Friday, June 25, 2010

Austerity, European Style

I've been enjoying the ridiculous debate taking place in Europe related to the concept of "austerity" vs. economic prosperity. According to this article:
World leaders from the U.K.’s David Cameron to Naoto Kan of Japan are betting they can deliver fiscal austerity without derailing economic prosperity. History suggests they may be right.
In case you haven't been paying attention, Europe has been mired in a serious economic crisis stemming from the various European nations' overwhelming sovereign debt loads and their perceived inability to service this debt going forward. Of course, Greece has made headlines, but there are many others including the so-called PIIGS (Portugal, Italy, Ireland, and Spain). Recently, interbank interest rates have spiked as fears mount over European banks' exposure to this sovereign debt.

As the crisis has spread, two schools of thought appear to have emerged among modern intellectuals. One side argues that these countries need to embrace "austerity", i.e., decrease spending, increase taxes, or otherwise do anything to lessen the level of indebtedness and increase the ability to service their debt. The other side, spurred on by Keynesian economists, argues that the government needs to spend even more and even be willing to print money to sustain or increase "growth." "Who would argue something so ridiculous?" you ask:

...President Barack Obama is pressing for more stimulus, not less, in the U.S. as he prepares to meet Cameron, Kan and other Group of 20 counterparts at a summit in Toronto June 26-27.

“We must be flexible in adjusting the pace of consolidation and learn from the consequential mistakes of the past, when stimulus was too quickly withdrawn and resulted in renewed economic hardships and recession,” Obama wrote in a June 16 letter to G-20 leaders.

In other words, Obama is urging them to do more of what has just led them to the brink of ruin. Enter the empiricists:

Governments have proven they can spur expansion by focusing their belt-tightening on spending cuts rather than tax increases, according to studies by Harvard University professor Alberto Alesina and Goldman Sachs Group Inc. economists Kevin Daly and Ben Broadbent.

“There have been mountains of evidence in which cutting government spending has been associated with increases in growth, but people still don’t quite get it,” Alesina said in an interview. He made a presentation to European finance chiefs on the topic during their April meeting in Madrid.
Note that these academics admit that they simply "don't quite get it," i.e., they do not understand how siphoning money from productive projects and pissing it down the sewer, known as a government's budget, does not lead to growth. Yeah, that's a real head scratcher. (p.s. I'm available to give a presentation...)

Of course, these countries need to "tighten their belts" and decrease spending. But, consider what Europeans mean by "austerity" or the donning of "hair shirts." According to this article:

Greece, as part of its broader austerity plan, has committed to bringing the minimum early retirement age up to 60 for everyone. And pension benefits for many will be reduced if they're claimed between 60 and 65.

In France, 60 is the kick-off point for most people to collect full pensions if they've worked 40 years. Those who started work in their teens can collect benefits as early as 56. But there is a proposal to raise the age to 62. French unions last week expressed their displeasure with the idea in a nationwide strike.

Gasp! The retirement age being raised to...62! Nooooo! Europe's definition of "austerity" can be likened to an alcoholic believing that cutting back to a case a day is a form of rehab. Well, one case is less than three, at least according to empirical studies.

8 comments:

Shane Atwell said...

seriously. to most of the politicians, 'austerity' means raising taxes, cutting gov't services, and leaving public employee salaries and pensions intact. the phrase they need to be acquanted with is 'dismantle the welfare state'

Mo said...

what do you mean by empiricists here?

Per-Olof Samuelsson said...

This is slightly tangential to your post, but I would like to get it off my chest:

With regard to retirement age, Sweden is better than Greece and France - but not much.

In Sweden, the legal retirement age is normally 65; but we have the option to retire as early as 61; and we also have the option to postpone retirement till 67.

Now, our government is planning to raise the lower limit from 61 to 63 (supposedly to entice older people to continue working); but they won't touch the upper limit of 67.

I can't help thinking this is sheer lunacy. To make retirement age flexible upwards is a reform that could take place even "within the current system"; it does not require some instant transition to laissez-faire capitalism. And it is simply a waste of resources not to let people work as long as they can and wish.

A retirement age of around 65 is atavistic: it made sense at a time when most people performed heavy bodily work and were often worn out at this age; today, it makes no sense at all.

Doug Reich said...

Mo,

"what do you mean by empiricists here?"

I'm referring to the dominant method in modern economics.

If someone proposed a 99% tax rate, I would say that such a tax would destroy incentive to work and kill economic growth.

The empiricist would say "I don't know what would happen unless I can study actual data from a case where there was a 99% tax rate." Then, if there were a proposal for a 95% tax rate, he would have to do another study. If no such case actually existed, he would be hard pressed to offer any conclusion at all until he had actual data.

Broadly, there appears to be this false alternative of empiricism as against rationalism. Rationalism being the theory that knowledge is "innate" or "a priori", independent of experience and empiricism being the theory that knowledge is derived from sense experience divorced from concepts. (I realize most people are a mixed bag and very few philosophers would fall neatly into one or the other...)

Objectivists see this as a false alternative and hold that knowledge is derived from integrating experience into concepts through reason.

Economics and finance specifically is dominated by empiricism. Academics in this field try and imitate physicists by treating the economy and human action as if they were molecules or atoms and applying mathematics to model their behavior. This means they tend to focus on empirical studies of data, regression analysis, etc. and offer only statistical conclusions as it relates to forecasting the effects of policy as in my example earlier. They refrain from making any broad generalizations. You can see this every day if you watch CNBC.

The only school of economics today with generally proper method is the Austrian school. Finance guys I like influenced by Austrian school would be Peter Schiff and Marc Faber and to some extend Hugh Hendry.

Let me know if that helps.

Mo said...

don't you think that those would be an unusual type of empiricists. Hume and Locke would certainly claim that you make certain generalizations based on past experience, which are not guaranteed to be true but are better or worse verified by the experiences.

Doug Reich said...

Mo,

"don't you think that those would be an unusual type of empiricists."

I think under the influence of more modern empiricists such as the logical positivists and Popper's "falsification" theory, etc. they tend to only make statistical statements, i.e., they hold nothing is "true" only more or less probable based on statistical analysis of empirical data.

The only economists that deal with cause and effect and make broad generalizations about the economic system tend to come from the Austrian school.

Doug Reich said...

Per-olof,

What are the benefits when you retire? Do they do a calculation based on your earnings or does everyone get the same? Is there such thing as private pensions in Sweden?

Shane Pleasance said...

Just introduced to your blog by a colleague here in New Zealand. Pleased to make its/your acquaintance!

Austerity measures. Hilarious. Democracy has run amok so the emperors clothes are hastily dressed down from ermine to mink.

Per-Olof. It still strikes me than ANY discussion about when you may or may not be allowed to 'legally' retire smells entirely of serfdom.