Wrong time for government austerity

Opinion

Hey there, time traveller!
This article was published 06/12/2016 (2690 days ago), so information in it may no longer be current.

I am certain that Premier Brian Pallister and Finance Minister Cameron Friesen honestly feel they are doing the right thing by cutting and freezing public spending, believing this will balance the budget and help grow the economy.

However, the Progressive Conservatives may get the opposite of what they hope for if they go down the path of harsh cuts and freezes, This approach could stall the economy and it will almost certainly leave the province poorer — with lower growth and even more debt than if they opted to borrow for spending.

Many people are on board with the PCs’ plans for austerity. After all, it jibes with what we have all been taught about economics since the 1970s, when Keynesian ideas got the boot and a new school of “neoclassical” or “orthodox” economics took hold.

Originally a conservative idea, the ideas were embraced across the political spectrum and around the world — Liberals, NDP and Conservatives in Canada, Republicans and Democrats in the United States, Conservatives and Labour in the United Kingdom.

In many universities in North America and around the world, orthodox economics are the only kind of economics taught. But there is increasing evidence — and warnings from experts — that these ideas are seriously wrong.

In September, Paul Romer, the World Bank’s chief economist, wrote a devastating critique of mainstream macroeconomics, calling it a pseudoscience. He argued that the complete failure to predict the 2008 financial crisis, which knocked the entire global economy off track should be reason to discard existing models.

In response to the crisis, governments either slashed or spent. When it comes to growth, since 2008, every jurisdiction that slashed was worse off and every jurisdiction that spent was better off — without exception.

Austerity certainly can work in two situations: at the level of the individual, or when the economy is booming. But if everyone cuts at once, it will make everything worse: if you run a business and all your customers stop spending, you go broke.

The time for government austerity — to pay down debt — is when the economy is hot. That’s not what’s happening in Manitoba or around the world. If the economy is already sluggish because private-sector spending has dropped, reducing public-sector spending means taking more money out of the economy.

Manitoba’s economy is projected to grow about 2.4 per cent next year. Manitoba’s deficit is about $900 million, or 1.5 per cent of provincial GDP. Nine hundred million dollars in cuts would shrink the economy by that amount, and possibly more. That $900 million is part of total provincial income — the people who earn it spend it at Manitoba businesses, and pay taxes with it.

The PCs said last spring they would run a deficit for about eight years, so there is no question public debt is going to continue to rise. Deliberately shrinking the economy while borrowing makes the debt-to-GDP ratio worse, not better. We will have higher debt and it will be harder, not easier, to pay off.

At first thought, adding debt to help the economy grow when you’re already in debt appears to make no sense. However, if the economy grows more than the debt, the debt-to-GDP ratio will be better, making it easier to pay off the debt in the long run. With interest rates still near historic lows, even moderate inflation could mean government debt could be paid back for less than the cost of borrowing.

These arguments will likely fall on deaf ears, due to a commitment to orthodox theory. It’s worth understanding exactly why that theory should be challenged.

In 2001, Australian Economist Steve Keen published Debunking Economics, in which he predicted the financial crisis. He points out that the model of economy like Manitoba’s is based on: “a single consumer, who lives forever, consuming the output of the entire economy, which is a single good produced in a single firm, which he owns and in which he is the only employee, which pays him both profits…. and a wage. Any reduction in hours is a voluntary act… and there are no banks, no debt and indeed no money in this model.”

Keen argues that, aside from mainstream economics being divorced from reality, it is blind to the real cause of financial crises and downturns: private debt. In Canada, household debt is more than 170 per cent of annual income and more than 100 per cent of GDP.

This is much far more than what governments owe, on far worse terms with much higher interest rates. This creates a further problem for austerity: if governments proceed with cuts, households at their debt limit breaking point are in no position to pick up the slack.

It’s unlikely the government will change course, but if austerity doesn’t work, they can’t say they weren’t warned.

 

Dougald Lamont is a lecturer in government-business relations in Canada at the University of Winnipeg. He ran for leader of the Manitoba Liberal Party in 2013.