With its intellectual justification in tatters, this government’s policy must change direction before it’s too late

The policy of austerity is finally dying with Europe and even the monetarist IMF realising their folly recently. With its intellectual justification in tatters this government’s economic policies must change right now.

Reinhart-Rogoff

On Wednesday morning George Osbourne was again asked if he had any doubts about his austerity plan after it was found that it’s most cited academic justification, the Reinhart-Rogoff paper, had fundamental flaws in both its data collection and methods of analysis. Mr Osbourne tried to deny its significance for his policies.

Let us remind ourselves, then, of what Osbourne, in his 2010 critical policy speech, ‘A New Economic Model’, actually said:

“Perhaps the most significant contribution to our understanding of the origins of the crisis has been made by Professor Ken Rogoff and his co-author Carmen Reinhart… they have demonstrated in exhaustive historical and statistical detail all financial crises ultimately have their origins in one thing – rapid and unsustainable increases in debt.”

That Reinhart-Rogoff used incorrect data was incredibly embarrassing. For others, the greater shame is that a paper whose results simple analytical common sense and comparative statistical analysis would show as immensely dubious ever had such a reach amongst those creating policy.

The common sense argument becomes apparent when you understand what the Reinhard-Rogoff’s book , ‘This Time it is Different’ tried to do: It made the stunning conclusion that by looking at the data sets of many different countries over an extensive period, sometimes 230 years, there was a correlation between Gross Domestic Production (GDP), national debt and its growth rate.

Further, in a subsequent paper, they concluded there was an economic magic number: 90. When the ratio of a countries GDP and national debt ratio had reached this inflection point economic growth will drop off dramatically.

The first question mark by anyone involved in statistical data or scientific analysis of any kind would be the integrity of the data. GDP and national debt are not abstract fixed terms. What constitutes these terms for a country is changing. For example, right now the UK GDP is different dependent on who you ask (UK GDP for the IMF is $2.45 trillion and $2.32 trillion for the CIA handbook.

So comparing countries over a 50 year timeframe, let alone 200 years, is fraught with danger. Further, thinking the understanding and recording of GDP (a term not invented till 1939!) and national debt was the same for 1790s USA (remember this is pre Napoleon!) and modern superpower USA, whose dollar is the world’s reserve currency is, to put it politely, statistically unsafe.

Another common sense argument is that they are mixing correlation and causation: to believe that GDP and national debt would provide a governing rule to hold through momentous world changing events such as world wars, whether a country was self-governed or a colony, or for a West Germany post-Second World War needing to re-build itself from scratch and a modern day reunified Germany, must be treated with immense skepticism.

And finally adding to the above skepticism is the comparative analysis that makes the findings of this report very suspect for the UK: since the war the UK has had a debt over 90 per cent from 1946 to 1964 within that period growth was on average 2.24 per cent, from 1965 to 2009 when it was lower then 90 per cent, growth was on average of 2.22 per cent, statistically insignificant.

Even more tellingly, if we take the same time periods of higher and lower than 90 per cent debt ratio (1946 to 1964 and 1965 to 1983), growth is higher when debt was above 90 per cent than below (2.24 per cent compared to 2.07 per cent) – the direct opposite of the Reinhard-Rogoff paper and what George Osbourne used to mercilessly cut, cut,cut:

“The latest research suggests that once debt reaches more than about 90 per cent of GDP the risks of a large negative impact on long term growth become highly significant…. we are forecast to break through 90 per cent of GDP in just two years time…”

The sensible approach would be to have the humility to say that any such link is uncertain and unknowable. To point out that over those 40 years post war, both Conservative and Labour governments had many wider geopolitical and national concerns to adapt to from time to time which would have lead to more or less debt.

Therefore, thinking that any economic golden rule could be devised between GDP and national debt from this data is fanciful. What would definitely not be prudent is to make such dodgy analysis a keystone for economic policy for a country, meaning misery for millions in lost jobs, wealth, education opportunities and investment; that would be madness, right?

When you take this all out of the theoretical and consider the devastation in everyday lives: the poverty, the loss of jobs, it brings real resonance to the words of John Maynard Keynes, as he warned us against the ideas of economists to influence against the facts at hand:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler.”

The policy of austerity is finally dying with Europe and even the monetarist IMF realising their folly recently. With its intellectual justification in tatters this government’s economic policies must change right now.

7 Responses to “With its intellectual justification in tatters, this government’s policy must change direction before it’s too late”

  1. LB

    So we have the ONS pointing out that the state pensions debts in the UK went up by 734 bn a year between 2005 and 2010. That’s hard evidence from the ONS.

    Now since taxes are only 550 bn now, its doesn’t take a rocket scientist to work out that the state is bankrupt.

    Hence Balls and Milliband won’t talk about debt.

  2. LB

    nd finally adding to the above skepticism is the comparative analysis that makes the findings of this report very suspect for the UK: since the war the UK has had a debt over 90 per cent from 1946 to 1964 within that period growth was on average 2.24 per cent, from 1965 to 2009 when it was lower then 90 per cent, growth was on average of 2.22 per cent, statistically insignificant.

    ==================

    So why leave off the pensions debts? Under the standard GAAP and FRS17 (accounting standards) you are missing of 5,300 bn of debt at a minimum.

    It’s not surprising that you come to flawed conclusions when you base them on a lie that the debts are just borrowing.

  3. Julian

    Who is George Osbourne?

  4. Jimmy

    Not that again? Yawn.

  5. LB

    Just doing what Balls and Milliband are doing.

    Just wait. At some point in the near future, the taxing coming from the pension contributions disappears, and the real payouts have to start. Its getting nearer. The debts are rising rapidly, there is bugger all growth. There won’t be the tax payers to pay the debts, so the debts won’t be paid. You can’t print and get out of inflation linked debts.

  6. Nodbod

    Let’s face it, GO is not the sharpest tool in the box. He will deny any contrary evidence and ignore what the IMF has asked (told) him to do; the time for austerity is over and you should be budgeting for growth. He may make the ultimate decision but he is reliant on his advisors; it is they who provide him with the “evidence” that he choses to use.

    It was never about austerity. Austerity is the rationale for the peasants. We are being put in our place! We voted Labour for 3 elections and we are being punished for it. Quantative easing, allegedly given to the banks to loan to businesses, has all gone to the mega-wealthy. It certainly never ended up with businesses; they still cannot get loans. We kick back on everyone on welfare; not because it is just but because we can no longer afford it. What strictures have been imposed on the banks, multinational companies avoiding tax or the mega-wealthy (or even the merely wealthy)? Not one!
    We are missing billions in tax from companies and yet what has this government done to address this? The have had a very long think about it and decided to do nothing. Not one line of tax law has been amended or introduced. However we will ask those nice chappies at the G8 to join us in absolutely condemming these practices whilst still not doing one concrete thing to address it.
    The fact that his entire economic philosophy is based on a flawed paper will just be ignored. The fact that he is borrowing more than ever will just be covered by pretending it is coming from another bucket, that we have paid off the structural deficit(?) but it is now the operating budget(?) that is out of control and the way to address that will be to reduce taxes on the wealthy (because they create wealth, don’t ya know) and cut costs everywhere else. Sort of has a familiar ring to it,doesn’t it?
    He cannot budget for growth. Firstly because he does not know how and secondly it does not fit with his political agenda.

  7. RR

    I run a small business with 10 employees. The simple fact is the success of my business, and any other economic entity, depends upon the leader’s ability to manage cash flow. The argument that GDP to Debt ratios are unimportant are absurd. Debt is a leveraging tool that can accelerate growth. But it is also an obligation that can slow growth and even kill a firm when the borrowed funds do not return gains in excess of the cost of debt. Whether a nation or an individual, once you have borrowed more money than you can afford the interest costs, let alone the debt repayment, you become insolvent. There’s no denying that countries that can print money have more tools than individuals, but each has their own debt capacity. Once debt capacity is exceeded, economic disaster follows. While many would like to discredit the entirety of “This Time it is Different”, there is a great deal of value in their research. The simple fact is, whatever the critical ratio, history has show us that once nations become insolvent they have either collapsed leaving lenders unpaid or they have inflated their way out of the debt, which is painful for everyone. I’d agree that argue that crossing 90% is not a cliff event, but high debt ratios carry a financial burden that can only become more burdensome as the economy cycles through a slowdown or when inflation exceeds growth.

    Resisting austerity seems like a noble cause, but its misguided. Government will always overspend because politicians are spending “other people’s money”. The benefactors of the spending spree can be relied upon to proclaim universal benefits, but their self interests are the driver. Call it what you like, but government spending should be limited to something approaching tax receipts. Let the various factions debate openly for the merits of their cause(s) and let’s try to create a better world for the generation that will follow. When governments overspend, its their cronies that get rich. And they do so at the expense of individuals.
    itt

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