Austerity Versus Growth Insanity

I would like to go back to something Herman Daly wrote. I quoted it in last Sunday's post Capitalism And Constraints On Natural Resources. Daly is talking about the relationship of debt to economic growth.

The reason so much debt was incurred is that we have had absurdly unrealistic expectations about the efficacy of capital to produce the real growth needed to redeem the debt that is “capital” by another name.

In other words the debt that piled up in failed attempts to make wealth grow as fast as debt is evidence of the reality of limits to growth.

But instead of being seen as such, it is taken as the main reason to attempt still more growth by issuing more debt, and by shifting bad debts from the balance sheet of private banks to that of the public treasury, in effect monetizing them.

The debt that piled up in failed attempts to make wealth grow as fast as debt is evidence of the reality of limits to growth. You can see this relationship between debt and growth in graphs like these illustrating our absurdly unrealistic expectations of efficacy of capital to produce real growth.

Source: San Francisco Fed. See my post Keynesian Delusions

First let's dispense with the question of why real economic growth failed to meet our expectations. Why did growth slow and debt grow so dramatically starting in about 1980? I don't know. While I am confident that resource contraints (among many other things) can explain why growth will fail in the future, such constraints do not explain why growth slowed in the past. Every explanation I've seen along those lines is deeply flawed and unconvincing. And we should bear in mind that growth slowed and debt increased in all of the developed world, not just the United States. We can see the same trends in Europe and Japan.

The true answer to the question of why growth slowed (and debt grew) over the last 30 years appears to be a very complex story involving multiple factors. For example, watch the first 12 minutes of the video The Earth Is Full (below). So if anything, the research agenda of economists should be to explain what happened in the real world over these past 30 years, not to push the same growth/debt trap.

Now, the real reason I bring this up today is the current debate about austerity, which is a simple concept. The idea is to pare down the massive debt accumulated during those decades when growth failed to meet our absurdly unrealistic expectations. Austerity is always contrasted with growth.

Leaders of the world’s richest countries banded together on Saturday to press Germany to back more pro-growth policies to halt the deepening debt crisis in Europe, as President Obama for the first time gained widespread support for his argument that Europe, and the United States by extension, cannot afford Chancellor Angela Merkel’s one-size-fits-all approach emphasizing austerity...

“Our imperative,” the leaders said in their statement, “is to promote growth and jobs.”

It is by no means the final word in the growth-versus-austerity fight that has been under way for two years...

But of course we can now see that the entire "austerity versus growth" fight is based on false premises. Over the last 30 years, every point of GDP achieved by the developed economies required more and more debt to support it. There is no reason to expect that trend will simply disappear, although we can not be sure of the deep underlying causes of that trend. The trend now seems to be firmly established.

And just as we would expect whenever there is some form of mass delusion going on, the "austerity versus growth" debate has become highly politicized. I'm sure you know it by heart. Republicans are cruel austerians. Democrats are righteous advocates of growth (and jobs). But if you understand what the true situation as outlined above, partisan cartoons like this one are wholly misguided.

And there is something else we need to realize in Daly's comments above. I'll quote it again for convenience.

But instead of being seen as such, it is taken as the main reason to attempt still more growth by issuing more debt, and by shifting bad debts from the balance sheet of private banks to that of the public treasury, in effect monetizing them.

Monetizing debt in this context means printing or borrowing money and getting it to circulate in the economy, which creates inflation. Inflation has two salutary effects according to standard neo-Keynesian theories: 1) you inflate the debt away (in real terms); and 2) you spur private spending and exports, which makes the economy grow, and allows the bloated public debt to be paid off eventually in devalued dollars. Wash, rinse and repeat.

Really, if you think about it for any length of time, you will see that I've just described the ultimate Free Lunch.

So now you will understand these remarks by Paul Krugman in a recent column Apocalypse Fairly Soon.

Yet financing isn’t enough. Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect of emerging from austerity and depression. Realistically, the only way to provide such an environment would be for the central bank to drop its obsession with price stability, to accept and indeed encourage several years of 3 percent or 4 percent inflation in Europe (and more than that in Germany).

Inflation is Krugman's general purpose prescription for what ails us. Just substitute "Federal Reserve" for "central bank", and "the United States" for "Europe" in that last sentence, and you will have a complete summary of the liberal pro-growth position.

But on closer inspection, given the general failure of growth to meet our absurdly unrealistic expectations, we can see what nonsense this position truly is. As I said, the real question of our day is to understand these past failures, not repeat them. Einstein defined insanity as doing the same thing over and over again and expecting different results. That sums the situation up, and I'll leave it at that.

Bonus Video — Paul Gilding's TED talk The Earth Is Full. Gilding goes off the rails at the 12 minute mark. That's when the obligatory hope begins, which is why he was allowed to give this talk.

 

Comments

[raintonite]

I agree that the austerity v growth dialogue is a false binary. Life often isn't just an either-or proposition. There are many shades, if you like, in between; as well as other options outside (given the imagination) of the binary.

Also I agree that resource constraints (diminishing resources and/or competition) must play a part in the complex equation that have limited growth potential. The neo-classical idea that capital is a creator of resources, especially as a substitute for basic resources like oil, is laughable.

One of the big themes during my time on Wall Street back in the 80s was the lament about the lack of new "horizon" industries, that is, entirely new industries like computing that would both require new hardware and software to spur growth by taking earth's resources, mineral and human, and converting them into investment opportunities - i.e. money for the bankers. I'm sure this part of the equation weighs heavily on future growth prospects as well. Funny money chasing too few new investment opportunities, and instead seeking rentier income that is slowly draining the life blood from our economies. (In Ireland they had their first reported case of child malnutrition. Apparently this isn't uncommon. Just not reported. And forget about the suicide rate that is sky-rocketing. Greece, forgedda about it!)

Of course the entire dialogue is severly constrained by how we define growth. The current debate demands we grow as we did previously, by taking already diminishing resources in their virgin states and turning them into ever more commodities.

An alternative would to be the growth of powering-down. Put some people to work dismantaling some infrastructure and reforming it. Take others to rebuild. Put more people on the land. Use any energy left wisely and frugally. Cut the birth rate by at least half world wide.

Ain't, never going to happen.

[Dave Cohen]

Re: Funny money chasing too few new investment opportunities, and instead seeking rentier income that is slowly draining the life blood from our economies

Nicely put.

-- Dave

[Mister Roboto]

I have an idea about why growth slowed during the late seventies/ early eighties. A system that grows can only grow so much, so that when it reaches a certain point, its growth must necessarily slow down. Of course, this is going to be a serious problem for a human social system whose well-being depends entirely upon growth for the sake of growth! The analogy I use is an apple on a tree-branch. The nineteenth and first-half twentieth centuries were the green-to-reddish "growth" phase. 1946-76 was the "fresh-ripe" stage, and 1976-2006 was the "overripe" stage". We are now in the "off-the-branch-and-rotting" stage. Heavens help us.

[John D]

Mister Roboto- My tree analogy with growth says that when a tree gets too large, the energy it takes to get the water from the roots to the top of the tree takes more energy than the growth it obtains. Our society has become so large and complex that the infrastructure to maintain it costs more than the growth is worth.

[Alexander Ač]

Dave, regarding your question, I note that "per-capita" energy consumption peaked in 1979. Could it be that in order to sustain unsustainable the debt began to rise (exponencially)?

US per capita is here (but is holds true globally): http://energyforumonline.com/705/u-s-per-capita-energy-consumption-and-expenditures/

Alex

[IDontExist]

Almost all say: Government spending is out of control, unsustainable, and uncurbed will:
Trigger total economic collapse
Democrats say: Austerity, cutting government spending would contract the economy and:
Trigger total economic collapse
Republicans say: Increasing taxes enough to significantly offset spending would:
Trigger total economic collapse
Democrats and Republicans say: Letting ultra- big businesses and financial firms fail would:
Trigger total economic collapse
Libertarians say: Bail outs prevent real recovery, increase moral hazard, and will in the end:
Trigger total economic collapse.

Funny thing is, I believe them all.

[BS]

Hummm, 1980. Reagan entered office in 82. The whole trickle down theory began it's long test. Perhaps debt increased because there was an insufficient 'trickle'. Wealth trickled to fewer and fewer while debt trickled to more and more. Disposable income for the middle class trickled out the door into the hands of bankers bent on giving you no interest for a year (and 20% thereafter). Even H.W. Bush said bank loan rates were too high, but he was quickly smacked down.

Perhaps there are limiting resource constraints but there is certainly no limit to the greed of the tricklers.

[Don Levit]

I have a chart from mybudget 360.com which shows Total Credit Market Debt Owed and GDP since 1970.
In 1970, the 2 were about the same.
In 2010, TCMDO was over $50 trillion, while GDP was $15 trillion.
Instead of a dollar of debt producing a dollar of GDP, it takes over $3 of debt to produce a dollar of GDP.
Don Levit

[Planningdown.wordpress.com]

Great post and comments. Clearly there are some diminishing returns at work here, as each increment of growth requires an ever larger increment of debt to fuel it.

As for the the growth vs. austerity argument, it does seem that all else being equal austerity hurts the poor more proportionally than the wealthy. At least in theory the Krugman 'growth' model would help the poor and middle hold on to a greater share of a shrinking pie.

Will either approach solve anything? Of course not. The charts you provide show that growth costs too much anymore. And everybody knows austerity is just another excuse to balance the books on the backs of those least able to afford it.

The more I think about it though, the more I agree with IDontExist's comment above that we're damned either way.

glaucus
www.planningdown.wordpress.com

[T E Cho]

In the 80's and 90's , investments went overseas , and were cut back % here. And it continues. Fwiw.

[Doug Guillory]

In my view a big part of the poor return on capital lies in the poor investments in bubble economies. We now have a huge overhang in housing, more housing than people need or can afford, representing money thrown away. To a much smaller extent the dot-com bubble caused loss of capital. Easy money is a dangerous thing.

[sharonsj]

I'm with BS. Real income for most folks has been flat for 30 years. In order to sustain a good middle class life, you could turn your house into a loan account and you could charge what you wanted/needed on a credit card. But that ends when housing sinks, you lose your job, and/or you can't earn enough to pay all the bills.

Now throw in the cost of private health care. Premiums are out of sight for lousy coverage. Get sick and kiss your savings and belongings good-bye. Something like 60-70% of all bankruptcies are due to medical costs.

Plus, I'd hate to think of my house and property as money thrown away. It still costs less to live in it than renting.

[Mike Roberts]

Yeah, Gilding went off the rails in the last four minutes. After explaining the total breakdown of the global economy, after explaining we're in systemic collapse, he then thinks we'll be able to solve the individual problems, that it's no worse a situation than Pearl Harbor or a set of business decisions. "The only thing we need to change is how we think and how we feel". Ah, right. Phew! Everything is going to be fine - I'll change the way I think and feel tomorrow and life will be great again.