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Accounting is not Keynesian, fighting austerity is

Letter to the Editor of the Wall Street Journal (unpublished at the moment of publishing in the blog).


Dear Sir,

in yesterdays’ editorial “Europe’s Austerity Fable” you take advantage of the evident shift in the European mood toward austerity to remind readers of the dangers of an awakening of the public spending party across the Continent.

What stroke me of your argument was a great deal of confusion regarding basic macroconomic and accounting features of the workings of any economy that I would like to underline here.

You say: “If a country could somehow borrow an amount equal to GDP and spend it all in one year, statistical GDP would therefore double. Yet no one thinks that country would suddenly be twice as prosperous. It would merely be in big debt. Likewise, if a government spends less, then statistical GDP shrinks, other things being equal. Lower spending therefore is bad for growth in the short-term as measured by Keynesian national accounts. But if controlling government spending means lower borrowing costs and lower tax burden combined with other reforms, it will lead to faster growth over time”.

That is wrong in an accounting and in an economic sense. If a country were to borrow such an amount from markets and transfer it in the shape of larger pension  benefits or to double the interest payments to bondholders, 2 examples of that important component of public spending called transfers, nothing would happen to GDP. In an economic sense, if indeed spending were to be directed at procurement or salaries, there is no doubt that independently of the quality of that spending officially recorded GDP would rise, maybe less or maybe more than the true level of goods and services the community really receives (having more policemen in a neighborhood might be highly valuable depending as to whether the policeman shirks or monitors thiefs).

“Other things being equal” is obviously a puzzling term that you use . When evaluating the economic impact of a policy move that requires more spending,  we know it also requires by definition more financing, whether through debt or taxation. So the impact of that financing cannot be removed for a complete analysis of the impact of more public spending  (and indeed you do not hold everything else equal when you describe the positive impact of reducing spending). So economically I would not be able to tell you whether, after raising by 100% of GDP the level of public purchases, GDP would go up: I would actually expect that given the very high number you provocatively mention, which requires taxing all income of citizens away, GDP would definitely shrink. However I would not dare call these national accounts “neo-classical” for that reason.

Anyway, we are blessed that those who argue today in favor of more public spending are more moderate in their proposals: possibly they suggest increases in public demand of the size of 1 to 3% of GDP.

But here comes the final argument of yours that I wish to debate vigorously: “Those who want governments to spend more to boost growth must believe these governments are still able to borrow more to spend more. They could tax more to spend more, but that simply means taking money out of the private economy so the government can spend it. But that is merely another form of austerity, since governemnts will spend most of the money less productively than will private actors”.

I could not dissent more. First, because it seems to imply that borrowing today is totally different for taxpayers from taxing today. Actually it isn’t that much. Most rational citizens know quite well that those governments that don’t tax them today will tax them tomorrow to repay their debt, and often save in precaution for that moment.

Second, and more importantly for the current economic cycle in Europe, taxing today to spend today indeed takes away from firms and citizens, but is turns out that exactly because of that it is exactly the opposite of austerity: since private actors currently do not spend (internal private demand being the culprit of the current European crisis, according to all governments and central banks’ analyses) because of fear of the future, only spending by governments will be able to push us out of this recession.

Two last things.

Does this mean that governments have to further increase taxes? No, they might be happy to use all of the higher revenues that over the past 2 years have been raised by many austere governments not to spend more but to repay debt, with the final sole and obvious result to raise debt GDP levels to historically record high levels.

The true challenge we should really focus on is to think how to make those governments that today smartly are ready to raise spending to get us out of this recession (and in the process save the euro and Europe) credibly   commit to lower it once we are out of this perfect storm.

You dont need to be a anti-Keynesian to hope the private sector in Europe will one day regain confidence and take the burden of leading the growth process.

Till that day, let austerity die, it has killed enough.

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