In 2010, two Harvard professors, Carmen Reinhart and Kenneth Rogoff, published a hugely influential paper, Growth in a Time of Debt, which claimed that economic growth falls off a cliff once a country’s debt to GDP ratio passes a threshold level of 90%.
The paper was deemed so significant that it was quickly being cited by doctrinaire politicians in the two biggest economies in the world, the US and the EU, as the rationale to persist with crippling austerity measures. Last year, Republican congressman Paul Ryan referred to its “conclusive empirical evidence” when advocating swingeing public spending cuts in his 2013 budget proposal. On this side of the pond, UK finance minister George Osborne was adamant the research had “demonstrated convincingly” the case for austerity.
The EU’s economic and monetary affairs commissioner, Olli Rehn, in a letter to EU finance ministers in February, said the “widely acknowledged” 90% threshold provided the impetus to continue with relentless cuts.
Mr Rehn endorsed their paper as recently as Apr 9, when he said the authors’ “serious empirical research” had definitively shown the 90% debt figure “acts as a permanent drag on economic growth”.
Imagine those politicians’ surprise when a graduate student, Thomas Herndon, last week revealed that the study was so replete with basic errors that a freshman college student would have been embarrassed to publish it. Herndon, working with two others, found that the report was stuffed full of coding mistakes and dubious methodological practices that “lead to serious errors which inaccurately represented the relationship between public debt and GDP growth.”
In short, the study is a crock and the 90% debt threshold is a myth. Reinhart and Rogoff were adamant that once the magic 90% figure was reached, a country’s GDP growth level would shrink by -0.1%. Herndon, after adjusting for their errors, has shown that the correct figure is 2.2%.
The difference is so startling that at least one prominent economist was prompted to ask, “how much unemployment was caused by Reinhart and Rogoff’s arithmetic mistake?” Quite a lot, as it happens, considering unemployment in the economic wasteland of the Eurozone is at a record 12%, but perhaps the luckless Harvard economists shouldn’t shoulder all of the blame. Last year, it was the turn of the IMF to be red-faced after it was revealed that they had seriously underestimated the impact of savage spending cuts on fragile economies. The IMF had calculated that €100 of austerity would cost the economy €50 in lost growth and unemployment, a price that was deemed worth paying. Regrettably, they also got their sums wrong and underestimated the devastating impact of austerity by a factor of up to three — meaning every €100 gouged from budgets costs an estimated €90 to €150.
This revised ratio perhaps explains why an ashen-faced Mr Osborne recently had to tell MPs that his chances of meeting his debt targets had “deteriorated” after the UK’s debt level rose from 85.5% of GDP, at the end of 2011, to 90% in December, despite his unrelenting adherence to austerity.
While Mr Osborne would prefer to wreck the economy rather than risk his reputation by admitting he is wrong, politicians in the rest of Europe may finally be willing to concede that austerity has been an unmitigated disaster.
On Monday, European Commission president Jose Manuel Barroso, echoing an earlier speech by Social Protection Minister Joan Burton, announced that austerity has “reached its limits in many aspects”.
Perhaps it was Citigroup’s latest forecast, which said the eurozone would remain in recession until the end of 2014 with a “quasi-slump” dragging on until 2017, which acted as the wake-up call. Or maybe it was the dire warning from Bill Goss, an unabashed capitalist and manager of the world’s largest bond fund.
“The UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not. You’ve got to spend money,” he urged.
The only mystery is that it’s taken this long for politicians to survey the wreckage of European economies and finally, tentatively, concede that they sacrificed their own citizens in pursuit of a failed ideology. Hell, even Angela Merkel has seen the light. Speaking last week, she drily noted; “there is nowadays much talk about austerity. That is of course not good in the long run”. The only problem is, she’s wrong. Expansionist policies are used to drag countries out of recession in the short run while, in the long run, prudent budgeting ensures economies remain stable.
Or, in the words of the authors of the Reinhart/Rogoff takedown: “Government deficit spending, pursued judiciously, remains the single most effective tool we have to fight against mass unemployment caused by severe recessions.”
The jettisoning of this fundamental economic tenet, and the stubborn refusal to revise that myopic decision, has come at a huge cost to society. Greece is a case in point. Unemployment has risen from 7.2% in 2007 to over 27% today, while youth unemployment stands at a whopping 60%. Household income is down an average 38% since the crisis began, basic health care, which is no longer universal, is an unaffordable luxury for many while suicides have increased by 40% in just two years.
MEANWHILE, in Ireland, which is now officially back in recession with an unemployment crisis that the IMF recently called “staggering”, Minister Brian Hayes, instead of attacking cuts, launched a tirade against “failure addicts” who dare to point out that the austerity emperor has no clothes.
Perhaps Mr Hayes thinks we should measure his Government’s success using metrics like suicide, depression, homelessness, domestic violence, inequality and the at-risk-of-poverty rate, all of which are escalating at unprecedented rates.
The minister may think that only “failure addicts” draw attention to the fact that policies and perceived wisdoms are demonstrably wrong, but actually, that’s the mark of a good politician.
His alternative sounds a lot like a bunch of sycophantic yes men, nodding dogs in the back of a car that’s being driven off a cliff. While one can understand the troika painting Ireland as austerity’s one success story, Europe’s lucky charm, the willingness of some within Government to connive in this patronising fiction, given the scale of the crisis here, is truly bewildering.
The mystery is not that a debate about austerity has started, or that a shift in policy seems to finally be on the horizon in Brussels, the only mystery is that it’s taken this long and that some members of Government don’t appear to want to take part and reap the benefit.