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James Pethokoukis posts on an austerity program that worked.
Now, we all all know “austerity” from deep spending cuts (not the tax hikes, of course) is killing Europe’s economy and would do the same here in America, right?
Well, here’s a story about austerity that critics such as President Obama, Paul Krugman, and Ezra Klein never seem to mention: From 1944 to 1948, Uncle Sam cut spending by a whopping 75% as World War II came to end. Spending as a share of GDP plunged to 9% in 1948 from 44% in 1944.
Superstar economist and devout Keynesian Paul Samuelson—later to become the first American to win the Nobel Prize in economics—predicted such shock austerity would cause “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” That dire, disastrous prediction was widely held by his fellow Keynesians, with one even predicting an “epidemic of violence.”
Except the doomsayers were wrong, even though Washington obviously ignored Samuelson’s call for gradual spending reductions. Despite cuts which dwarfed those seen in the EU today—not to mention those Republicans are calling for here at home—the U.S. economy thrived. There was no mass unemployment despite rapid demobilization of the armed forces. As George Mason University economist David Henderson explains is his 2010 paper, “The U.S. Postwar Miracle” (which this entire post draws upon): …
Writing in the Washington Examiner, Veronique de Rugy says successful austerity programs come primarily from spending cuts.
… In a 2009 paper, Harvard University’s Alberto Alesina and Silvia Ardagna looked at 107 attempts to reduce the ratio of debt to gross domestic product over 30 years in countries in the Organisation for Economic Co-operation and Development. They found fiscal adjustments consisting of both tax increases and spending cuts generally failed to stabilize the debt and were also more likely to cause economic contractions. On the other hand, successful austerity packages resulted from making spending cuts without tax increases. They also found this form of austerity is more likely associated with economic expansion rather than with recession.
The Baltic nations of Latvia, Lithuania and Estonia provide good examples of successful fiscal adjustments. In the last few years, and contrary to the rest of Europe, the Baltic countries have focused on significantly cutting government spending without equivalent increases in taxes. As a result, the Cato Institute’s Dan Mitchell reports, between 2008 and 2011, Estonia and Lithuania reduced nominal spending by 5 percent, and Latvia by 11 percent. France and the United Kingdom increased spending more than 8 percent over the same period, and Spain and Italy increased spending by 3 percent. In contrast to these others, the Baltic states have experienced some of the largest economic gains in the world: Between 2009 and 2010, Estonia’s economy rose from an annual GDP growth of minus-13 percent to 3.1 percent.
Sweden is another good example. …
The above two items lead to a piece from Browser on the reasons for studying economic history. This takes the form of an interview with Simon Johnson, former IMF chief economist.
In choosing these books, you mentioned you were interested in whether economic history, or books about it, can influence policy and help convince people about the future. Can it?
The problem for economics is that to a lot people it’s kind of boring. Particularly if you write about analytical economics, there’s no narrative that draws you in like a novel or even other social science books can. If you’re talking about big macro themes, it’s hard to write an anecdotal history in a compelling way. I’ve chosen books that are intended to add those dimensions, to talk about historical experiences in such a way that you can say, “Oh yes, I get that, I understand the story.” Then you can think about how to apply that story to the modern predicament and what policy could be in the future. …
Let’s talk about this more as we go through the books. Your first choice is A History of Interest Rates, in which Sidney Homer and Richard Sylla look at interest rate trends and lending practices over four millennia. Tell me why you chose it and what the lessons are for our time.
This is one of my favourite type of books, which are just about data. You can argue all kinds of things about the past, but then you have to go back and look at the actual numbers. The interesting thing about interest rates is that you have these decade-long swings. It’s important to try to situate today in that historical context. We are in the fourth decade of a very long bull market in bonds – meaning rates have gone down and bond prices have gone up – and at some point that will switch. We need to be aware of that. It’s a very simple observation. I don’t know when rates are going to turn against us, but Homer and Sylla’s history shows us that interest rates can go down – and they can go down for a very long time – and then they go the other way, they go up. This means that you can’t build your public finances on the view that, “Oh yes, today’s rates are going to be the rates in two decades.” You can’t bet on the US being able to borrow indefinitely, an infinite amount, at 2% interest. …
Tell me about Why Nations Fail, which looks both at countries around the globe, and at examples from history, to figure out what political and economic institutions make for economic success.
Why Nations Fail is by two of my favourite economists, two very close friends and co-authors of mine, Daron Acemoglu and James Robinson. They’re tackling a subject that I’ve worked on with them, and they do a great job of bringing it to life and making it vivid. Why Nations Fail is like Jared Diamond’s Guns, Germs, and Steel – which I didn’t mention because it’s such an obviously famous book – one of those books that stretches your mind and gives you all these examples and connections between them, so that you come away from it saying, “Wow. I didn’t know that.” It’s really, really interesting.
By the way, it turns out their blog is even better than the book, and they’re even better on Twitter than they are on their blog. So there’s no limits to the genres these guys can master.
So one of the questions they’re asking in the book is whether, politically, America has moved from “a virtuous circle in which efforts by elites to aggrandise power are resisted” to “a vicious one that enriches and empowers a small minority”.
Yes, I have not exactly a beef, but a constructive dialogue going, particularly with Daron, about whether or not the US is already in a period of having, in their language, more “extractive” institutions and less inclusive ones. I recognise there is a big gap between the US and, say, Sierra Leone or Haiti, or whichever troubled country you want to pick from the book. But – and this is going back to Teddy Roosevelt – I fear that we have let the concentration of economic, financial and political power go too far. This is really bad for democracy and for the opportunities of most people in this country, and it’s exactly the kind of thing they mean by extractive institutions.
I don’t know if you saw it, but Matthew Yglesias gave a wonderful and hilarious review of Why Nations Fail, in which he compared it to The Hunger Games. His point is that the dystopian view of the world, which is rather chillingly and vividly portrayed in The Hunger Games, is not that far from things we’ve seen in history and things we see around the world today. It’s actually a very extreme form of extractive institutions in which a few people live very well and most people live in squalor. You could say, been there, done that – not for the US, but for many countries. So could the US go down that path? Is our democracy forever? Are our institutions so strong that we have republic-long immunity from those problems? I don’t think so. Ben Franklin was accosted by a stranger upon leaving the constitutional convention in Philadelphia in 1787. She asked him, “Well, Doctor, what have we got – a republic or a monarchy?” And Franklin said, “A republic, if you can keep it.”
So you’re more of a pessimist than the authors?
I would say I’m more of a realist, but yes, they would say I’m more pessimistic. …