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.

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.

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