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The Austerity Trap

Louis-Philippe Rochon is associate professor of economics at Laurentian University and co-editor of the Review of Keynesian Economics.

Originally published by CBC.  See here.

In its April budget, the federal government announced it had succeeded in balancing the budget. Such an achievement, however, will prove to be at best a Pyrrhic victory. History shows austerity and balanced budgets never work and only doom our economies to more misery.

The Austerians, as American economist Rob Parenteau calls them, are clearly winning the policy war.

In Canada, as in many other places around the world, governments are turning once again to austerity policies in order to reign in public spending believed to be out of control.

These cuts, however, are usually done in vital social programs, such as health care, education, social housing and unemployment benefits.

As is the case with other policies, austerity has both winners and losers.

The victims of austerian economics are often the disenfranchised and the unemployed, whereas those who benefit from austerity invariably tend to be wealthier Canadians, through reduced tax rates and, in Canada specifically, through a panoply of boutique tax policies such as the recent doubling of tax-free savings accounts and income splitting.

In this sense, austerity is not a haphazard policy but a well-crafted approach to rewriting the Canadian social contract.

It is a deliberate policy that aims to take away from the poor and give to the rich. Those who disagree with the statement have the burden to show how austerity is a success, but they will have great difficulty proving it.

Academic research has come down against austerity. In fact, austerity has zero empirical support, and it has been completely discredited and proven to be the result of questionable research.

The most famous case was a landmark 2010 paper written by Carmen Reinhart and Kenneth Rogoff (both from Harvard University, no less), which argued debt-GDP ratios over 90 per cent would result in considerable damage to national economies, notably a marked decline in economic growth.

Their paper had a huge impact on policy and accounted in many respects for the great policy U-Turn of 2010 when countries reversed their previous Keynesian spending policies and reverted to austerity.

This was a policy fiasco, with the inevitable result that our economies stalled and have remained in this zombie state ever since.

Yet, the paper was completely discredited. Nobel Laureate Paul Krugman went even further and stated unequivocally, “All of the economic research that allegedly supported the austerity push has been discredited. Widely touted statistical results were, it turned out, based on highly dubious assumptions and procedures – plus a few outright mistakes – and evaporated under closer scrutiny. It is rare, in the history of economic thought, for debates to get resolved this decisively.”

Bucknell University economist Matias Vernengo has publicly called for the paper to be officially retracted  or “unpublished.”

Despite this great humiliation, austerian ideology endures. So how, then, can we explain the continued obsession with balancing budgets and austerity policies?

Austerians, of course, believe their policies will work and will eventually result in increased growth.

Yet evidence shows that economies cannot grow without an adequate level of public spending, or if they do grow, they grow at very low rates, as has been the case for the last three decades.

In this sense, the evidence indicates austerity is a policy failure on a grand scale. How then can such a flawed idea gain so much traction?

The first explanation is political. The counter-revolution began in the 1980s when a parallel was drawn between personal finances and public finances.

We were told that if individual Canadians could not live within their means, then neither should (nor could) the state.

Canadians thought it made sense and bought it. This was perhaps the greatest victory of the right: to convince Canadians the state should not live beyond its means, otherwise it could jeopardize the livelihood of our children and grandchildren.

This was all smoke and mirrors, of course. Concepts like “living within its means” have different meanings when applied to the state. The state does not have the same constraints as you and I, and as far as I know, citizens cannot print their own money.

But the idea did gain traction – political traction, and today, no political parties dare utter the expression “deficit spending.” Even the NDP has bought into this myth.

The second explanation is ideological. It is no secret that Canada has one of the most ideological governments in the world today.

Austerians are anti-state; they see no benefit from having a large government. So, the ultimate goal of austerity is not to achieve sound finances for the government but rather to shrink the size of government and ultimately to reduce the size of the state; cut revenues and you must cut spending if you want to balance the books.

There is now a growing consensus regarding the failure of austerity. Yet, in Canada as elsewhere, governments are not listening. This can only result in a full collapse of our economies. In fact, we are starting to see the early signs of this collapse now.


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Comment from Purple Library Guy
Time: May 29, 2015, 3:13 pm

The third explanation is class war. As you so directly pointed out, “It is a deliberate policy that aims to take away from the poor and give to the rich.”
Given that, it doesn’t matter that much to the recipients whether it’s any use for growth or general prosperity. They get theirs, and if the rest of us get hosed that is if anything a feature, rather than a bug–with a smaller total pie, their share is bigger and their control is greater.

Comment from Larry Kazdan
Time: May 29, 2015, 5:50 pm

Letter in Toronto Star:

Ottawa’s cupboards can never be bare

Re: Trudeau keeps faith with middle class but disappoints the poor, Opinion May 8

Carol Goar repeats conventional wisdom that future governments will be financially constrained because Ottawa’s coffers are almost empty. However, the federal government owns the Bank of Canada, and constitutional lawyer Rocco Galati is currently suing the bank on the grounds that it fails to make low-interest loans to federal and provincial governments though it is mandated to do so.

Where does the Bank of Canada get its money? Banks create money deposits by computer entry out of thin air. In order to settle with other financial institutions for net amounts owed, commercial banks must also have sufficient bank reserves (deposits at the Bank of Canada) for clearing. However, the Bank of Canada can always settle government cheques because it creates these bank reserves at will. Government cheques never bounce.

In other words, there is no limit to Bank of Canada money creation. We know this because the BoC is the lender of last resort for the banking system, and the federal government had no problem creating a $200 billion Extraordinary Financing Framework to bail out our commercial lenders after the 2008 financial crisis without ever having to raise taxes.

Though the government with a central bank issuing a fiat-currency can never “run out of money,” this doesn’t mean that it should spend without limit or overspend and cause inflation, or that government should spend any sum unwisely.

But it does mean that the coffers can never be bare, and that so-called scarcity of funding can never excuse inaction on alleviating poverty, creating employment or protecting the environment.

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