Beyond Debt and Growth
This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the July/August 2013 issue of Dollars & Sense magazine.
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Nothing warms the heart quite like a story of the high and mighty brought low. Harvard economists Carmen Reinhart and Kenneth Rogoff were the high and mighty—prestigious academics whose influential paper on government debt and economic growth was widely cited by policymakers and commentators to justify painful austerity policies. The underdogs who brought them down were three members of the UMass-Amherst economics department: graduate student Thomas Herndon and professors Michael Ash and Robert Pollin. As Dean Baker of the Center for Economic and Policy Research (CEPR) argues, it is no accident that UMass economists were the ones to debunk Reinhart and Rogoff. The department, Baker notes, “stands largely outside the mainstream” of the economics profession and so is “more willing to challenge the received wisdom.”
Reinhart and Rogoff had claimed that countries with government-debt-to-GDP ratios of over 90% could expect dramatically lower future economic growth than other countries. But when Herndon attempted to replicate this result for a course in applied econometrics taught by Ash and Pollin, he found that he couldn’t. In fact, as the Herndon-Ash-Pollin published paper would report, there was no dramatic growth dropoff above the supposedly critical 90% threshold. The reasons behind the faulty finding? Well, there was the world’s most famous spreadsheet error—which has received extraordinary media attention mainly because it is so embarrassing, so all the more delicious given the lofty position of the authors. More importantly, however, was Reinhart and Rogoff’s questionable treatment of the data. Most of the difference between their results and Herndon-Ash-Pollin’s was due to no mere error, careless or otherwise, but to deliberate (and, in Pollin’s view, “indefensible”) decisions about how to average the data, how to divide it into different categories, and so on.
Pollin is the co-director of the Political Economy Research Institute (PERI) at UMass-Amherst and is well-known for his work on minimum-wage and living-wage laws as well as the project of building a green economy. Dollars & Sense co-editor Alejandro Reuss sat down with him to talk not only about the Reinhart-Rogoff paper and the Herndon-Ash-Pollin takedown, but also larger issues about the economic crisis and austerity: the role economists have played in abetting austerity, the reasons behind policymakers’ determination to impose austerity policies, and the diverging paths before us—the profit-led recovery promised by neoliberal economists versus a wage-led recovery pointing toward a more egalitarian social-democratic system. —Eds.
D&S: While Reinhart and Rogoff’s so-called “Excel error” got a lot of attention in the media, this was a relatively small factor in the findings they reported. What do you think are the key critiques of the view that high debt-to-GDP ratios doom growth, both in terms of the figures and interpretation?
RP: I recall one commentator said that the Excel coding error was the equivalent of a figure skater who was not doing well, but it wasn’t entirely clear until he or she fell. Even though the fall itself wasn’t the most significant thing, it dramatized the broader set of problems. I think that’s true of the Reinhart-Rogoff paper. The main things that were driving their results were, first, that they excluded data on some countries, which they have continued to defend. Second, and most importantly, was the way that they weighted data. They took each country as a separate observation, no matter how many years the country had a high public debt-to-GDP ratio. For example, New Zealand had one year, 1951, in which they had a public debt-to-GDP ratio over 90%. And in that year New Zealand had a depression. GDP growth was negative 7.6%. The UK, by contrast, had 19 years in which the debt-to-GDP ratio was over 90%, and over those 19 years GDP growth averaged 2.5% per year, which is not spectacular, but not terrible. Now, according to the way Reinhart and Rogoff weighted the data, one year in New Zealand was equally weighted with 19 years in the UK, which I find completely indefensible.
D&S: So when you correct for these problems, you end up with a modest—maybe not even statistically significant—negative relationship between the debt-to-GDP ratio and future growth. What are the main arguments about how to interpret this relationship?
RP: Reinhart and Rogoff have been making the defense that even the Herndon-Ash-Pollin results still showed public debt-to-GDP over 90% being associated with a GDP growth rate of 2.2%. Meanwhile, at less than 90% debt-to-GDP, growth is between 3 and 4%. So they’re saying, “Well, we made some mistakes but it’s still a 1% difference in growth over time, which matters a lot.” And I wouldn’t disagree with that observation.
But there are other things in here. First, is it statistically significant? One of the other things we [Herndon-Ash-Pollin] did was to create another public debt-to-GDP category, 90% to 120%, and then above 120% debt-to-GDP. For the 90–120% category there’s no difference in future growth rates [compared to the lower debt-to-GDP category]. So it’s only when you go way out, in terms of the debt ratio, that you will observe a drop-off in growth. Second, what happens when you look over time? In their data, for 2000 to 2009, the growth rate for the highest public debt-to-GDP category was actually a little bit higher than in the lower categories. So what’s clear is that there really is no strong association.
Who, Me?
Since the publication of the Herndon-Ash-Pollin critique of their research, Reinhart and Rogoff have both defended their findings and backed off the most forceful interpretations. They claimed in the New York Times (April 25, 2013) that, far from arguing that high debt caused low growth, their “view has always been that causality runs in both directions, and that there is no rule that applies across all times and places.” And they have washed their hands of commentators and politicians who “falsely equated our finding of a negative association between debt and growth with an unambiguous call for austerity.”
Judge for yourself, based on Rogoff’s words back in 2010:
Indeed, it is folly to ignore the long-term risks of already record peace-time debt accumulation. Even where Greek-style debt crises are unlikely, the burden of debt will ultimately weigh on growth due to inevitable fiscal adjustment. ... [A]n apparently benign market environment can darken quite suddenly as a country approaches its debt ceiling. Even the US is likely to face a relatively sudden fiscal adjustment at some point if it does not put its fiscal house in order.
—Kenneth Rogoff, “No need for a panicked fiscal surge,” Financial Times, July 20, 2010
In addition, some people have then taken their findings and asked which way causality is running. Is it that when you have a recession, and you’re at lower growth, you borrow more? Well, that’s certainly part of the story. And Reinhart and Rogoff have now backpedaled on that. But to me even that is not nearly getting at the heart of the matter. The heart of the matter is that when you’re borrowing money you can use it for good things or bad things. You can be doing it in the midst of a recession. If we’re going to invest in green technologies to reduce carbon emissions, that’s good.
We also need to ask: what is the interest rate at which the government is borrowing? The U.S. government’s debt servicing today—how much we have to pay in interest as a share of government expenditures—is actually at a historic low, even though the borrowing has been at a historic high. The answer obviously is because the interest rate is so low. When you’re in an economic crisis and you want to stimulate the economy by spending more, does the central bank have the capacity to maintain a low interest rate? In the United States, the answer is yes. In the UK, the answer is yes. Germany, yes. In the rest of Europe, no. If you can borrow at 0%, go for it. If you have to borrow at 9%, that’s a completely different world. And the Reinhart-Rogoff framework doesn’t answer the question. It doesn’t even ask that question.
D&S: Looking at research touted by policymakers to justify austerity policies, which has now been debunked, do you see the researchers putting a “thumb on the scale” to get the results that they wanted? Is that something you want to address, as opposed to simply getting the data, seeing what’s driving the results, and debunking the interpretation when it is not justified?
RP: It’s clear that politicians seized on these findings without questioning whether the research was good. That’s what you’d expect them to do. Politicians are not researchers. The only research Paul Ryan cited in the 2013 Republican budget was the Reinhart-Rogoff paper. George Osborne, the Chancellor of the Exchequer in the UK—same thing. People at the European Commission—same thing. Now, speaking about Reinhardt and Rogoff themselves, I don’t know. In general, it is certainly a tendency that if someone gets a result that they like they may just not push any further. I think that may have happened in their case, without imputing any motives. All I can tell you is that they wrote a paper which does not stand up to scrutiny.
D&S: All this raises the question of why elites in Europe and in the United States have been so determined to follow this austerity course. How much do you see this as being ideologically driven—based on a view of government debt or perhaps government in general being intrinsically bad? And how much should we see this as being in the service of the interests of the dominant class in society? Or should we think of those two things as meshing together?
RP: I think they mesh together. I think part of it comes from our profession, from the world of economics. It’s been basically 30 years of pushing neoliberalism. It has become the dominant economic agenda and certainly hegemonic within the profession. When the crisis hit, countries did introduce stimulus policies and one of the criticisms [from economists] was that this is really crude and we don’t really know much about multiplier effects and so forth. That’s true, and the reason that we have only this crude understanding of how to undertake countercyclical policies is because the mainstream of the profession didn’t research this. It was not a question. They spent a generation proving that we didn’t need to do these policies—that a market solution is the best. So that’s the economics profession and it does filter into the political debates.
But then, beyond that, is the agenda of getting rid of the welfare state and I think a lot of politicians want that to happen. They don’t want to have a big public sector. Either they believe that a big public sector is inefficient and that the private sector does things more efficiently, or, whether they believe that or not, they want lower taxes on wealthy people (and wealthy people want lower taxes because that lets them get wealthier). They don’t want constraints on their ability to enrich themselves, and they certainly don’t want a strong and self-confident working class. They don’t want people to have the security of health insurance or pension insurance (i.e., Medicare and Social Security in this country). That’s the model of welfare-state capitalism that emerged during the Great Depression and was solidified during the next generation, and these people want to roll it back. The austerity agenda has given them a launching pad to achieve this. I have no idea whether Reinhardt and Rogoff believe this or not, but their research enabled people like Paul Ryan to have the legitimacy of eminent Harvard economists saying we’re killing ourselves and we’re killing economic growth by borrowing so much money.
D&S: Policymakers in the United States, Europe, and elsewhere, to a great extent, have just tried to “double down” on neoliberal policies. But with the structural problems of neoliberalism, keeping the same structure looks in effect like a way of keeping the same crisis. What do you see as the possible ways out of the impasse, both desirable and undesirable?
RP: I think there are fundamentally only two approaches—basically profit-led models versus wage-led models. In the Financial Times today [June 10], the well-known columnist Gavyn Davies is saying that the reason the stock market is going up—and it’s going up very handsomely—is fundamentally because the current model of capitalism is able to proceed by squeezing workers even harder. The wage share, which had been relatively stable for generations, is going down and the profit share is going up.
Now is that sustainable? Presumably you’re going to have a problem of demand at a certain point because if workers don’t have enough in their pockets, how are they going to buy the product? One answer is we can export to rising Asian markets and so forth. But the Asian countries themselves are depending on the exact same model. The alternative, which I think makes more sense logically and is also more humane, is to have a more equal distribution of income—a social democratic model of capitalism in which you do have a strong welfare state that acts as a stabilizer to aggregate demand and also enables workers to buy the products that they make. And that’s true for China and for the United States.
We have to add into that the issue of environmental sustainability. At the same time that we’re building a new growth model it has to be a model in which carbon emissions go down per unit of GDP. I don’t think it’s that hard to do technically. Whether it happens is another matter.
The Legacy of Michal Kalecki
Michal Kalecki (1899–1970) was a Marxist economist, a scholar at Cambridge and Oxford, and an economic advisor to the governments of his native Poland and other countries. His key insights about the causes of the Great Depression preceded Keynes, but he was not widely recognized for these achievements. (Unlike Keynes, he did not publish mainly in English, was not well-known, and was not connected to elite policymaking circles.) Kalecki is perhaps best remembered for his brief article Political Aspects of Full Employment (1943), in which he argued that full-employment policies would erode capitalists’ power in the workplace and state, and so would be sure to face capitalist opposition. Robert Pollin calls this “probably the most insightful six pages ever written in economics.”
[The 20th-century Polish macroeconomist Michal] Kalecki, of course, recognized this a long time ago, saying you can have a model of capitalism based on repressing workers. (He noted that it’s helpful, if you’re going to do that, to have a repressive fascist government—not that he was advocating doing that, of course.) After a while, and this was in the Financial Times today, workers are going to see that they’re not getting any benefit from a recovery, and it’s going to create all kinds of political results, and we don’t know what they’re going to be. But people are going to be pissed off.
D&S: That brings us to a central question, which Kalecki raised, that a social problem may be solved technically and intellectually, but still face barriers of economic and political power. That applies not only to full employment, the issue he was addressing, but also to environmental sustainability and other issues. Can our most serious problems be resolved within the context of capitalism, or do they require a new kind of economy and society, whatever we may call it?
RP: The challenge that Kalecki introduced points to some version of shared egalitarian capitalism, such as a Nordic model. Whether that model works and how long it works is an open question, and it varies for different countries.
Certainly, when we think about environmental infrastructure investments, collective solutions are workable. We know from Europe that initiatives, which are collectively owned and collectively decided, for building renewable energy systems really do work. In large part, this is because it is the community saying, “We don’t mind having wind turbines if it’s done right within our community and we have a stake in it.” If some big corporation were to come and say, “We’re wiping out 18 blocks here to put up some turbines and we have a right to do it because we own the property”—it doesn’t work. We have public utilities and that works just fine in this country.
Expanding the role of the public sector in my view is totally consistent with what’s going to happen in the future. So that starts transcending the primacy of corporate capitalism. But we can’t get there in ten years. No matter how much anybody wants it, that’s not going to happen. We have a problem of mass unemployment and we have an environmental crisis with climate change, and if we’re not going to transcend capitalism in ten years we have to also figure out ways to address the concerns now within the existing political framework. That’s not fun. When I deal with mainstream politics in Washington, it’s very frustrating, but that’s the world we live in.
I think that if we press the limits of the existing system, that helps me to understand how to move forward into something different than the existing structure. My professor Robert Heilbroner, a great professor who had a beautiful way of expressing things, talked about what he called “slightly imaginary Sweden.” So it’s not the real Sweden but this notion of some kind of egalitarian capitalism. As you press the limits of that model, you can intelligently ask what’s wrong with it. If we’re pushing the limits and something is holding us back, let’s solve that problem. I think that’s a good way forward.
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