The Case for Meta-Economics Pt.1: Fiscal Austerity as Prudence…or Madness

The most immediate and obvious case to be made for (something like) a meta-economics, or the equivalent, is the lack of a consensus among respected economists about what to do about the sovereign debt crises in Europe and the push for fiscal austerity that has emerged this year in the US and in many other countries.  We have many politicians as well as economists on the one hand claiming that now is the time to cut budget deficits by cutting spending (mostly on social programs) and on the other hand we have economists and some politicians who are calling this the equivalent of madness, urging steady or higher levels of government spending to stimulate weak economies.

Two Opposed Schools of Thought

The debate can be viewed either from the point of view of individual economists, who show some variability in their opinions, or as a clash of two schools of economic thought with regard to the value and use of fiat (paper) currencies and government spending.  Keynesian economists believe that government (fiscal) deficit spending is necessary in economic downturns to make up for reductions in demand from a troubled private sector.  In the case of our current economic crisis, households and businesses are either loaded down with existing debt and/or cannot get access to credit to buy goods and services.   With a fiat currency (where the government can print money), governments can choose to go into more debt and/or risk inflation of the currency by spending more than they collect in taxes to spur the economy.  The priority for Keynesian economists is to boost employment and spur demand for goods and services by the means available to make up for the slump in private spending.  Keynesian economists point to the relative economic stability of the period 1940 to 1980, as well as the lack of a clear association between government debt and economic prosperity at least in countries that control their own currency, to make the case for deficit spending.

Opponents of deficit spending, deficit “hawks”, many of whom share the assumptions of neoliberal/neoclassical economics, are concerned about how lenders in financial markets will view governments’ apparent disregard for the debts they are running up to stimulate their economies and will impose more stringent credit conditions on lending to these governments.   In general, these proponents of fiscal austerity as a cure to what currently ails us, represent a “hard money” position, in that they fear inflation more than Keynesians, who might even recommend “inflating away” national debts.  Fiscal austerity that cuts government spending and activity has the critical “side benefit” for neoliberals in that it cuts government regulation of industry as well as reduces the role of government as a competitor in the provision of goods and services to the private sector (Social Security competes with investment managers for instance).

A related but subsidiary issue is the type of government deficit spending in a recession based on what Keynes called the multiplier effect.  Some types of spending will circulate more quickly in the economy based on people’s propensity to save or spend.  Spending on wages and social welfare programs will circulate more quickly in the economy producing larger effects, multiplying the economic effects of the initial spending.  The neoclassical school objects to or questions the multiplier effect on the assumption that people will not spend the money assuming that higher taxes are coming to pay off the government debt generated by deficit spending.

For the purposes of this short post, I am going to assume that the dispute is fiscal austerity or no, but a reasonable case can be made that the fundamental dispute between these two groups is about the type of government spending rather than the amount of that spending.  As we shall see below those in the fiscal austerity camp differentially favor cutting social spending rather than defense spending or other programs favored by the political right-wing.

Individual Economists

Paul Krugman,  Brad DeLong, Dean Baker and others who occupy more of a Keynesian position on fiscal spending, are most scathing in their indictments of the calls for fiscal austerity that can be heard now around the world.  Krugman points out, as does Dean Baker and others that measures of what lenders think of the creditworthiness of the US government indicate that there is no current concern about the US’s fiscal health (low CDS spreads).  Krugman and other in the Keynesian camp, like Brad DeLong, point out how deficit hawks tend to blur the distinction between countries that control their own currency (the US, Great Britain, etc.) and the countries of the Euro-zone who are constrained by Euro-wide currency policy.   There are differences in the degree to which Keynesians pay attention to the question of budget deficits:  some think that raising deficits is a temporary fix while others are relatively indifferent to the amount of the deficit.

On the other side of the fiscal austerity debate are also many respected economists, some of whom did predict the financial crisis of 2008.  Ragu Rajan reads a number of macroeconomic signals, including increased employment in Brazil, as indicating that the Fed might think about raising interest rates, which is an anti-inflationary measure and a sign of pulling back on monetary stimulus of the economy.   Krugman lambastes Rajan and others as submitting to a climate in which pain infliction on the economy and especially the poor is considered to be a way to “reassure markets”.  Jeffrey Sachs, also a highly respected economist is caught by Brad DeLong assuming that Obama’s stimulus spending raised interest rates that private lenders charged the government when it didn’t.   Both Krugman and DeLong feel their opponents are ignoring data on the ground and imposing upon and reading into reality their prescriptive model for how the economy should have, is and will behave.

Economic Advocacy Organizations

Driving the debate within and outside the academy are the work of advocacy organizations that, apparently, believe that social spending should be cut instead of targeting military or other budgetary items.  The billionaire and former Secretary of Commerce under Richard Nixon, Pete Peterson has had a major influence in inspiring the Obama Administration’s deficit commission through his funding of numerous foundations, economists and advocacy organizations.  Peterson, through his great wealth and political influence has been able to create a climate of economic opinion within which he has insistently attempts to create concern about government budget deficits while favoring only one of many possible solutions.  As can be seen in this 2003 interview with Bill Moyers, Peterson decries tax cuts and other signs of profligacy by both parties yet almost uniformly prescribes cutting social spending over either cuts in other discretionary programs or tax hikes on people like himself.  Peterson’s perspective is also premised on a theory of political behavior by policymakers who he assumes will never raise tax rates to deal with what he bemoans as a great evil, the imposition of debt upon future generations.  The assumption of this type of political behavior by Peterson does agree with the anti-tax prejudice of Peterson’s political milieu.

Making Sense of the Conflict

In broad terms the conflict in systemic terms is between two economic theories with opposing interpretations of that subsection of the data that they both address and also in this case some variance with regard to how much or which parts of the data are accounted for by the “story” that each side tells.  Furthermore, even if there is or would be some partial agreement on interpretations, the solutions offered are at odds (which part of the deficit to reduce or cut and when).   On the one side we have people who see government spending as a tool that now because of slumping economic conditions must be deployed, despite the negative impact on budget deficits.  On the other side we have people who place a higher negative value on budget deficits and the risk of inflation relative to the potential positive impact of spending on employment and current demand for goods and services.  For the latter group, the tradeoff is so, seemingly, frightening (or they wish to inspire fear in others) that they appear to imagine or invoke the prospect of events for which there is currently little or no data.  Alternatively they may be seeking to inspire “retribution” by private markets on the debts of governments, prospectively, by painting a negative picture of how these governments manage their budgets.

To me, as may be apparent from the way I am presenting the data, the case is better argued from the Keynesian side.  In this case, DeLong and Krugman seem to be presenting more apposite and solid data but the counterfactual “worries” of Sachs and Rajan are not to be entirely dismissed given their positions of authority and the reflexivity of financial markets, where opinion can become reality through the action of powerful and/or motivated stakeholders.  It is not unknown that powerful financial market actors can create chaos because of antipathy towards a government or because they simply want to achieve a higher return.  Claims of fiscal imprudence by authoritative voices can be invitations to markets for attacks on the currency.

While the point of recounting this debate may elude people who are not economic policy “wonks”, the stakes in what passes for an intellectual debate here could not be more immense:  if the austerity group prevails we may see, as in 1937, a very deep second dip to this recession, though these advocates would deny that this would be the outcome.  If the apparent wishes of economic advocates like Pete Peterson are achieved, we will see an undoing of the social and economic stabilizers created by the New Deal and Great Society in the period from the 1930’s to the 1960’s.  Furthermore, and more assuredly, choosing fiscal austerity, especially those who wish to cut social and other domestic spending rather than military spending and not raise any taxes, will bring much of the movement towards a green and oil-independent economy to a halt.  While some politicians and voters may be able to salvage some portion of existing social programs, the “new arrivals” in the areas of climate and energy that may require some deficit spending to be jumpstarted will almost certainly fall by the wayside.

Class Interests and Government Spending

While I am treating this here as a problem of systemic theories of the economy, many imply or state that this is a class conflict between economic groups.  The accusation leveled at Pete Peterson by his opponents can be parsimoniously stated as that he is waging “class war from above” by differentially targeting those social programs that stand in the way of financial capital in maximizing its profits.   Even more insidiously, the effort to stir hysteria about fiscal spending can be seen as effort to create a “balance of terror” by actors from the financial sector to guard its huge profits and downplay its culpability in the 2008 financial crash (“we weren’t the imprudent ones, you were”).  On the other side, deficit spending and social spending combined with progressive taxation redistributes income downward, leading the “haves” to feel that they are supporting the “have-lesses” and the “have nots”.   The implication by the “haves” is that they represent economic virtue while the “have-lesses” and “have nots” have not been prudent and are asking for a hand-out.

Alternatively, if we accept that there are economic classes with different and conflicting interests, the conflict is over a renegotiation of the social contract between those classes.  The post-New Deal, post-WWII consensus was that the “haves” owed a portion of their income to the society at large and to the less fortunate.  The idea was that everybody has an obligation to society and that individual success contains an element of luck.  The Reagan-Thatcher neoliberal criticism of the post-War consensus was that each person earned according to what he or she is due and that the society-at-large did not represent an economically important entity.  Redistribution of income via governmental spending and progressive taxation was and is opposed by neoliberals because it violates this principle and does not reward economic success.  This schematic view overlooks complexities of either position.

If this is a matter of economic class conflict two basic solutions are possible:  either one allies oneself with one or the other class or one attempts to stand apart and negotiate some compromise between those class interests.

Resolving the Conflict:  Three Strategies

I can see at the moment three basic strategies for economists and policymakers in dealing with this critical challenge and the yawning gap between the two positions as regards immediate action.

Strategy 1:  Make Better Arguments for Each Position

Advocates for one position or the other have good reasons, if they believe that what they represent is true, right and good, to make better arguments for each position.  I have a strong bias in favor of the Keynesian position at this point in time because of my concerns both about our overall economic health in the short and medium term as well as long-term environmental sustainability:  I see, at the least in the US, no significant moves to reduce oil dependency and address climate change without some deficit spending.  I am also persuaded by the relevance of the data presented by Keynesians to the questions being asked by both sides, in particular the phantom nature of market “concerns” about the security of lending to the US government at this point in time.  By both sides making clearer arguments, we may see clarification of the issue.  One danger without a strong meta-economic framework is that one side or the other would make arguments that are emotionally persuasive in nature but not well-reasoned and/or would use its considerable financial means to broadcast the less well-grounded argument in emotionally compelling but fallacious terms over the airwaves.

Strategy 2:  Political Compromise Between the Two Positions

While a bipartisan deficit commission and similar bodies may need to engage in compromise to reach consensus, this strategy may only serve to confuse the scientific and intellectual issues involved.  Some items from one “side” will be adopted and some proposals from the other “side” will be adopted in a melange of proposals.  While one sides’ arguments may be popular with politicians but wrong they will appear to be given equal or greater weight to  positions that are well grounded in reality.   If on the other hand there is an implicit recognition that there is no systemic economic theory that works but simply a class compromise between two interest groups, then adopting a political compromise which reflects the balance of power or the outcome of the discussion is the only possible outcome.  Either the compromise between systemic views or the compromise between classes would postpone clarity on the issue, though might prevent a disastrous outcome.

Strategy 3:  Develop a meta-economic framework for evaluating claims of both positions

The final strategy requires more time and preparation but I believe it will ultimately lead to better results: create a meta-economic framework for evaluating as much of the relevant data and positions involved as possible.  Such a framework would be able to weigh the benefits of economic stimulus, perceptions of government debt by private financial markets, other risks associated with debt, inflation costs and benefits, group/class interests and overall social welfare projections that are associated with an number of different scenarios.  I am calling this a “meta-economic” because it would straddle both the Keynesian and the neo-liberal or “hard money” position but create a new and better scientific framework rather than a melange of both positions as would “Strategy 2”.  New factors may be introduced from within economics or from a related discipline like political science, psychology, the natural sciences, etc to create new perspectives on hardened positions rather than to mix perspectives up as part of a political compromise.

None of these three strategies is mutually exclusive.  In upcoming posts here, I will look into this issue as well as other questions that would lead one to build a meta-economics.

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About Michael Hoexter
I'm a clean energy marketing and policy strategist and consultant based in the San Francisco Bay Area.

One Response to The Case for Meta-Economics Pt.1: Fiscal Austerity as Prudence…or Madness

  1. Pingback: The America Speaks Budget Deficit “Townhall” of June 26: Folk Economics In Action Pt. 1 « Meta-economics

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