it doesn’t work too well as social policy. Especially if you’re not part of the mob, Sparky.

  6. Dave Schuler says:

    A neat summary. Thank you.

    I think there are a couple of other distinctions that need to be made. I think we should be cautious about what we characterize as austerity. Slowing the rate of growth does not strike me as austerity.

    Reasonable people can differ on the best ways and means for addressing our current economic slump. Some sincerely believe that we can borrow and spend our way out of it. They have solid, theoretical support for their beliefs. Other equally reasonable people attribute the present slump to excessive borrowing and are skeptical that, under the circumstances, we can support the economy much by additional borrowing. Cf. the post over at my place on debt to GDP.

    As I say over there, the fix we’re in now has been building for a very long time and it’s likely to require a very long time to correct. While we’re correcting it we should take care not to throw the weakest and most vulnerable under the bus.

  7. Ron Beasley says:

    @john personna: You are correct – and hows it working out for them?

  8. john personna says:

    @Dave Schuler:

    Slowing the rate of growth does not strike me as austerity.

    If we were only slowing the rate of growth, we’d only be slowing the addition of government employees. We would not be seeing net reductions, month after month.

    (I’m actually a fan of fuzzy logic, and believe fuzzy austerity began a year or two ago, but the data are no longer even fuzzy.)

  9. john personna says:

    @Ron Beasley:

    To quote Mr. Zhou Enlai … “Too early to say.”

  10. Dave Schuler says:

    @James Joyner:

    Germany’s mercantilism has a good deal to do with its relative success. The mad thrashing by the ECB is largely targeted at preserving German banks, those most exposed to the debt of the EU’s debtor nations. It is still possible that Germany could crash hard.

    An additional factor behind Germany’s success over the last dozen or so years has been that, unlike most of the rest of the world, Germany has run persistent trade surpluses with China, largely due to the “factory in a box” technology that German companies have championed and sold successfully there. The Chinese are not unaware of this, the tide has begun to turn, I expect that Germany’s surpluses with China may be a thing of the past, and I further expect China to compete with Germany in “factory in a box” delivery. Germany’s good days may be nearing an end, too.

  11. Dave Schuler says:

    @john personna:

    Just as the military has expanded not by adding troops on the ground but by adding contractors, the same has been true on the civilian side. You can’t measure growth in spending by counting government employees.

    Nonetheless I am generally unconcerned about non-defense discretionary spending. I think it’s a distraction, a sideshow. We’re spending too much on the military and healthcare now and in the medium term the projected increase in healthcare spending is frightening.

  12. john personna says:

    @Dave Schuler:

    Just as the military has expanded not by adding troops on the ground but by adding contractors, the same has been true on the civilian side. You can’t measure growth in spending by counting government employees.

    Really? Where the austerity rubber really meets the road is in state and local spending.

    Do you have any data that those have grown spending while cutting employees?

    I thought they’d cut both, head count and spending.

  13. john personna says:

    Also, state employment may have more to do with austerity impact, even if it coincides, say, with growth in pensions:

    Aug 5 (Reuters) – State and local governments continued shedding thousands of jobs in July, part of a trend that analysts say could damage everything from trash collection to the entire U.S. economy.

    “We are looking at the worst contraction of state and local government employment since 1981,” said John Lonski, chief economist for Moody’s Capital Markets Research.

    “When state and local government spending and payrolls began to contract noticeably toward the middle of 1981, the second leg of the last double-dip recession began to materialize.”

    Lonski said the job loss — states shed 23,000 jobs in July and local governments 16,000 — coupled with spending cuts helped push up the chances the U.S. economy is entering a double-dip recession by 25 to 50 percent.

  14. Dave Schuler says:

    @john personna:

    Sure. Take my own state of Illinois, for example. It’s increasing spending every year.

  15. Dave Schuler says:

    Cook County shows the same picture: expenditures are growing year over year.

  16. James Joyner says:

    @john personna: German austerity is almost old news by this point, for reasons Dave Schuler lays out above. (TIME)

    Will German Austerity Help or Hurt the Global Recovery?

    Germany austerity deal calls for €80bn saving by 2014 (Bild)

    Why Budget Cuts Don’t Bring Prosperity (Leonhardt, NYT)

  17. James Joyner says:

    @Dave Schuler: You’re almost certainly right that Germany’s model would be not only very difficult to copy but is likely unsustainable even for Germany. Export-led growth is just incredibly difficult for a developed, high income society to sustain. And, even leaving the Chinese aside, the EU partners aren’t too thrilled with Germany’s beggar-thy-neighbors policy. But Germany is driving the train right now.

  18. john personna says:

    @Dave Schuler:

    Weren’t we talking percentage of state GDP?

    This chart shows a peak for Illinois state and local spending in 2010, and then a decline.

  19. Dave Schuler says:

    Chicago, too.

    The big fiscal problem hereabouts is that revenues aren’t rising as fast as spending. A lot of that is due to higher cost healthcare.

  20. Dave Schuler says:

    @john personna:

    No, I’m talking about spending increases. Spending is increasing.

    Even more importantly it’s increasing relative to income. Spending to GDP isn’t the right metric.

    For one thing GDP rises as borrowing rises which is misleading.

  21. john personna says:

    @James Joyner:

    I had forgotten the earlier German news. We really need something to normalize these various national efforts, like percent reduction as percent of GDP.

    @Dave Schuler:

    I think spending is commonly normalized to GDP for a very good reason, but if you’d like to do it per capita or something, dig up the data. Because, abstract dollars are not comparable.

  22. john personna says:

    @Dave Schuler:

    Even more importantly it’s increasing relative to income. Spending to GDP isn’t the right metric.

    Depends on whether you are talking budgetary impact, or austerity impact.

  23. JohnMcC says:

    Seems to me that if you look at the debt/deficit as a still picture you have this idea of a huge mound of trouble trembling above the house like an avalanche only waiting for the slamming of a door to come sliding down and kill us. If you look at the debt/deficit as a scene in a movie, you say ‘look at all these problems and with interest rates so low we can borrow a couple of $trillion and solve them.’ I read on Brad DeLong’s economics blog that the ‘break even 5 year inflation’ number on 10 year T-Bills is now 1.7% (the interest that one must collect to make an over-inflation return). Basically, the Masters of the Universe look 10 years ahead and see no, none, zero inflation. And borrowing costs reflect that expectation.

    There’s a cliche: A pessimist sees the glass is half empty; an optimist sees the glass is half full; an engineer sees the glass is twice as big as it needs to be.

    Being totally pragmatic — as if we woke up this morning and couldn’t remember whether we’re conservatives or liberals — this is a fortunate time to hire a lot of construction workers with very cheap loans and build a hell of a lot of railroad track and water mains and sewage treatment plants and electrical grids.

    But it’s probably too late in the afternoon and we’ve all remembered where we fit in this drama.

  24. john personna says:

    @JohnMcC:

    Basically, the Masters of the Universe look 10 years ahead and see no, none, zero inflation. And borrowing costs reflect that expectation.

    Or, alternately the global savings glut remains an overlooked force in lower yields worldwide.

  25. JohnMcC says:

    Well of course you are correct, Mr Personna. With some $2Trillion in profits by American corporations held as ‘savings’, I’d say that ‘glut’ hardly begins to be the appropriate term. And having seen the decline in equities that occurs when that $2Trillion is withdrawn from investing and hiring and buying and selling, it is now in T-Bills. Therefore the low interest; because the reasonable expectation is deflation. Much better for the money to be re-introduced into the economy as loans than that it sit in money-management accounts.

  26. Anonne says:

    I’d say that Britain has a good year of data and we can see how austerity is working out for them. Of course, that means we must ignore the evidence here and do it anyway.

  27. Moosebreath says:

    On the other hand, we do have data from state and local government’s austerity measures, and it’s not pretty. We’ve lost over 500,000 jobs at those levels in the last 2 fiscal years, largely because state governments have preffered to cut employment over raising taxes. By itself, that’s nearly .5% added to the unemployment rate.

  28. James Joyner says:

    @JohnMcC: Hell, I’m a conservative and would be happy to spend a ridiculous amount fixing infrastructure. I thought that made a lot more sense than TARP three years ago.

    The problem, though, is that it’s not 1932. While hiring a lot of people to swing hammers and operate equipment would both improve the employment picture and create long-term instrastructure benefits, the problem isn’t a lack of construction jobs but a radical restructuring of the economy. Working on a road crew isn’t a long-term solution for these people.

  29. john personna says:

    @James Joyner:

    Isn’t this post about a conflation of short and long term needs? Hiring people directly is about short term aggregate demand, and not about a long term solution for the same folk.

  30. Gerry W. says:

    @James Joyner:

    The problem, though, is that it’s not 1932. While hiring a lot of people to swing hammers and operate equipment would both improve the employment picture and create long-term instrastructure benefits, the problem isn’t a lack of construction jobs but a radical restructuring of the economy. Working on a road crew isn’t a long-term solution for these people.

    Well then, there is nothing else. In my town the private sector is mostly gone. And where do you go from here? And what widgets can you make when they can be made anywhere in the world? We were told that we were going to be an information society or a service society. And we were told that we did not have to make the low end products. What we did was close 57,000 factories in over a decade and have nothing to replace those factories and jobs. So, the choice is to do nothing or do something. All those Bush tax cuts is spent money, no differently than welfare, and with that, we lost the jobs and we lost the stimulus. And in many parts of the country, there is no way you can have economic growth as the so called economists, politicians and the fed would have it.

    So, in my view, globalization is a major factor and it means loss of jobs and wages. And yet, most everyone in Washington including Obama is holding on to free trade (for its own results). While free trade is here to stay, we did nothing to replace the jobs that we gave away, and 2 billion cheap laborers is so overwhelming (along with automation, lean principles, and mergers and consolidation) that all the tricks in the book are not working. The previous president was to busy with his useless tax cuts, his borrowing for war, and neglecting the infrastructure. And what we see, was his own roaring 20’s, and we face a near depression today.

    And with that, none of the politicians running today has given any answers. They are just going to wave the magic wand of the constitution, free market principles, and God and country.

  31. hey norm says:

    From the point of view that if we

    “…cannot adequately diagnose our problems it will be even harder to fix them…”

    Cantor is now circulating a paper that advocates…wait for it…wait…wait…ready…the 4:1 spending cuts to revenue increases that the Obama/Boehner Grand Bargain consisted of and Cantor himself submarined.
    You can’t make up how stupid the Republican House Caucus is.

  32. Laurie says:

    @James Joyner:

    Why does putting people back to work today on needed infrastructure need to be a long term solution. As a teacher and parent I am partial to Jared Bernstein’s FAST (Fix America’s Schools Today) plan. I believe it’s even deficit neutral with an identified source of funding.

  33. Ebenezer Arvigenius says:

    Germany’s mercantilism has a good deal to do with its relative success.

    I really wish people would stop this nonsense. A trading surplus does not mercantilism make. I don’t really see Germany engaging in protectionism or large-scale government control of foreign trade.

  34. Ben Wolf says:

    @James Joyner: Germany’s economy is doing well because German labor policy protects jobs at all costs, and because Germany has been pursing a begger-thy-neighbor strategy of flooding other countries with German products. Let’s also not forget the Germsn government consumes 40-50% of GDP, hardly the poster child for austerity.

    Germany weathered the storm through massive stimulus spending in 2009 and protectionist policies. We, however, can’t get stimulus of proper size and structure, and we actively encourage shipping jobs overseas. Maybe we should take a page from their playbook.

  35. john personna says:

    Germany finds itself in the enviable position of selling premium products in an export economy. National “cred” of this sort, where mere origin implies quality, is something you can take to the bank.

  36. An Interested Party says:

    Maybe we should take a page from their playbook.

    Oh but we can’t do those things! Government stimulus spending is socialistic! And protectionist policies are anti-capitalistic! No sir, we can’t possibly do such things, we are America, you know…

  37. Gerry W. says:

    Just listening to the Washington Journal on C-Span today and listening to the economist Diana-Furchtgott Roth and she was saying, like the rest of the right says, “if we cut corporate tax rates and regulation, maybe we will get a lot of our jobs back from other countries.” Here again, I find this ignorance prevailing throughout the elite. Now, I am not against tax cuts if they work, but what is she implying? Are we going to get all 6 million jobs back that we lost over a decade? Are the 57,000 factories that closed up, are they going to open up again? And what will be the labor cost?

    The fact remains is that we still have 2 billion cheap laborers and we put them into the free market system when communism failed. We own those people in a free market system. And since they are in our system, it means lower wages and loss jobs for our middle class anyway you look at it.

    Now, there is nothing wrong, within reason, to cut taxes and look at regulation, but that regulation was in there for a purpose. Are we willing to work longer hours with lower pay? Are you going to have OSHA standards? Are we supposed to lower our standards to the archaic standards of China and other countries?

    Now that all the intellectuals are running the show, can they ever admit to making a mistake that free trade is a disaster? Can they ever admit that we lost 6 million jobs in a decade and have no way of replacing those jobs. Why is it, you cannot get a decent answer from these people. Why is it that it is the same sound bites. Does the New World Order have something to do with this? What impact on their decisions does it have on the middle class? Why do they keep ruining our lives and our country? Don’t they have any shame? Tell the American people what you want. Tell us we need to work to the equivalence of the third world countries. Can you tell, in all honesty, the Americans, British, and others to do this? What kind of people are you? Everything you say is not reality to what is happening. You keep ignoring, keep being arrogant, and you have no answers. Now, you should have answers as capitalism is perfect, as tax cuts creates prosperity. But that is not what happened. So, explain, and leave the democrats out of it, just how are you going to create jobs with 2 billion cheap laborers in the system?

  38. Barry says:

    @James Joyner: “Interestingly, we’re seeing the austerity vs. stimulus debate play out in Europe, too. The Germans are the kings of austerity and it’s working out pretty well for them, except for the anchor that comes with having the PIIGS on the same currency. ”

    http://krugman.blogs.nytimes.com/2010/08/24/what-about-germany/

    “Basically, here’s the German story: it’s an economy that didn’t have a housing bubble, so it wasn’t caught up directly in the bust. But it’s very export-oriented, with a focus on durable manufactured goods. Demand for these goods plunged in the early stages of the crisis — so that Germany, remarkably, had a bigger GDP decline than the bubble economies — but has bounced back since summer 2009. This has pulled Germany back up; exports to China have done especially well.”

    Please – in economic arguments *always* check Krugman.

  39. Barry says:

    @john personna: “Or, alternately the global savings glut remains an overlooked force in lower yields worldwide. ”

    In which rates will stay low for a loooooooooooong time, and it’s a good time to borrow.

  40. Barry says:

    @James Joyner: “Working on a road crew isn’t a long-term solution for these people. ”

    True, but it’s a short- and medium-term solution, and our biggest problems are short- and medium-term. In addition, it wouldn’t just be roads – lots of energy stuff and IT infrastructure.