One of the many puzzles about the economic crisis is that people still listen to economists. Even the queen noticed that the economics profession failed to anticipate the financial crash of 2007-08. Indeed, the mathematical models constructed by mainstream economists effectively ruled out such a crash as impossible.
But the model building continues, this time to justify austerity. A central role has been played by two former economists at the International Monetary Fund, Kenneth Rogoff and Carmen Reinhart.
They published a statistical study in 2010 that has been widely cited by proponents of austerity. As they explained in 2012, “Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP.”
Rogoff was treated to an admiring “Lunch with the FT” interview with the Financial Times’s chief commentator, Martin Wolf. Wolf wrote that Rogoff “has been consulted by President Barack Obama and is known to have spent many hours with George Osborne, Britain’s chancellor.
“Rogoff’s advice—that heavily indebted governments had to get serious about cutting their deficits—strongly influenced the British government’s decision to make controlling spending its priority.”
So imagine the embarrassment when last week three economists from the University of Massachusetts Amherst (with one of the few surviving left of centre economics departments in the English-speaking world), published a critique of Reinhart and Rogoff.
The study of RR, as they’ve come to be known, covered a range of countries to show that economic growth falls off sharply when debt reaches 90 percent of national income.
The Amherst authors found that RR had made an error in their use of an Excel worksheet that excluded five countries.
They also left out countries when they had both high debt and high growth and didn’t take into account the length of time that a country had 90 percent debt. When all these mistakes were corrected, the average growth rate for countries with 90 percent debt was 2.2 percent a year—not, as RR found, 0.1 percent.
RR rapidly responded to these very damaging criticisms. They pointed out that other findings weren’t affected by these errors. And they denied their study was intended to support austerity policies.
I think they’re protesting too much. The article by them quoted earlier is headlined, “Too Much Debt Means the Economy Can’t Grow: Reinhart and Rogoff.” It was this claim that was cited as “conclusive empirical evidence” by Tea Party ideologue and Republican vice-presidential candidate Paul Ryan when he proposed slashing public spending.
Even if RR’s evidence were stronger, what would it prove? All that they could claim to have shown was a correlation between high levels of debt and low economic growth.
But it’s a basic principle of scientific method that correlation isn’t causation. There may be a high correlation between rain and my getting out my umbrella. But this doesn’t tell us whether my using my umbrella causes the rain or vice versa.
As many critics of RR have pointed out, it may be that low growth causes high debt, rather than the other way around.
For example, Fitch last week became the second rating
agency to deprive Britain of its triple-A status. The reason?
A shrinking economy has made it harder for the coalition to meet its target of reducing debt compared to national income. The more sluggish the economy, the more the
government has to borrow and spend money on unemployment—and the smaller national income is compared to debt.
Both the US and Britain had higher than 90 percent debt after the Second World War. Rapid economic growth made this problem disappear. And this points to the real problem facing Western capitalism today. The rate of profit today is much lower than it was the late 1940s and early 1950s.
But this is beyond the ken of RR and their ilk.
Crises are on the horizon