As a follow-up to my last post "Economic Non-Sense and the Deepening Crisis in Greece" and before I review the German blueprint for the labor market reforms imposed on Greece in the next post, I think it is important to share with you a Manifesto for Economic Sense I recently found and signed. Written and supported by some of the best economists on the planet, the Manifesto underlines the seriousness of the current economic situation and debunks the old 1930s style arguments put forward by the Very Serious People in power as a justification for their austerity policies and the massive suffering inflicted upon their peoples:
[original text, mark-up added by this blog's author]
More than four years after the financial crisis began, the world's major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.
These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.
The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions - other than Greece - this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but - just like the similar response of debtors in the 1930s - it has proved collectively self-defeating, because one person's spending is another person's income. The result of the spending collapse has been an economic depression that has worsened the public debt.
The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that's exactly what many governments are now doing.
The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn - focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing and exacerbating the dampening effects of private-sector spending cuts.
In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy - while it should do all it can - cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.
How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.
The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.
But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.
Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMF's study is clear - budget cuts retard recovery. And that is what is happening now - the countries with the biggest budget cuts have experienced the biggest falls in output.
For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment. So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.
The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side - by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.
In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.
As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.
Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem.
We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at www.manifestoforeconomicsense.org and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.
Signed By
Aaron Goldzimer - Stanford Graduate School of Business / Yale Law School
Alan Manning - London School of Economics
Alan Maynard - University of York
Alan S. Blinder - Princeton University
Alasdair Smith - University of Sussex
Alfonso Lasso de la Vega - Former Deputy Director in UNCTAD
Ali Rattansi - Professor, City University, London
Andrew Graham - Oxford University
Barbara Petrongolo - Queen Mary University and CEP (LSE)
Barbara Wolfe - University of Wisconsin-Madison
Barry Bluestone - Northeastern University
Barry Supple - University of Cambridge
Charles Wyplosz - The Graduate Institute, Geneva
Chris Pissarides - London School of Economics and Political Science
Christian Kroll - University of Bremen / Jacobs University
Christopher Allsopp - Director, Oxford Insitute for Energy Studies, Oxford
Colin Thain - University of Birmingham, UK
David Blanchflower - Dartmouth College
David Hemenway, economist - Harvard School of Public Health
David Sapsford - Edward Gonner Professor of Applied Economics (Emeritus), University of Liverpool
David Soskice - University of Oxford
David Vines - Oxford University
Demetrios Papathanasiou - The World Bank
Donald R. Davis - Columbia University, Dept. of Economics
Eric van Wincoop - University of Virginia
Erzo F.P. Luttmer - Dartmouth College
G C Harcourt - University of New South Wales, School of Economics
Gary Mongiovi - St Johns University, New York
Geoffrey M. Hodgson - Professor, University of Hertfordshire, UK
Geraint Johnes - Lancaster University
Gianni Zanini - World Bank (Consultant; former Lead Economist)
Hannes Schwandt - CEP/LSE and Universitat Pompeu Fabra
Heinz Kurz - University of Graz, Austria
J. Bradford DeLong - U.C. Berkeley
Jan-Emmanuel De Neve - University College London & LSE Centre for Economic Performance
Jeffrey Frankel - Harvard University
Jeremy Hardie - LSE Centre for Philosophy of Natural and Social Science
Joan Costa Font - London Sschool of Economics
Jocelyn Boussard - European Commission
John H Bishop - Cornell University
John Van Reenen - Centre for Economic Performance, LSE
Jonathan Portes - National Institute of Economic and Social Research
Joseph Gagnon - Peterson Institute for International Economics
Justin Wolfers - Princeton University
Kalim Siddiqui - Business School, University of Huddersfield, UK
Ken Coutts - Faculty of Economics, University of Cambridge
Kevin ORourke - University of Oxford
Larry L Duetsch - Emeritus Prof of Econ, U of Wisconsin - Parkside
Lesley Potters - European Commission
Marcus Miller - Warwick University
Mariana Mazzucato - University of Sussex
Mark Setterfield - Trinity College, Connecticut
Mark Stewart - Warwick University
Max Steuer - London School of Economics
Michael Ambrosi - Professor Emeritus, University of Trier
Michael Graff - ETH Zurich and Jacobs University Bremen
Michael Waterson - University of Warwick
Nathan Cutler - Harvard Kennedy School
Nattavudh Powdthavee - University of Melbourne and Centre for Economic Performance, London School of Economics and Politcal Sciences
Nicholas Rau - University College London
Olaf Storbeck - Handelsblatt - Germanys Business and Financial Daily
Oriana Bandiera - London School of Economics
P.E. Hart - Emeritus Professor of Economics,University of Reading
Patricia Rice - University of Oxford
Paul Anand - Open University/ HERC Oxford University
Paul Gregg - Professor, Dept of Social and Policy Sciences, University of Bath
Paul Krugman - Princeton University
Paul Whiteley - University of Essex
Peter E. Earl - University of Queensland
Peter Elias - University of Warwick
Peter J. Hammond - University of Warwick
Peter Taylor-Gooby - University of Kent
Peter Temin - MIT
Philip Arestis - University of Cambridge
Philippe Martin - sciences po (paris)
Professor Sir Richard Jolly - Institute of Development Studies
Raffaella Sadun - Harvard Business School
Raja Junankar - University of New South Wales, University of Western Sydney, and IZA
Raquel Fernandez - NYU
Richard J. Smith - Faculty of Economics University of Cambridge
Richard Jackman - London School of Economics
Richard Layard - LSE Centre for Economic Performance
Richard Murray - former chief economist, Swedish Agency for Public Management
Richard Parker - Harvard University
Rick van der Ploeg - University of Oxford
Robert A. Feldman - IMF and Adjunct Professor Georgetown U. (retired)
Robert H. Frank - Cornell University
Robert Haveman - University of Wisconsin-Madison
Robert Neild - Emeritus Professor,Trinity College, Cambridge
Robert Pollack - Boston University
Robert Skidelsky - Wawick University
Roger Middleton - University of Bristol
Roger Stephen Crisp - St Annes College, Oxford
Ronald Schettkat - Schumpeter School, University of Wuppertal
Sergio Rossi - Department of Economics, University of Fribourg, Switzerland
Shaun P. Hargreaves Heap - University of East Anglia
Sheila Dow - University of Stirling (emeritus position)
Simon Wren-Lewis - Oxford University
Stefan Szymanski - University of Michigan
Stephen E. Spear - Carnegie Mellon University
Stephen Gibbons - London School of Economics
Susan Himmelweit - The Open University, UK
Terry Barker - University of Cambridge
Tony Venables - University of Oxford
Victor Halberstadt - Leiden University
Wendy Carlin - UCL
William Brown - University of Cambridge
William T. Dickens - Northeastern University and The Brookings Institution
Recent Comments
- This manifesto points clearly what is important and what is not to overcome the deepening of current crisis. I agree with it in 100%
Rafał Tenerowicz
- Fully agree with Krugman and Layard.Austerity programme may not be the prime cause of the contraction in demand but it has clearly exacerbated the problem and at a time when the private sector is cutting back on demand will clearly prove to be self-defeating.
Roy Thomas
- I have been reading Krugmans column for years, and wish that it was required reading for politicians. I hope that this succeeds!
Donna Stone
- The real test for economic policy is whether it works in the real world. The results are in and Keynes was right.
Robert Michlowitz
- The people at the bottom need hope. The system will get to breaking point without a change. We must move towards greater equality or there will be real trouble. This manifesto is somewhere to start from. Good luck.
Philip Martin
- In these, what should be enlighted times, I can but wonder how policy makers fail to see the evident truth. Especially considering the past experiences from the 1930s. This manifesto is well formulated and hopefully it will have an impact on our policy makers.
Klaus Salonen
- Very good idea. Every professional economist, regardless of political persuasion, should join this effort.
Max Johns Sr, PhD
- I may not be a professional economist, but the need for a sensible countercyclical fiscal policy, based on long-term stability rather than short-term gain, is not exactly rocket science.
Brian Thomson
- Right on! Thank you so much for this Manifesto of Good Sense. I am not an economist, but I can see that austerity is the opposite of what our country and the world needs now. Onward with common sense for Economic Sense!
Lauren Teixeira
- Many people who favour smll government are using the crisis as an argument for reducing the role of government, regardless of the consequences. Either they do not care about unemployment, or have an absurd faith that private demand is always forthcoming. It is clear that grinding the economy down is not a way to reduce public debt.
Max Steuer
- I have watched for 22 years "Demand" reduce , i am not an economist ,I am one of those people who contribute to the data ,In my state (NJ) there are only a handful of independent bedding stores left ,I am one of them , is that enough credibility for this statement ?
Anthony Benyola
- I agree with the bulk of your argumentation, although I think in this crisis there is a high proportion of vested interests in its origin.
Alfonso Lasso de la Vega
- I agree with the broad thrust and the depression concern underscored in the manifesto. However, as usual the devil might be hiding in the details. I for one would have liked to see some discussion on the importance of the composition of demand. Consider the case of Turkey, not an advanced one, but a largish emerging economy which pulled of an impressive growth record amidst a global recession. This is attributable to the surge in internal demand and was facilitated by the ability to finance large current account deficits. During this time the government followed prudent fiscal and monetary policy, and improved tax collection. Wisely it did not follow the stricter austerity proposals of the IMF but did not try to stimulate demand either. The growth was accompanied by a real estate boom and an unprecedented increase in private borrowing. These developments provide the markings of a bubble. This particular combination of internal demand surge and deficit financing strikes me as something which is not sustainable. Returning to the manifesto, I have to ask "building what?"
insan tunali
- I don believe those who favor austerity to foster growth are being honest. What they really want to do is "starve the beast" and thus foster less government. Oh, I wish these issues were publicly debated with people stating their real intentions.
Brian McGihon
- Excellent proposal and a great idea in general agree with the manifest
Eduardo Ramírez Cedillo
- It is indeed crucial to give these arguments a higher profile in the public debate. Its a piece of enlightenment in times of obscure moralist reasoning and growing nationalist reflexes.
Andreas Fischer-Barnicol
- The arguments and analysis contained in this Manifesto are substantive and, more importantly, sensible. Simply put, if the private sector balks, then it is up to the government to step in to get the ball rolling again and this means unleashing capitol. If both balk, then disaster ensues.
Adrian Panaro
- I fully agree with the contents and objectives of this manifesto. Time as come to put an end to this insanity that is driving the world economy (and our social organization) to the ground.
Vivaldo M. Mendes
- My coauthor and I have introductory text (McGraw-Hill-Ryerson) that has been Keynesian throughout its 7 editions.
John E Sayre
- I thought at first this time would be different from the thirties because we had learnt that lesson. But its now quite frightening.
Michael Phelps
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