Monday, 4 March 2013

Why politicians ignore economists on austerity

I 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.


  1. I've thought about this a lot lately myself. Maybe I'm just cynical, but I lean towards a more venal explanation. In any sort of economic recovery, there will be some increase in inflation. Properly managed, that isn't necessarily a problem... during a recovery, one would expect wages to recover also, and as long as inflation stays below that, the recovery can continue. But there is still a risk of sudden, short-term spikes. And if you're an exceedingly wealthy person, that means a lot more to you net-value-wise than it does to a more middle-class income.

    My gut feeling is that the exceedingly wealthy in various countries have given marching orders to their politicians of choice that even the _risk_ of short-term inflationary spikes is not to be tolerated. This gives them little alternative to anti-Keynsian austerity measures, just to show that they're "doing something" about the problem, even though it's the wrong problem...

  2. derrida derider4 March 2013 at 22:57

    Bluntly, central bankers are bankers. A Marxist would say they have the same class interest as private bankers - sound money is everything for them because that's the source of their power. It is much less painful for them to sacrifice other's prosperity than run even the slightest risk of making money marginally less sound. This has been the case since at least the 18th Century, and all the debates and vicissitudes since then have not altered it.

    Plus don't underestimate the feeling of many people, even voters, that if something is painful it must be doing you good. You never hear of nice tasting medicinal potions for that reason - the nastier the stuff tastes the more it sells.

  3. Dutch economic policy is in more ways a disaster.
    Partly caused by the PM Rutte who really hasnot got a clue about it and so do the cabinet members/MPs of his party. Nearly all their policies look counterproductive not only the Keynesian stuff, whatever you may find of these. And roughly same for Dutch Labour (use more to press through their political ideas than that it makes sense). The French president is not withoiut reason called Hollande.

    - They are kicking out the bottom of the RRE market, while pre crisis the tax sytem forced everybody to max their mortgage. Moving to 100000s people close to getting under water; banks have a problem; guaranteefund possibly hugely underfunded; construction basically killed off.

    - Austerity goes mainly via tax increases. Usually hardly succesful.

    - Trying to equalise incomes which didnot have a good result in especially the PIIGS.

    - Pensions are under heavy pressure and are cut (because of lower yields because CB policies). Uncertainty with the aging population, percentages of 10s of % are going over the media, not the way to get consumption started.

    But like not going countercyclical it has nothing to do with economics. Just find a theory that suits their political purposes (except for the pensioncuts btw).

    1. CPB is losing its reputation of a truly independent agency and will most likely be more and more ignored. They profile themselves a bit like yourself or Krugman (lefties with beard) and these are more or less per definition suspect with the other half of humanity (whether they are right or wrong and at least if they keep selling their views in the clumsy ways they do, utterly poor presentation skills for the political arena). Same as the other way around in general, but their standard presentation skills are better suited for this crisis.
    2. What is also playing is that the cost of especially healthcare but actually aging in general could not be brought under control. It is my strong impression it is used for this as well and the governmetn doesnot want an increase in other entitlements. From 2010 to 2040 they have roughly a cost-increase of nearly 1/2% of GDP annually to cover. So 1/4 of the structural growth will be gone. That is structural growth pre crisis now it likley will be lower anyway. Clearly preparing the country for that and using the crisis for it.
    3. They see the need to give an example for the South. Which also makes anti-austerity politically simply a no go area. Something you still have problems with to grasp. You can in no way sell extra spending for the South (with Northern money (directly or indirectly).
    It is simply austerity medium or austerity heavy (no other flavours).

    Easy to set up a system for that I just did (so cannot be too difficult) but had too many characters. And in Holland it might have actually worked. But add a list of projects to start up so that it is not used for new cars (like there was now, while the country hardly has any carindustry) or stuff which are difficult to cut(like more entitlements). Typical weak point of Keynesians they always tell the story much too complicated and in a way that it doesnot matter how it is spend (which makes it completely counterintuitive for a normal person).

  4. I don't see how spending = income = output is complicated? Spending or tax cuts, or both.

  5. Hi Simon

    Just two points I hope you can clarify:
    When Tuelings cites his three reasons as to why politicians are ignoring politicians, the third was "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".
    In the last sentence, what "success" with regard to short-term austerity is Tuelings alluding to?

    Secondly, and similar to Legion's comment above, there is little mention of the influence of big business and the wealthy elites on politicians, who enact policies which minimise or even protect these groups. 'Political capture' by wealthy intitutions, individuals and the City & Corporation of London must surely have great influence on policy decisions and actions?
    An outstanding (and disturbing) book which considers this somewhat overlooked but massive issue is 'Treasure Islands: Tax Havens and the men who stole the world' by Nicholas Shaxson - just wondering if you've had a chance to read it?
    Kind regards

  6. Hi Simon:

    I too have thought about this and it may be sensible to add another reason. Far too many Economists were so wrong and missed the crash and the following Great Recession, that their creditably is seriously damaged. Many politicians simply dismiss economists. There is merit in the other reasons suggested, but it only takes one reason per politician, so they may each have differing favorites. Has anyone asked politicians?

    1. True - many politicians do dismiss economists, but there were plenty who did predict this crisis. I suspect the 'political capture' argument outweighs the credibility of economists argument, but perhaps we'll never know as I can't imagine many politicians admitting their reasons - especially not the 'political capture' reason! I highly recommend the above mentioned book as it provides an incredible, but worrying insight into this aspect.

    2. derrida derider5 March 2013 at 17:14

      MANY economists, across a wide range of political predilections, predicted at the time of Maastricht that the Euro exercise would end in tears - and for pretty precisely the structural instability reasons that it has so ended (a monetary union of very disparate economies without either massive labour mobility or large scale and continuous internal transfers). Google "optimal currency area".

      It was, yet again, a case of the politicians ignoring the economists for political reasons.

      To me, it is as plain as a pikestaff that far and away the least painful way out of the current mess is a deliberately engineered Euro inflation (with consequent devaluation). That creates the opportunity for a large real internal devaluation in the periphery, the burden of which unlike austerity will be shared more with local elites than local workers (perhaps exactly why policy elites would be horrifed by it). But absent changes to fix the structural problem this just means we muddle through until the next mess.

  7. From the standpoint of economics of production and physics, austerity is the only available option. Due do limiting force of oil prices, currently any meaningful economic growth is impossible for oil importers. Should oil importing countries force growth with some sort of increased debt, it would logically lead to higher oil prices and again no growth, but rather increased debt. One has to consider that there is no such thing as efficient market with oil. Some economists proposing end of austerity simply do not understand that what we have on our hands. This is not 1979 oil crisis, where it was clear that oil prices will go down again sometime in the future. There is zero chance that oil prices would substantially drop in the near future.

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  9. Its pretty simple
    1 Economist come off as arrogant know it alls; they should study dale carnegie or sales training

    2 when you have Nobel Prize winning economists calling each other idiots in public, why on earth should politician listen, and, even if they do, how on earth can they tell which NPWE is smart and which is dumb ?

    3 Many times, economist advocate policys (free trade) that (a) clearly benefit economists, and (b) seem to be based on grotesquely simplified models; it is not at all clear how these models relate to the real world (this failure to explain is linked to point 1)

    for the stupid: free trade causes low income/skill people to loose their jobs, and get replaced with cheap overseas products, and it means lower wages for gardeners, nannies, etc.
    Since at least the upper stratum of academic economists belong to the moderately well to do (at least in the US - not sure of Oxbridge pay scale) they benefit hugely from free trade; they get cheap tvs and cheap gardeners.
    that advocating a policy which so clearly is economist' personal benefit might be looked askance by others never seems to occur to them - again, back to point 1

  10. when you are in a PR battle, the SLOGAN counts
    you are never, ever gonna win a PR battle against austerity -after all, as any darn fool can plainly see, you need to save money in tough times.

    So, what you need to do is stop , and learn from your psychology and b-school marekting brethren about how to sell something - and a catchy slogan is first.

    Keynsianism ain't cuttin the mustard.

  11. Politicians are the result of an electoral process and elections determine who holds power, not who holds the truth (I wouldn't go as far as saying that economists hold the truth, though). In my view the vast majority of politicians do not have adequate knowledge and skills to understand even the basics of economics, let alone some sophisticated theories over which there is conflict even between academics. Their knowledge of economics (and of many other subjects) appears often to be purely anecdotal and heavily biased by political ideology. Economics it is not a very difficult subject, but its understanding requires some hard thinking, research skills, intellectual curiosity and honesty, proficiency in quantitative reasoning. How many politicians can you see fitting this profile?

  12. Austerity - especially coupled with loose monetary policy - favours asset-holders at the expense of wage-earners. Asset prices are higher relative to wages and the public view this positively irrespective of the productive capabilities of those assets.

    The voters who own the assets - houses and investments, against which they may have liabilities - care a great deal about their value. Politicians respond with policies to support asset values at the expense of lower employment and growth - in the 30's; in German unification; and now.

    I don't think there's anything surprising about this, and until the electorate take the view that the long-term productive output of their assets matters more than their nominal value, it is unlikely to change.


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