The Many Errors of His Ways …

An editorial by well-known leftist economist Joseph Stiglitz has recently been published in the Guardian, entitled “Austerity has been an utter disaster for the euro zone”.

Before we are taking a closer look at it, we want to stress that we also believe that the EU’s approach to economic policy is worth criticizing in many respects. Just because we believe that Mr. Stiglitz is essentially an economic crank doesn’t mean that we disagree with every criticism of the so-called “austerity” policy as pursued by the EU. Below are several excerpts from his article with our comments interspersed.

“If the facts don’t fit the theory, change the theory,” goes the old adage. But too often it is easier to keep the theory and change the facts – or so German chancellor Angela Merkel and other pro-austerity European leaders appear to believe. Though facts keep staring them in the face, they continue to deny reality.”

The “old adage” is actually a well-known bonmot by J.M. Keynes – curiously, Stiglitz doesn’t mention that. Although it has merit with respect to the natural sciences, it does not apply to economic theory, which is a science of human action and not a study of inanimate objects without volition. Theorems of economics cannot be proved or disproved with “empirical data”. We do e.g. not need empirical data to prove the truth of the theorem of marginal utility, or to create a price or value theory, or to prove the truth of the law of association, etc.,etc..

All of these economic laws have been discovered by inner reflection and the process of logical deduction. They are only “empirical” in a Thomist or Aristotelian sense (for a detailed explanation of this point of view, we refer readers to Rothbard’s monograph In Defense of Extreme Apriorism -pdf).

To put it differently: one can use economic theory to explain the facts of economic history, but one cannot use economic history to argue for or against points of economic theory. If we look at economic statistics, we see that every slice of history is slightly different, as the contingent data, which are always extremely complex and varied, are different in every case. And yet, the same economic laws have time and place-invariantly operated in every instance and will continue to do so for all eternity, or at least as long as there are human beings who can act with purpose. Stiglitz continues:

“Austerity has failed.But its defenders are willing to claim victory on the basis of the weakest possible evidence: the economy is no longer collapsing, so austerity must be working! But if that is the benchmark, we could say that jumping off a cliff is the best way to get down from a mountain; after all, the descent has been stopped.

But every downturn comes to an end. Success should not be measured by the fact that recovery eventually occurs, but by how quickly it takes hold and how extensive the damage caused by the slump.

Viewed in these terms, austerity has been an utter and unmitigated disaster, which has become increasingly apparent as European Union economies once again face stagnation, if not a triple-dip recession, with unemployment persisting at record highs and per capita real (inflation-adjusted) GDP in many countries remaining below pre-recession levels. In even the best-performing economies, such as Germany, growth since the 2008 crisis has been so slow that, in any other circumstance, it would be rated as dismal.

The most afflicted countries are in a depression. There is no other word to describe an economy like that of Spain or Greece, where nearly one in four people – and more than 50% of young people – cannot find work.”

(emphasis added)

First of all, “austerity” is really only a buzzword. Below are two charts showing euro area-wide government spending in absolute terms, and aggregate budget deficits relative to economic output. Government spending in the euro area remains at record highs to this day. On an aggregate basis, it has merely not grown further since 2010 – as several governments in the periphery have simply gone bankrupt and were indeed forced to cut their spending. In many other countries, government spending has continued to grow.

Government spending in the euro area: stuck near record highs over the past four years – click to enlarge.

As a percentage of GDP, euro area budget deficits since 2008 have been the highest in 30 years – click to enlarge.

We are not quite sure why everybody insists to continue to call record high government spending “austerity”. In fact, there has been an implementation of austerity in a sense, but mainly the private sector has been subjected to it, as taxes were raised across the board almost everywhere, especially in France, Italy, Spain, Greece, Ireland and Portugal. A number of EU governments also simply grabbed their citizens’ private pension funds and nationalized them. Most have studiously avoided to actually shrink the size of government, and have instead decided to impose fresh burdens on the already reeling private sector.

Mr. Stiglitz is correct when he states that there is an economic depression in Greece. But this is not the result of “austerity”, it is simply the mirror image of the preceding boom, during which capital has been malinvested on a vast scale and the government has squandered scarce resources with both hands. The bust and depression are nothing but the unmasking of capital consumption and losses that have actually been made a long time ago already.

We are also not quite sure what Mr. Stiglitz expects the Greek government to do. Let us not forget, Greece’s government went bankrupt, and de facto, it remains bankrupt even now. How is a bankrupt government supposed to increase its spending? This is akin to berating a panhandler because he hasn’t rushed into the show rooms to buy the newest Ferrari. It makes no sense whatsoever.

A Look at Some of the “Evidence”

As regards the “evidence” which Mr. Stiglitz incessantly invokes, we will take a look at some of it below. In actual fact, a number of countries that have not only cut their government spending, but have also implemented the very kinds of economic reforms Mr. Stiglitz would sotto voce deride, today exhibit the best economic performance in the EU. Especially noteworthy are the Baltic nations in this context, but to a lesser extent also Spain.

If the idea were correct that a decline in government spending causes economic failure, this would ipso facto be impossible. Spain has been outperforming France for the past several quarters. Now, we believe that Spain has not done enough in terms of economic reform by a long shot; its recent recovery may well prove unsustainable as a result.

However, contrary to France, it has actually cut government spending, and has definitely liberalized its economy to some degree, mainly by reforming its labor laws and making life easier for businesses in other respects as well – in other words, Spain has done precisely what Mr. Stiglitz believes is leading to failure, while France has done precisely what he believes to guarantee success. So let us take a look where things stand by his own criteria.

First up, that socialist paradise, France. We are looking at three data points: government spending in absolute terms, GDP growth and the growth in industrial production (which we believe is actually a better reflection of the underlying economic situation than GDP growth).

French government spending continues to make new record highs every quarter. Note that the current level is about 12% above the levels of 2007, at the peak of the boom – click to enlarge.

French GDP growth is going nowhere, in spite of the steady increase in government spending – click to enlarge.

Industrial production in France is an ongoing catastrophe – click to enlarge.

And now the same three data points in Spain – note here that Spain suffered the collapse of one of the biggest real estate bubbles in the history of mankind. The country’s overall economic situation is still far from regaining any semblance of normality. We merely want to demonstrate that what Mr. Stiglitz alleges not to be possible – namely that the economy of a country in which government spending has been cut can outperform one in which the opposite has happened – is in fact occurring at this juncture. Of course, the contingent data are an important factor: one of these countries has reformed its economy by liberalizing it somewhat, while the other has – so far – done the exact opposite.

Spain’s government spending has declined – not by much, but this is still a big contrast to what has occurred in France – click to enlarge.

Spanish GDP growth was in the dumps for quite some time as the real estate bubble collapsed. However, it is recently accelerating instead of remaining stuck at zero as is the case in France – click to enlarge.

Spain’s industrial production growth is quite a contrast to France’s as well at present – click to enlarge.

Now, it is easy to understand why cutting government spending cannot possibly be bad for the economy. In fact, government spending is a burden for the economy, as it tends to consume and waste scarce resources. As Ludwig von Mises pointed out in Human Action:

“At the bottom of the interventionist argument there is always the idea that the government or the state is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes.

This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrineand enthusiastically endorsed by all those who expect personal advantage from government spending.

As against these popular fallacies there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens’ spending and investment to the full extent of its quantity.

While government has no power to make people more prosperous by interference with business, it certainly does have the power to make them less satisfied by restriction of production.”

(emphasis added)

All of this should be blindingly obvious. Apparently though it isn’t to Mr Stiglitz, who has actually won a Nobel Prize in economics (this is most of the time a kind of contrary indicator actually). We would guess that he probably wouldn’t win any prizes for his displays of common sense.

The Ivory Tower Perspective

What follows next shows that Mr. Stiglitz has apparently not really looked at France’s economic data in a very long time. He believes that a government that is spending a record 58% of GDP every year – more than any other government in the allegedly capitalist countries – and that is well-known for having instituted the highest tax rates in Europe and having put in place the most onerous business regulations imaginable, is a paragon of “pro business austerity”!

To say that this is utterly ridiculous is the understatement of the century. How can one make such an assertion and keep a straight face? Hundreds of thousands of young entrepreneurs have fled France for more business-friendly places such as the UK, because they simply felt they could not operate in France’s extremely hostile business climate. If this is “pro-business austerity”, we would really hate to see the implementation of whatever Mr. Stiglitz has in mind as an alternative. What does he want? A complete socialist Zwangswirtschaft run by bureaucrats?

“France voted to change course three years ago. Instead, voters have been given another dose of pro-business austerity. One of the longest-standing propositions in economics is the balanced-budget multiplier – increasing taxes and expenditures in tandem stimulates the economy.And if taxes target the rich, and spending targets the poor, the multiplier can be especially high. But France’s so-called socialist government is lowering corporate taxes and cutting expenditures – a recipe almost guaranteed to weaken the economy, but one that wins accolades from Germany.

Cutting taxes for business will “weaken the economy”? On what planet? Is Mr. Stiglitz unaware of the fact that France has introduced a 75% marginal tax rate for high income earners, which is in fact the highest in the world?Stiglitz should in fact explain to us why the sure-fire “success” of this policy in France is so conspicuous by its absence (since he asserts above that raising taxes on the rich will “boost the economy”!). Stiglitz is evidently making up stuff out of whole cloth so he can proceed to knock down straw-men.

One doesn’t necessarily need to have experience in running a business in order to have an opinion on business matters. However, anyone who has struggled with establishing a small business in hostile bastions of socialism in the EU such as France – and many others, it must regrettably be said – will probably be incredulous upon reading the following:

The hope is that lower corporate taxes will stimulate investment. This is sheer nonsense. What is holding back investment (both in the United States and Europe) is lack of demand, not high taxes. Indeed, given that most investment is financed by debt, and that interest payments are tax-deductible, the level of corporate taxation has little effect on investment.

This is spoken like a life-long leftist academic and bureaucrat who has never created one iota of real wealth in his life, who has never taken any personal risk or ever had to worry about paying someone else’s wages. Anyone who has ever taken the risks about which Mr. Stiglitz evidently knows nothing will confirm how utterly misinformed this comment is. In Europe, the entrepreneurial spirit has been completely crushed in many places due to extremely high taxation and massive over-regulation. And yet, how does Stiglitz believe new wealth is going to be produced? It’s not going to drop from the sky, that much is certain.

The problem of a “lack of demand” exists only in the heads of Keynesians like Stiglitz, who believe one can spend oneself to prosperity. As long as there are unfulfilled human wants, demand is practically without limit. The question is only whether one can actually pay for one’s demand. In order to do so, one must first produce something. It is savings, investment and production which lead to economic growth, not “spending”. Contrary to what Stiglitz asserts, all of these can indeed be promoted by cutting taxes and cutting the burden of government spending.

Finally, Stiglitz cannot refrain from reminding us of his hostility to private property by deriding the planned privatization of inefficient government-run businesses in Italy and lauding its prime minister for not moving forward with the necessary reforms. This is by the way typical leftist fare in the sense that the Left believes strongly in stagnation (curiously, it nevertheless calls itself “progressive”). In all leftist screeds beginning with Marx, the economy is regarded as some sort of static fixed pie, which the “classes” are waging war over, and which the bien pensants must “redistribute” once they have come to power.

“Likewise, Italy is being encouraged to accelerate privatization. But prime minister Matteo Renzi has the good sense to recognize that selling national assets at fire-sale prices makes little sense. Long-run considerations, not short-run financial exigencies, should determine which activities occur in the private sector. The decision should be based on where activities are carried out most efficiently, serving the interests of most citizens the best.”

We would really like to know which types of business activities are carried out “more efficiently” by governments. Is there any evidence for something like this anywhere, at any time in history? Stiglitz denounces the costly US health care system as an example of private sector inefficiency in his editorial – however, the health care sector in the US is one of the most highly regulated sectors of the economy, and is light years away from even remotely resembling a free market. If anything, it is an excellent example for the inefficiency and waste of government interference in the economy – in other words, it is yet another straw-man.

Socialist “new” Keynesian economist Joseph Stiglitz

(Photo via Bloomberg | Getty Images)

Conclusion:

There is a danger that due to the failure of Europe’s economy to gain traction, loopy ideas such as those Stiglitz is promoting will gain in support, in spite of their utterly dismal record. Most people thing about economics only in the most superficial terms, and superficially, Keynesian recipes may actually appear appealing to many people. They seem to offer an easy way out. The reality though is that these interventionist policies have failed whenever and wherever they have been tried, because the theory they are based on is unsound (we are trying to be polite about it). This is not to say that there are not a great many things worth criticizing about economic policies in the EU – there most assuredly are. However, non-existent “austerity” is definitely not one of them.

Charts by: Tradingeconomics