Make ‘em Prove the Causality before They Cause Any More Suffering: Part One

By Joe Firestone

OK, austerity has always been about the causality. The people who are trying their best to get us to cut more and more spending, somewhat less than their best to get us to raise taxes, and who are doing nothing to fix our fraud-laden financial system, or the worst period of dis-employment we’ve experienced since the Great Depression, have been making other people (never themselves) suffer, because they believe the theory that excessive public debt hurts economic growth, and that to get rid of it we must follow a plan of long-term deficit reduction. And I’m being very charitable when I opine that they believe in this theory, because the alternative is that they don’t believe it, but are just using it as an excuse to make other people suffer, and widen the wealth gap between themselves and the rest of the population.

Either way it’s important for the rest of us to demand that before we do anything more based on that theory, they should be forced to prove that it is the best theory out there about the causal relationship between public debt and economy growth. Actually, we should have made them prove that before we allowed Congress and President Obama to start playing austerity games with us way back in 2009 – 2010, because there’s been a lot of water under the bridge since then, including continuing very high disemployment, thousands and thousands of people dying due to lack of health insurance, suicide, depression-related illnesses, crime that need not have occurred, and all the effects of hopelessness that afflict the poor and the middle class during bad economic times. And now, our wonderful leaders have managed to inflict the sequestration upon us, while planning to inflict entitlement cuts on the old and the sick.

Lately, of course, the armor of the austerians, and their claims of empirical support for their view that high levels of the debt-to-GDP ratio are associated with and/or cause very low or even negative rates of economic growth has suffered repeated blows from Economics Graduate Students and Professors at the University of Massachusetts and the University of Missouri at Kansas City, in recent papers. I’ll review those studies in Part Two. In the rest of this part, I’ll evaluate the proof austerians had for their policies before this new research work appeared.

What Proof Did They Have?

So, what proof did they have, before the recent research appeared, that austerity is the best course to follow? Well, it’s been practiced all over Europe for years now, and what are the results? Only record unemployment, shrinking economies, increasing public debt, crime, public unrest, increasing suicide rates, damaged health care systems denying care to people who need them, no improvement to speak of in the economic outlook, and immense dissatisfaction all over the continent.

How about here? A stagnant economy, three steps forward, two steps back, high youth unemployment, no jobs for college graduates, layoffs in the public sector and declining services, low wages, recovery limited to the financial sector and the stock market — the kinds of results that in not so many years will produce a plutocracy, if one doesn’t exist already.

Everywhere austerity is being practiced we see a slowed economy. In some places, like Japan, we see short periods of it followed by some backing off, producing stagnation for close to a quarter of a century. In other places, like Australia and Canada we’ve seen enough of it that the prosperity they could have enjoyed is beyond their grasp.

Sure, Germany, hasn’t hit real hard times yet because their export-led economy gives them more policy space to run surpluses, but most of the nations of the Eurozone can’t run a trade surplus, so for them, continuing government austerity results in private sector losses, year after year, absent a change in rules by the Eurozone. Even the German economy has been slowing as its neighbors can afford less and less German goods, and France is seeing more than 10% unemployment and is rapidly becoming another basket case, creating the need for changing the well known Eurozone acronym to the PFIIGS. Is there an unambiguous success for austerity since the Second World War in a country running a trade deficit? I don’t know of one.

So, what about the work of Carmen Reinhart and Kenneth Rogoff? Didn’t it show that, on average, nations experiencing debt-to-GDP ratios above 90% had negative rates of economic growth? And doesn’t this provide evidence that excessive debt does cause low economic growth and even economic contraction, so that if we value economic growth, we must reduce the debt-to-GDP ratio to a much lower level than 90% before we try to use deficit spending to try again to grow?

Well, the answer to these questions is no, and no. I’ll explain the second “no” first, and consider the first “no” later on in Part Two.

Common Fallacies: First, Reinhart and Rogoff never claimed that the findings of their analysis of their very extensive cross-national, historical database supported causal inference. It’s true that after they wrote their paper and published their book reporting on their data and analysis, they recommended austerity policies and either referred to their work in that context, or have been identified by others hosting an appearance or publishing an article as having done that work to support their “expertise.” So, they talked out of both sides of their mouths; but in their work itself they acknowledge that correlation isn’t causation, and that they hadn’t proved cause and effect. And they urged further research to explore cause-and-effect relationships.

In addition, critics of their work have long emphasized that the reported association between high debt-to-GDP levels and low economic growth for all nations, had nothing to say about cause and effect in individual nations and therefore could not serve as the basis for a fiscal policy of austerity, or for Reinhart and Rogoff’s mere opinions that such a policy, expressed in other contexts should be implemented. One problem is that the association between debt-to-GDP and economic growth at levels of debt-to-GDP above 90% doesn’t apply to every instance in every nation. It’s an average, a mean or a median which is reported.

So, the association is ecological across all instances. It is the well-known ecological fallacy of social science to conclude that it applies to all or even most instances in the high debt-to-GDP category. To go on from there, and then suggest that the association is causally relevant in individual systems, is to compound the ecological fallacy with the correlation is causation fallacy. To do that is just terrible social science.

Currency Regime Variables: Second, we know that the instances in the high debt-to-GDP category vary considerably in their history and in key attributes that can critically affect economic growth. In particular, nation-instances in the R-R database vary according to whether Government debt is denominated in its own fiat currency, whether it allows a freely floating exchange rate, and whether it has a currency that is non-convertible. These variables determine whether a nation does or doesn’t have solvency constraints, and so cannot possibly involuntarily default on its debts. A nation has a sovereign fiat currency if it is non-convertible, freely floats and if the nation has no debts denominated in any other currency. R-R didn’t consider these variables in their classification, and it is very likely that any association between the debt-to-GDP ratio and economic growth will vary with these variables.

Yet, R-R simply ignored these variables in their work, even though Kenneth Rogoff was once the Chief Economist of the International Monetary Fund (IMF). It is mind-boggling to think that R-R did not know about these distinctions. They must have known about them, and their possible significance. So why did they ignore them in their analysis? Were they afraid that including them would have shown that the key association in high debt-to-GDP level nations they were reporting (which we shall shortly see was in error anyway) was spurious?

Control Variables:Third, of course there are a host of other variables in addition to the monetary ones I just mentioned that could, if data were gathered, and they were taken into account, have shown that any simple reported ecological association between debt-to-GDP and economic growth was spurious. I’ll just list the first five of a much longer list that might have been considered in a serious research design:

— the gap between actual output and projected “full” output;

— High involuntary unemployment vs. full employment;

— Price stability vs. inflation or hyperinflation;

— Minimum wage vs. a living wage;

— No operative right to health care for everyone;

There are many more variables that might plausibly be related to economic growth and that, if included, could have affected any observed simple correlation. So, why weren’t such variables in the database? And if the answer is that the resources were not there to provide them, then why weren’t very loud disclaimers included in the RR study telling readers that the results reported were very exploratory, could not serve as the basis for any policy, and might well be swept away by a more comprehensive analysis.

Conclusion

So, even before the recent empirical work casting further doubt on the idea that austerity is necessary, or at least good policy, because it is generally true that high levels of the debt-to-GDP ratio are associated with and/or cause very low or even negative rates of economic growth, there were several considerations of theory, methodology, and facts on the ground, showing that any generalization of the associational and causal relationships assumed by austerity advocates (and reported in the R-R work) to individual nations and times had no basis in fact. So, decision makers who adopted austerity were doing so in the absence of proof and on the basis of a theory that sounded right to them.

Erskine Bowles made this very clear in his response to the new paper by Thomas Herndon, Michael Ash, and Robert Pollin, showing significant errors in the RR work. He said:

What it doesn’t change is the common sense and my own personal experience in both the public and private sector that when any organization has too much debt that is an enormous risk factor and your risks go up then people lending you money will want more money for their money.

Or, in other words, he’s had his theory and he’s sticking to it whatever the research says, and however much harm it’s already caused in the real world. It’s infuriating to see this kind of attitude expressed by people who know well the results of austerity in Europe and who are also very well aware of the great damage it is causing elsewhere, including the United States. The rage one begins to feel has, I’m sure, a lot in common with the rage French peasants felt at the entitled aristocrats of 18th century France. It is the “let them eat cake” attitude expressed by those who, from their comfortable and often lavish financial perches, counsel the rest of us to wait, wait, wait, for the favorable effects of their austerity to bring us all nirvana, that really gets to you. They keep forgetting that “prosperity is just around the corner” didn’t work for Herbert Hoover, and that “in the long run we’re all dead.”

Just yesterday, in a post calling for the repeal of the sequester Richard Eskow pointed out that President Obama’s weekly address called for replacing the sequester with his “balanced” austerity-filled deficit reduction budget. Eskow says:

It’s as if the White House hadn’t received the memos: That the Reinhart/Rogoff paper’s been discredited. That contractionary policy kills economies … and dreams. That the jobs picture is still lousy, but that Keynesian economics still works so we can create some.

Well, I don’t know about the Keynesian economics part, preferring the MMT approach myself, but Eskow’s right to point to the anomaly of the Administration continuing to advocate for austerity, when it is now plain that the austerian emperor has no clothes. This President gives the impression of being reasonable and open-minded, but when it comes to fiscal policy he has shown a troubling unwillingness to acknowledge failure and to adapt. Not least in his refusal to counter debt ceiling crises by filling the public purse with platinum coin seigniorage. And his continued adherence to his austerity budget in the face of both the older critiques and the newer studies undermining austerity means that we, the people, must demand that he and the Congress, The Washington Post, and the various other “captains of catfood” we hear so much from these days, prove causality before he and they, together, inflict any more suffering on the rest of us.

I don’t know about you. But I’ve had it with all the austerians up to here. And I say that it’s time to get them to put up or shut up. If they can’t prove that the policies they’re advocating and have been implementing will work, then let them either can austerity, or resign, and get out of the way of people who can make things better.

Part Two will review the recent empirical research on the R-R study.

22 Responses to Make ‘em Prove the Causality before They Cause Any More Suffering: Part One

  1. Brad Sandler

    I have yet to have any discussion with an austerian where they could create a narrative that demonstrates how austerity creates general properity. This should be the groundwork against which one would then be able measure the theory against. So, to ask them to prove it will only result in vague stories about freeing capital in order to create incentives for businesses to hire folks. My retort has always been to explain to me how having extra money from lower taxes is going to make the guy who owns a local pizza shop hire another pizza maker? Their proof will continue to present the mythical family constrained by an inability to earn more and thereby forced to survive off of a can of chef-boy-ar-dee for dinner and dry cereal for breakfast.

    • Joe Firestone

      Exactly! But if they can’t prove it then we should turn every Representative and Senator who votes for austerity out of office in 2014; whatever else they do. It should be a one issue campaign. Do they oppose austerity or not? If so, then they are for plutocracy and against democracy and are enemies of the people.

  2. Austerity has always been about big money owning Congress and Congress doing big money’s bidding. Everything else is window dressing.

  3. I think Ayn Rand hit the nail on the head when she wrote, “When you hear anyone preaching sacrifice, run for you life, because they’re talking about your sacrifice, not theirs.”
    But apart from that, the real question is “Who is going to make “em” prove anything?” Everyone can talk about it, but no one is in any position to make ‘em” do anything at all – not the politicians, not the courts, and not even the President.

    • Joe Firestone

      We all are Guggzie. What we need to do is vote against anyone who votes for austerity regardless of Party. If this happens during the election of 2014 in all districts, whether red or blue, then austerity will be dead. Make it a single issue campaign.

      • Iowa Housewife Suggests

        Seems not unlikely to me that voters who do oppose austerity policy will nevertheless succumb to fears they’re only handing the election to the (even worse) other side if they dare actually turn against their own party’s austerian on election day – and for that reason fail to carry out a threat many would actually like to follow through on.

        But employment of SIM-POL, the Simultaneous Policy, might help. Could it make your suggestion a success? If people haven’t heard of it, that’s where everybody signs a pledge to do a thing, but they know before they sign that they are only obligated to carry out their promised action if and once a predetermined number of signatures has been reached. The action will be taken by a known and sufficient number of voters, or not at all. Don’t get enough signatures, nobody is obligated to risk anything. In the case of, say, a movement to mass-withhold tax payments to Fed Gov to protest spending for war, people are assured a large enough number will do it simultaneously so there are way too many participating to prosecute anybody. Safety in numbers – if the numbers are high enough. With SIM-POL there is no worry the numbers aren’t high enough – there is no guessing how many are willing to participate. In the case of voting out austerians, it could be green light everybody go only if/when, say, at least X million Dem and X million Republican voters have signed on? I dunno – I’m just thinking out loud here.

        Might even be the case you’d get enough signatures the press could not ignore it. News articles might pop up about both D and R voters coordinating a solid promise to punish austerians on election day based strictly on the 1 issue, party loyalty be damned, more or less taken out of the equation.

        We know Congress always hears it when the dog doesn’t bark. I’ve long thought that SIM-POL is an extremely under-used tool. Use it and we bark through a megaphone? Is there a better way to pre-assure congress- critters the bite coming is a certainty? Is SIM-POL an effective force-multiplier?

  4. Finally, some refreshing detail with a refocus on reality. A jaded observer would wonder if this contre-temps is meant to distract from reality. That reality, and a stark one at that, would include: high and unyielding and costly unemployment; increasing inequality in an already very unequal society; undisguised attack on Social Security and other social programs. And to that reality you are striving to force the refocus.

    And on that detail, we would have thought that model specification would be the thing – as you have shown by going beyond the one ‘explanatory’ variable, sort of like introducing Chapter Three in an econometrics course. And to have reached Chapter Three we would have already learned stuff like the importance of data collection, transformation and verification as well as variable definition – the grade is an incentive.

    Moreover, it is curious that, for example, Professor Rogoff would have cautioned against causality (…Of course, there is a two-way feedback between debt and growth…’ in his article, ‘Austerity and Debt Realism’ of 1 June 2012 in Project Syndicate. Yet he would precede that caution with the confident assertion that there is that 90% Debt/GDP ‘Cliff of Doom!!!’ over which the world fall, an assertion promulgated into the ‘Law of Finance’ by the well-renowned Professor Niall Ferguson.

    The agenda is austerity and Fiscal Cliffs of Doom. The agenda is a cynical and costly distraction from reality, and the agenda deserves to be ridiculed along with its well-renowned promoters who appear to be neglecting their primary role and responsibility as strict practitioners of economics.

    • Joe Firestone

      Mostly right, and it certainly is about model specification and rigorous testing as I made clear many years ago in this piece:

      On this:

      ‘there is a two-way feedback between debt and growth…’ I’d add that the feedback relationship is different for different systems. If the debt accompanies deficit spending with high fiscal multipliers, then the automatic stabilizers will eventually work on increased growth to lower the debt-to-GDP ratio. But, if the increased debt accompanies the wrong kind of deficit spending or a pattern of stop and start in deficit spending, as in Japan, then economic growth will decline or remain low,while the debt-to-GDP ratio increases. So, there’s no general feedback relationship that applies to all systems. It’s different depending on context.

      • Joe Firestone

        Sorry forgot to include the reference to my piece published 42 years ago. Here it is: Firestone, Joseph M., “Remarks on Concept Formation: Theory Building and theory Testing,” Philosophy of Science, 38,(1971) 570-604

        • Thanks for the reference.
          And to admit an error, and do so early, is a trait that does have the advantage, of not only reflecting professional stature, but of tempering further criticism – hence the disappointment with Profs Reinhart and Rogoff, accomplished economists. A quick admission of error would have avoided Prof Whitehead’s gem, ‘When does +2.2% = -0.1%? er, never?’
          And, yes, I failed to indicate that, just as with a fiscal stimulus, a fiscal contraction can have that multiplier effect, but with a likely impact more socially destructive in the latter case as we witness today. Had there been a stimulus of the size, targeting and timing as recommended by several economists, its impact would have made moot any subsequent discussion of the immutable ‘Law of Finance’ of Prof Ferguson, and that ‘Cliff of Doom’, that 90%.

    • Joe Firestone

      Yes, I know what it means. I read Festinger long ago and other cognitive balance theories as well. What specific point are you making? Please amplify.

  5. I’ve only been following MMT for 6 months to a year now, but I am very optimistic at this point about its future. Once this austerity crap has finally been put to bed, what else could take its place? MMT is the logical next step. Change comes very slow in the world of accepted economic theory/policy – and perhaps you all have been expecting it for a long time and mine is just wishful thinking – but it seems that we are seeing a very real transformation take place right now. The arguments get weaker and weaker, research gets discredited, etc. My feeling is that this will take place first in the Euro area as they are facing the most public pressure and the most urgency to find a solution, and perhaps then the US/Japan/others will adopt much more aggressive fiscal policy.

    Or maybe I’m just delusional..?

    • Joe Firestone

      Well, there are the 100% percent reserve banking people at the American Monetary Institute. Check out people like Stephen Zarlenga and Ellen Brown.

  6. “This President gives the impression of being reasonable and open-minded”

    Citation needed.

    • Joe Firestone

      I can’t give one off-hand, because I always find him faux reasonable. But I’m quite sure he always tries to appear as if he’s the reasonable adult in the room, and that people who don’t look too closely can easily be fooled. See this one and this one on how lack of reasonableness often comes in.

      Also, in the January 2012 decision of the Administration not to use Platinum Coin Seigniorage to defuse the debt ceiling, the President hid behind the Fed and the Treasury, neither of which really explained why they were opposed to using PCS. They just said it was off the table.

  7. Nice discussion, Joe. Looking forward to part 2.

  8. Joe Firestone

    Thanks, aj. Perhaps tonight or tomorrow. I’m getting to it this evening.

  9. Pingback: Make ‘em Prove the Causality before They Cause Any More Suffering: Part Two, the Fall and After | New Economic Perspectives

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