Fact # 9: Austerity had a recessionary impact and damaged the potential GDP growth

[If you have read ANY of the Facts #1 through # 8 of the current series, you have already read the premise. Thus, you should skip it and proceed to read Fact # 9 below]

Premise

On October 5, 2014  I decided I should embark on writing a series of short newspaper-like articles with the goal of attracting attention to explanations of the current situation of the Italian economy alternative to the ones offered by the (overwhelmingly neoclassical) austerity lovers. While I had not planned to publish both in Italian and in English, the ‘likes’ I got on the first three pieces in Italian convinced me that I should go the extra mile and publish them in English as well.

Of course, ‘likes’ on socials are not the only reason to publish in English. My preoccupation is that even many foreign colleagues of valor tend to adhere, along with the foreign general public, to judgments about the Italian economy that are not facts at all but, rather, judgments presented as facts. I thought it would be worthwhile to alert colleagues and public alike: when reading austerians, please take what you read cum grano salis, my friends!

And here is Fact # 9:

IT IS NOT TRUE that austerity is the means through which we are achieving gradual reduction of public debt as well as an improvement of the economy in general. This is a truth that good economic theory, which goes along well with common sense, has been saying, is saying, and will keep saying. Any arguing to the contrary in ideology, not science.

In order to avoid boring www.scenarieconomici.com readers to death, I will not go into the good old theory, or the old good common sense that goes along well with it, and remind everybody that there are just four engines available to jumpstart our economies. All of them, obviously, demand-side engines, demand being that factor in the absence of which firms at first slow production down and then shut down entirely (the path followed from the first to the second depends very much on country-specific legislation and firm-specific factors, but the story is easily told anyway: reduction of overtime, turnover repeal, early retirement, unemployment compensations, and the…And, of course, throughout the entire process aggregate demand falls because incomes fall, and the recession processes reinforced at every step).

The four engine that could in principles be fired up are household consumption expenditures, firms’ expenditures for investment goods, foreign demand for domestically produced goods, government. That households and firms may increase expenditures during a prolonged period of recession and stagnation is something that only those who have religious faith in markets can believe (the same way one believes in Snow White. More noble usages of the verb are not called into use for the purpose of this discussion). As to exports, it is hard to believe that ‘they’ will buy eagerly our goods and services, given that ‘they’ have problems of their own and would rather export themselves than import from us. (Data supports all this, of course). Only governments are left.

However, European governments do not intend to spend. Not since 2008. Rather, since 2009 they have adopted a new religion, that of balanced budgets and debt reduction. Good: has anybody seen government debts falling? Do you remember Professor Monti’s government? Do you remember its stated objective, debt reduction? Well, I am not going to supply you with the numbers, all I shall give you is advice: data are available and easily accessible, go and seek them to answer the following question: how much was Italian government debt before and after Monti? (Same story for Letta or Renzi, of course, the prime minister’s name makes no difference; they are all austerians who have increased the level of debt and the debt/GDP ratio!). While you do that, please, do not forget that good economic theory (a well as good common sense) says that attempts to debt reduction through current expenditure reduction (yes, even when it consists of ‘wasted expenditure reduction’ about which many market believers raise a lot of fuss), a recession will be induced (actually three recession in Italy between 2008 and today), all of which will reduce the tax base and lead to an increase of the debt/GDP ratio.

Which is exactly the story that figure 1 tells us. The interesting insight from which is that history matters, not same-time differences: what matters is not so much who is on top and who below at any point in time, but rather the different behaviors in the grey and the white areas. No real comment is need, just this: if it were true that ‘markets’ se are careful at evaluating the debt/GDP ratio as the criterion to select countries whose governments are ripe for attack and destruction, then … #Congratulazioniausteri!

Fact9-Figure1

Somebody will ask: all right, debt/GDP has been growing while the austerians were saying it would shrinking; but let us see the correlation with growth! Well. Here it is.

Fact9-Figure2

Ok, ok, somebody will say: but all you are saying does not imply that the same story will go on forever, right?  Or, in slightly more technical terms: the short-run, impact effect of austere policies is contractionary on the level of economic activity, but do they have a negative impact on the growth of potential GDP, that is, on what we can potentially produce? In other words still: are austerity measures likely to generate a long-lasting effect, a structural effect?

Beautiful question and a difficult one to answer. So, I leave the answer to Larry Ball and Paul Krugman. Want the long and the short of it (figure 3): yes, austerity measures are damaging our long-run growth potential irreversibly.

#Congratulazioniausteri!

Fact9-Figure3

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