Multiplying mistakes: Tallying the economic costs of austerity

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In 1936, the British economist John Maynard Keynes published his celebrated General Theory, a book that provided a scientific basis for understanding the Great Depression, the worldwide slump lasting from 1929 until the outbreak of World War II in 1939. Only recently has the International Monetary Fund realized his research insights apply to today's world economic mess centred in a stagnating Europe, and a slow growth U.S. The IMF rediscovery of Keynes has not yet registered with the Harper government, which continues to mislead Canadians about what to do about the sluggish economy.

Keynes showed that spending -- what he called effective demand -- was the driving force creating employment. When consumers slowed spending, business stopped investing. As a result, government revenues plunged, and deficits appeared.

The British Treasury held that to cure the Depression, the government should cut its own spending and balance the budget. Keynes argued that this Treasury view was wrong and when implemented, made thing worse: since reducing government spending further reduced consumer spending, and further discouraged business investment, the economy fell back even further, throwing even more people out of work.

Keynes referred to the "paradox of thrift." When economic agents decided to cut back simultaneously on spending, since one group's spending represents other groups' income and revenues, supposed "thrift" led to increased unemployment, and lower incomes all around.

Keynes further elaborated his theory by means of the "multiplier," a measure of just how much overall spending falls (or rises) when government spending decreases (or increases). Until recently, the IMF has estimated the multiplied effect of government cuts to be about 50 cents of overall output for each one-dollar change in government spending. In effect the IMF was arguing that the paradox of thrift was irrelevant, since a reduction in government spending reduced overall spending (and therefore incomes) by less than the amount of the cutback.

In its latest World Economic Outlook, the IMF announced its recent research showed the multiplied effect of government expenditure reductions was some two times to over three times greater than it had earlier estimated. A one dollar reduction in spending led to as much as $1.70 (or as little as 90 cents) in reduction in output depending on what was cut, not 50 cents overall as it had earlier assumed. In looking at Europe, the IMF judged that government cutbacks undertaken to reduce deficits were weakening economies, slowing recoveries, inhibiting job creation, and, yes, making deficits worse.  

Until weeks ago, the austerity approach dominated policy recommendations made by the IMF to deficit countries. The IMF has now changed its message, and is calling on giving deficit countries more room to grow their economies, and easing up on austerity measures.

Austerity (a.k.a. fiscal consolidation) is the modern version of the Treasury view disproven by Keynes. Unfortunately, however misguided or disproven, the doctrine of austerity prevails in Ottawa. Indeed it was at the infamous 2010 Toronto G20 summit that the Harper government argued successfully for fiscal consolidation as a priority for advanced countries in order to reduce debt and deficit levels. For pursuing this austerity agenda, Europe and the U.S. are paying the price in stagnation and unemployment.

In Canada, the Parliamentary Budget Office (PBO) estimates that current federal austerity policies will cost Canadians approximately 125,000 potential new jobs from 2014-2016. To these job gap figures, need to be added the future jobs lost because of austerity policies practiced by municipal and provincial governments. Moreover, the PBO uses Department of Finance estimates for the multiplier effect of planned spending reductions, and there is good reason to believe these multipliers should be adjusted upwards to take into account the IMF upward revisions of its own multipliers. 

Understanding that government spending contributes to employment creation and economic well-being should not be that difficult, even for Conservatives. Financial Times columnist Samuel Britain, once part of the monetarist counter-revolution that dismissed Keynes, has recently explained why balancing the budget does not make sense as a policy objective. He remarks that because of "counterproductive fiscal austerity," British economic output in 1938 was no higher than in 1918. No wonder Keynes, incensed by the Treasury view, worked to refute it.

Duncan Cameron is the president of and writes a weekly column on politics and current affairs.

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