Democracy Gone Astray

Democracy, being a human construct, needs to be thought of as directionality rather than an object. As such, to understand it requires not so much a description of existing structures and/or other related phenomena but a declaration of intentionality.
This blog aims at creating labeled lists of published infringements of such intentionality, of points in time where democracy strays from its intended directionality. In addition to outright infringements, this blog also collects important contemporary information and/or discussions that impact our socio-political landscape.

All the posts here were published in the electronic media – main-stream as well as fringe, and maintain links to the original texts.

[NOTE: Due to changes I haven't caught on time in the blogging software, all of the 'Original Article' links were nullified between September 11, 2012 and December 11, 2012. My apologies.]

Thursday, May 16, 2013

Why austerity may be wrecking the recovery

As head of the world’s largest bond fund, Bill Gross has the kind of voice that can move markets. For much of the last few years Gross, who runs the $2-trillion Pacific Investment Management Co., has been warning about the day of reckoning that would befall countries like the U.S. and Britain as they buried themselves under mountains of debt. In 2010, Gross declared British bonds were “sitting on a bed of nitroglycerine” and dumped his entire holdings of U.S. Treasuries with a prediction that soaring government debts would pose the greatest risk to bondholders.

This year, Gross started buying again. His flagship mutual fund is now made up of nearly a third U.S. Treasuries. These days, Gross warns that the biggest problem facing Western economies isn’t the spectre of rising government debt, but that the sweeping budget cuts countries are using to try to repair their balance sheets are killing investor confidence. Governments “have erred in terms of believing that austerity, fiscal austerity in the short-term, is the way to produce real growth,” Gross told the Financial Times last month. “It is not. You’ve got to spend money.”

Gross is part of a growing chorus of opposition to the fiscal straitjacket being imposed on many European countries in the aftermath of the financial crisis. When they were first embraced, such policies seemed like a logical solution to the reckless spending that drove half of Europe to the brink of collapse, a necessary dose of tough medicine to clear the way for future growth. But critics argue that years of tax hikes and spending cuts have instead left countries awash in unemployment, stagnant growth and mounting debt.

Eurostat, the statistical agency of the European Union, released revised economic growth figures last week showing that even though its member countries have slashed their budget deficits nearly in half since 2009, their debt-to-GDP ratios have ballooned from 80 per cent of GDP to 90.6 per cent as the economy grew at an anemic rate (less than one per cent last year). Job growth has also been non-existent. Unemployment is now at a record 12.1 per cent. Austerity, it seems, has neither spurred a recovery nor fixed balance sheets.

Protesters took to the streets of Greece and Spain last week to demand an end to austerity. Italian Prime Minister Enrico Letta pledged to reverse a series of tax hikes, declaring that “Italy is dying from austerity alone.” In France, Finance Minister Pierre Moscovici promised to end the “dogma of austerity,” saying it has harmed economic growth.

The fierce opposition has even inspired a bevy of anti-austerity literature. David Stuckler and Sanjay Basu, researchers from Oxford and Stanford universities, argue in the forthcoming The Body Economic that austerity has become a public health problem, with rising joblessness and cuts to health and social programs responsible for everything from rising alcoholism in Britain, to an HIV epidemic in Greece. That country has even seen an outbreak of malaria because of cutbacks to budgets for mosquito spraying. “Recessions can hurt,” they write, “but austerity kills.”

The backlash is moving across the Atlantic, where despite massive stimulus spending from 2009 to 2011, a recent shift to austerity is causing concern. Automatic budget cuts in the U.S. have been blamed for everything from a slowdown in hiring in March, to flight delays because of furloughs affecting air traffic controllers. In Canada, the parliamentary budget officer warned that Ottawa’s plans to balance the budget in time for an election in 2015 would sacrifice as many as 62,000 potential new jobs over the next three years and cut GDP growth by 0.12 per cent.

All this is shaping up to be one of the most important economic debates of our time. If the anti-austerity movement is right, the global economy is being strangled at a time when what it needs most is a boost. If they’re wrong, and austerity is abandoned too soon, the debt crisis could haunt the world for decades to come.

Opponents of austerity have been winning some powerful, not to mention surprising, allies recently. The International Monetary Fund, previously one of the leading voices in favour of austerity, did an about-face last month, using its World Economic Outlook to urge countries to scale back on their austerity plans. It called on Britain to introduce greater “flexibility” in its plans to slash its deficit to one per cent of national income by next year despite narrowly staving off an unprecedented triple-dip recession.

This week, European Central Bank president Mario Draghi announced he would be willing to slash interest rates to “less than zero” after the bank cut them to record lows last week—a clear sign that the bank believes fiscal austerity alone has failed to stabilize struggling economies. European Commission president José Manuel Barroso, meanwhile, declared that while austerity was still “fundamentally the right thing to do,” the policy had “reached its limits” of political and social support. That has left Germany as the lone voice of austerity in Europe, with Foreign Minister Guido Westerwelle warning that persistently high debts will only “cement mass unemployment for many years.”

In what is being held up as the most significant—if largely symbolic—blow to the austerity movement, a graduate student at the University of Massachusetts uncovered serious flaws in widely cited research by Harvard economists Carmen Reinhart and Kenneth Rogoff that claimed a country’s economic growth began to suffer when its debts topped 90 per cent of GDP. The two economists argued that their research hadn’t even attempted to clear up the long-standing debate over whether it was high debt that caused economic growth to slow, or poor economic growth that caused debts to rise. While it’s largely an academic controversy, critics have claimed it as decisive proof that, as economist Paul Krugman wrote, “austerity had been sold on false pretenses.”

For a time after the financial crisis, the world seemed pretty much in agreement on the right thing to do to guide economies. After 2008, when the U.S. subprime mortgage crisis morphed into a global banking disaster, governments agreed to spend their way out by nationalizing toxic financial assets, slashing interest rates and unleashing trillions in stimulus spending.

Perhaps they were inspired by the barren landscape of Canada’s Far North, but by the time finance ministers from the G7 met in Iqaluit in February 2010, the pendulum of political opinion had begun to swing in the opposite direction. Having stimulated away the worst of the recession, it was time for governments to get their balance sheets in order.

But these days, despite the noisy opposition in Europe, there is hardly any consensus on whether austerity is good or bad medicine for an economy struggling to find a cure for recession and mounting debt. Proponents say that what is failing Europe isn’t fiscal austerity, but growth-killing policies like tax hikes, or threatening small depositors with losing their savings as officials initially proposed as part of a bailout for Cyprus. French President François Hollande’s plans to fix the economy included a 75 per cent tax on millionaires that was ruled unconstitutional in December. By contrast, Baltic countries—Latvia, Lithuania and Estonia—made deep spending cuts in the wake of the 2008 financial crisis and have seen some of the best growth in Europe.

“People say austerity didn’t work, but what austerity?” says Niels Veldhuis, who heads the B.C.-based Fraser Institute. “If you look at Portugal, Italy, Ireland, Spain, they have all increased their spending. We’ve got to be very careful when you say austerity hasn’t worked in Europe. It’s simply not true.”

Yet opponents of austerity argue that cutting government spending in the midst of a global recession can send a country’s economy into a death spiral. Slash spending, they say, and you cut jobs, which drives down wages and increases unemployment. That kills consumer demand, which in turn hurts investor confidence. The result is that government spending falls, but economic output falls faster, causing a country’s debt-to-GDP ratio to balloon despite austerity measures.

That can morph into long-term unemployment with huge consequences for economic growth, says Michael Mendelson, a senior scholar at the Caledon Institute of Social Policy. “People have this sense of a morality story where we’ve spent, spent, spent and now we have to suffer the consequences. But it’s not a morality story. It’s a question of what are the numbers,” he says. “Some of our future advantages are being sacrificed now in the search for short-term savings, even if those savings may not have much of in impact on our debt burden anyway.” Others go as far as to say that austerity represents a form of class warfare, since it’s wealthy investors who benefited the most from governments’ decisions to guarantee the risky debts of insolvent banks, while regular citizens bear the brunt of tax hikes and cuts to programs. “What you’ve managed to do is a bait and switch with the debts of the private sector ending up on the public balance sheet and magically recast as excessive government spending,” says Mark Blyth, professor of international political economy at Brown University and author of Austerity: The History of a Dangerous Idea.

Budget hawks, on the other hand, like to see austerity as the start of a virtuous cycle. Governments that trim their deficits can lower borrowing costs, making their debts even cheaper to pay off. That boosts the confidence of investors, who then pour money into an economy. Too much debt, they argue, can become a broader economic problem if borrowing costs become unsustainable, causing a government to default and sparking a run on banks that hold government bonds. “Once you have a better fiscal performance, investors look at that and say this country is being prudent and therefore that’s a place where we want to invest,” says Veldhuis.

Supporters of this idea of “expansionary austerity” have argued that how you cut is just as important as how much and that the wrong fiscal policy can plunge a country into economic collapse, while the right one can stave off a recession altogether. For instance, Veldhuis argues cuts to education can be damaging to an economy, since such spending improves the skills of the labour market. Cut business subsidies, on the other hand, and “you can actually get very positive results.”

One of the most frequently cited examples of successful expansionary austerity is the budget-cutting of the Chrétien Liberals in the mid-1990s. By slashing department spending and public sector jobs, the government returned the federal budget to a surplus in three years after nearly three decades of steady deficits, and also saw the start of an economic expansion.

Slaying the deficit made room for the government to cut taxes, which made Canada a more attractive place for investors, says Veldhuis. “We made Canada much more competitive, and what happened when we did those things? Canada was a superpower in the world,” he says. “Austerity does actually lead to a better fiscal climate.”

But Mendelson argues that Canada’s success in the 1990s had less to do with austerity creating a pathway for growth than economic growth creating an opportunity for austerity. By the time the government began its economic reforms in 1995, the economy was already growing by five per cent a year, thanks largely to exports to the U.S., which was in the midst of an economic boom.

The lesson from Canada’s experience, says Mendelson, is that austerity only works when your major trading partners are growing, not in the midst of a global recession and not when all of your neighbours are also cutting back on their spending. “You’re going to have nobody spending and then where is the economic activity going to come from?” he says. “You can’t float a boat at low tide.”

The current battle over austerity strikes at the heart of the broader debate on the government’s role in the economy. Should governments try to create jobs, or get out of the way of those who do? Can they stave off a recession or merely respond to it?

Despite centuries of economic data—Reinhart and Rogoff’s controversial analysis spanned 200 years—that debate is far from over. Until countries can experiment with fiscal austerity in a global economic vacuum, it’s a debate that may never be settled.

“When researchers tested Prozac on depressed patients, they divided their subjects randomly into control and experimental groups, and conducted many trials,” says Yale economist Robert Shiller. “We cannot do that with national debt.”

Original Article
Source: macleans.ca
Author: Tamsin McMahon

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