Wednesday, October 20, 2010

Stiglitz Counsels Stimulus, Not Austerity - Beware the "Confidence Fairy"

What is it about the Nobel Prize that makes economists think alike?   After all, Stephen Harper is an economist (sort of), he was never even nominated for a Nobel for his (non-existent) work in economics, and yet he sees the global economy and Canada's for that matter entirely differently than guys like Joe Stiglitz and Paul Krugman.

These Nobel Prize winning economists believe this is no time to introduce austerity budgets.  Krugman has been saying so in The New York Times for months.   Stiglitz is saying the same thing in today's Guardian:

The Keynesian policies in the aftermath of the Lehman Brothers bankruptcy were a triumph of economic theory. In Europe, the US and Asia, the stimulus packages worked. Those countries that had the largest (relative to the size of their economy) and best-designed packages did best. China, for instance,maintained growth at a rate in excess of 8%, despite a massive decline in exports. In the US the stimulus was both too small and poorly designed – 40% of it went on household tax cuts, which were known not to provide much bang for the buck – and yet unemployment was reduced from what it otherwise would have been – over 12% – to 10%.

Britain, and the world, cannot afford not to have another stimulus. We cannot afford austerity. In a better world, we might rightfully debate the size of the public sector. Even now there should be a debate about how government spends its money. But today cutbacks in spending will weaken Britain, and even worsen its long-term fiscal position relative to well-designed government spending.

There is a shortage of aggregate demand – the demand for goods and services that generates jobs. Cutbacks in government spending will mean lower output and higher unemployment, unless something else fills the gap. Monetary policy won't. Short-term interest rates can't go any lower, and quantitative easing is not likely to substantially reduce the long-term interest rates government pays – and is even less likely to lead to substantial increases either in consumption or investment. If only one country does it, it might hope to gain an advantage through the weakening of its currency; but if anything the US is more likely to succeed in weakening its currency against sterling through its aggressive quantitative easing, worsening Britain's trade position.

  cutbacks in investments in education, technology and infrastructure will be even more costly in future. For they will spell lower growth – and lower revenues. Indeed, higher unemployment itself, especially if it is persistent, will result in a deterioration of skills, in effect the destruction of human capital, a phenomena which Europe experienced in the eighties and which is called hysteresis.

 Matters may be even worse if consumers and investors realise this. Advocates of austerity believe that mystically, as the deficits come down, confidence in the economy will be restored and investment will boom. 

...Austerity converts downturns into recessions, recessions into depressions. The confidence fairy that the austerity advocates claim will appear never does, partly perhaps because the downturns mean that the deficit reductions are always smaller than was hoped.

...Critics say government won't spend the money well. To be sure, there will be waste – though not on the scale that the private sector in the US and Europe wasted money in the years before 2008. But even if money is not spent perfectly, if experience of the past is a guide to the future, the returns on government investments in education, technology and infrastructure are far higher than the government's cost of capital

Stiglitz is right.  Krugman is right.   But Stephen Harper and Jim Flaherty know better.  They know its best to gamble on the same conventional political wisdom that got the developed world in this hole in the first place.   Guys like Krugman and Stiglitz saw the global meltdown coming and warned anyone who would listen but so what?

The past couple of years have been less than stellar for the Parliament of Canada and not just the Tories.  Liberals have plenty to be ashamed of.   As the recession loomed and Harper prorogued Parliament, Ignatieff took it as an extended school holiday and devoted his time to writing an invaluable history of his mother's family.  

The Liberals had months in which they could have and should have been hammering out a stimulus initiative of their own, a package ready to present to the public when Parliament reconvened.   And so the Harvard schoolboy went back to school without his homework.  Harper unveiled his laughable, even pathetic stimulus budget and a woefully unprepared opposition could do little but back it, cloaking their incompetence by pompous nonsense about putting Harper "on probation."

Like the Americans, we handled the stimulus very poorly.  The lack of vision and leadership at the federal level, on both sides of the aisle, among every party was breathtaking.   Instead of identifying where we could get the best bang for the buck, how we could invest those deficits in assets - think education, think technology, think infrastructure - so as to reap a tangible, fiscal return for years or decades to come, our political parties offloaded that responsibility on provincial and municipal governments and tossed the rest away for home improvements.

Now, instead of taking the measure of the building global economic uncertainty and the rising prospect of both currency and trade wars, Mr. Ignatieff and his gang are using the deficit as a political football, hypocritically attacking Harper for the very spending they demanded and approved.  In taking this tack, instead of listening to wiser voices coming from people like Stiglitz and Krugman, the IgLibs are fueling Harper's drive for austerity when they ought to be attacking it.   One thing both Harper and Ignatieff have powerfully demonstrated over the past two years is that neither one of them is remotely fit to lead our country.

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