Why Politicians Ignore Economists On Austerity

simon wren-lewisI have written before about fiscal policy in the Netherlands. I have done so in part because that country has a strong macroeconomic tradition, and I regard their long standing fiscal council (CPB) as a model of how to try and get good economic analysis and evidence into the policy debate. It is therefore an indication that something is very wrong when the political consensus there follows the austerity line.

The key target for policy in the Netherlands appears to be the 3% budget deficit number that was at the centre of the old Stability and Growth Pact. The latest CPB forecasts are for deficits of 3.3% of GDP in 2013, and 3.4% in 2014. The main reason is that the economy is in recession: GDP is expected to fall by 0.5% this year (following a fall of 0.9% in 2012), and grow by only 1% in 2014. The governing coalition includes the Labour Party, and its leader Diederik Samsom says it would be unwise to sharply cut government spending in a recession. What he means by this is that they will not try and hit the 3% figure this year, but instead do so next year! After announcing austerity measures of over 2.5% of GDP in the autumn, the coalition has recently prepared a list of additional cuts totalling 0.7% of GDP. These include tax increases, a pay freeze for public sector workers and extra charges on industry.

So we have a discretionary procyclical fiscal policy, in an economy without its own monetary policy to offset its impact. The one ray of hope is that the trade unions, who have previously been prepared to discuss the details of austerity, no longer wish to do so. The FT reports  the largest labour federation as describing the cuts as “stupid and ill-advised”. The Labour Party is urging the unions to take part in discussions about the cuts, so they can – as one report puts it – “seize the opportunities offered by new measures to stimulate the economy”. This sounds a bit like asking a Christmas Turkey to talks about the recipe for the stuffing. The unemployment rate, which was 4.4% in 2011, is expected to rise to 6.5% in 2014.

So why are politicians, in the Netherlands and elsewhere, pursuing a policy that most economists regard as an elementary error? This was a question raised by Coen Teulings, who is the director of the CPB, the Dutch fiscal council. He was commenting on an IMF sponsored conference in Sweden, at which most economists argued against short run austerity when the economy was weak, and instead advocated dealing with budgetary problems through long term structural reform. The politicians in the audience, led by the Swedish finance minister Anders Borg, disagreed. He summarises their view as follows: “Politicians lack the ability to commit today to austerity measures to be implemented tomorrow. Hence, the only option is to take action straightaway.” (Borg was a driving force behind setting up Sweden’s own fiscal council, but his subsequent interaction with it has been more difficult, as Lars Calmfors and I describe here.)

Tuelings does not take this argument seriously, for good reasons. Instead he provides three suggestions as to why politicians are ignoring the economists. The first is a memory of the 1970s, when Keynesian policies were pursued because many failed to see the structural impact of the oil crisis. Politicians do not want to make the same mistake again. The second is that economists neglected countercyclical fiscal policy for too long, and therefore have failed to provide politicians with a clear guide to what policy should be, like perhaps an equivalent to the Taylor rule for monetary policy. Third, while both structural reform and short term austerity have political costs, politicians can sell the latter more easily, and success can be demonstrated more quickly.

The last argument can be partly seen as the austerity counterpart to the common pool explanation for deficit bias: structural reform can hit particular groups hard, while generalised austerity spreads pain more widely (or perhaps hits particular groups who have a small political voice). There may be something in the second argument, but there is a chicken and egg issue here. As someone who has written papers evaluating fiscal rules for a number of years, I have not noted much interest from European policymakers.

I suspect, however, that most of the interest in Taylor rules for monetary policy comes from central banks rather than politicians. I think this is a key problem with fiscal stabilisation policy: the lack of an institution that fosters research of this kind, that consolidates knowledge and pools wisdom. In my dreams I imagine a linked set of national fiscal councils that could play that role. What is unfortunately very clear is that central banks (or at least those running them) cannot do for fiscal policy what they have done for monetary policy: just look at the detailed and well formulated analysis of austerity in this recent speech (section 3.1) by the president of the Bundesbank. Returning to the Netherlands, it is no secret that the CPB is not part of the austerity consensus, while the Dutch central bank certainly is.

This column was first published on Mainly Macro

  • http://www.pogge.ca Purple Library Guy

    Well, there may be some grains of truth here, but we’re rather ignoring the elephant in the room: Class war. Most of the politicians work for the very rich, and the very rich, particularly in the financial sector, like these policies even if they’re bad for growth because they indebt the general population, because they break the unions, because they erode the power of government relative to private power, because they generally help the wealthy gain a bigger share both of money and control, even if it’s of a smaller pie.
    Doesn’t matter if austerity works as advertised, that was never the point anyway–it does the things they want it to do, they just can’t admit what the point is because nobody would vote for them if they said “We want these policies so we can put the voters at the mercy of billionaire banksters”.

  • tom

    I guess that answer is this – people are not especially happy about social democracy as a simple redistribution. Emerging middle class (we can debate how strong it is now and how much of the recent achievements has been swept out by the recent crisis, but in any case, the dream about middle class ir alive and there is nothing better) see and experience that today job market is demanding – it requires education, life-long education and improvement of skills and all this can be achievied by more effort than simply doing 35 or 40 hours a week the same tasks one year after another. There for there is no much sympathies for those that don’t want to achieve more.

    I guess that the right answer to the recent crisis should be three-fold:
    1) give more visibility to the agenda that the future of Europe requires education and sopisticated work. Give more opportunities to the people to get education, to have time for internships and skill building and also – to have resources for building social capital – it is important as well. The governments can not be anymore the accountants only that only receive taxes and take decisionas about redistributions. The governments should lead to the better, more wealthy and more sophisitcated union;

    2) the governments must support high-tech industries and must support the move of the ordinary people to better jobs. I genuinely believie that everyone has some talent but lack of material opportunities, lack of mentoring is simply push many people back. That is why there is poverty traps, so much working people with low wages. Governments should support sciences more and open them for wider competition and participation. The governments should withdraw any support for primitive businesses, it should be only good that higher minimum wage requirements simply put such primitive businesses to the death. We should look on the low-wage earners as future middle class, provide opportunities for reeducation.

    3) the governments should support smart investments – e.g.developing technologies for manufacturing, for health industry, for energy and so on.

    This is bold program and it requires from the politicians both the knowledge and also the belief in the people’s skill and will to achieve more. The support for the third-way movements was and is the clear indication that simple redistribution is no acceptable and will no be accepted.

    I guess that many left-wing politicans can be ready to accept such outlook but sometimes they (or their advisors) are not sufficiently sure about themselves and sometimes they require more push from the non-governmental organisations. But they should be aware that this push from the NGO can be missed simply because the left wing voters are not wealthy enough to participate in politics in such a capacity. the right wing trade groups are in better position to issue laud statements and to lobby for their – no less bold – interests.

    The reforms are necessary and they can happen, the left wing parties can guarantee that the social security during the reforms is preserved and that the reforms are individually tailored and don’t neglect the peculiarities of different regions, or different groups (age, gender, skills, and so on.).

    • http://www.pogge.ca Purple Library Guy

      Not a bad program as far as it goes. But I see two problems. One, the people with the money don’t want it to happen. But I’ll leave my class war perspective aside. Two, the evidence suggests that there isn’t actually a whole economy’s worth of those high-skilled jobs, and contrariwise there remains a need for low-skilled jobs to get done.

      For instance, do we want clean streets, or not? If we do, what is our excuse for underpaying the people who do stuff we want done? IMO if the education is available and cheap and connects well to the jobs, people will happily acquire the skills and do the interesting, empowering jobs–we don’t need to discipline them into it by immiserating the people who do necessary low-skill labour.

      This should probably be combined, particularly in the long term, with a shorter work week. As a recent article around here pointed out, technology is gradually eroding the need for work–and that includes not just in manufacturing production but much work we would have considered “skilled” pretty recently. Software marches on.

  • tom

    Just wanted to clarify two points.

    The first point – maybe it is good to reduce some wages, to lay back people that are on the government payrolls or in inefficient and failing business. But all this should come together with the opportunities for reeducation and building skills. And it is the responsibility of the left wing parties and governments that austerity is always complemented with these support measures;

    The second point – EU is already quite bold about its future (there was Lisbon strategy, now there is Agenda 2020) as a sophisticated knowledge-based community. The problem is created by some member countries that are quite happy to be internal China (the China as it was some 10-20 years ago, to be sure) for the European companies, to be the destination of near-sourcing. EU member countries should discipline such primitive countries more. Such primitive countries can sometimes achieve quite spectacular numerical results – like large GDP increses (against low base, to be sure), low inflation readings and balanced budgets, but usually such countries neglect the necessities of the ordinary pepole and almost always such countries are to fond to primitive businesses. That is way such primitive countries should be brought into the limelight and the discussion should be held – are they shareing the common and basic values of this union and this society. Such discussion can help to clarify the internal discussion in each country as well – when the people from the good part of the Europe will be able to the the possible future of the full scale non-hedged austerity then they will be more prone to more elaborate solutions.

  • HEIL GAP
  • http://twitter.com/lbsterling Toby Sterling (@lbsterling)

    I just think that this only touches tangentially on the real reasons Dutch why politicians are ignoring what economists are telling them about austerity.
    The real reasons:
    1) They don’t believe it.
    There may be some cognitive dissonance at work, because they don’t *want* to believe it (below), but also Keynsian fiscal policy seems counter-intuitive to the politicians and certainly to the public.
    2) They have a much bigger interest in making the euro work; and thus they are willing to go along with austerity in any case, simply because austerity in Southern Europe is a sine qua non for Germany to remain involved in the euro.

    And there there are dual issues, first that there is a reflexive public resentment against Southern Europe that no German (or Dutch) politician has dared to counter. Rather, they have encouraged it. Now it would be political suicide to depart from the course they’ve charted, especially in Brussels.
    And secondly, somewhere in the German (and Dutch) economic establishment there truly is a fundamental rejection of Keynsian theory. Simply put, it’s seen as short-termism.

    3) Finally there’s Dutch political cycle. There’s an old chestnut here that says that the smart way for incumbents to operate is to make any spending cuts early in a term, when one can afford to be unpopular, and then to begin reversing them toward the end, when new elections are in sight.

    The current Cabinet is only several months old.