It is one of the most quoted economics papers of the last decade. It is cited time and time again by supporters of austerity. It provides the empirical data to support George Osborne’s strategy for the UK. Even critics of austerity, those who support the idea of government stimulus, take on a veneer of uncertainty when the paper is mentioned. Shocking news just in: the paper’s conclusions may be wrong.
Actually it’s a paper and a book. It’s available in good book shops, it sits on a bookshelf less than five feet away from the computer this article is being typed on. It appears the paper has so-called ‘coding errors’. The single biggest academic rationale behind austerity may be in disarray.
It is called ‘This time is different’- the title is ironic. It is really saying this time it is the same as always. It was penned by Carmen Reinhart and Ken Rogoff. Martin Wolf, the leading economics journalist in the world and arch critic of austerity, often prefixes his arguments for stimulus with praise for Reinhart and Rogoff’s findings. It is as if he tries to get his retaliation in first. “Their paper is masterly, but…” says Wolf.
So what was it that Reinhart and Rogoff found? Well whenever a government debt rises above 90 per cent of GDP, the wheels come off the economy. It is as if it is magic. 89 per cent of debt is okay. 89 .5 per cent is okay. 89.9999 per cent is okay. But 90 per cent and it is as if the hounds of economic hell have been released.
The book’s authors hit us with reams of data. They say they have drawn on data going back centuries. From the time of the medieval age onwards, 90 per cent is the level of debt governments must avoid.
There is one obvious snag, of course. How do we know which way the link between government debt and economic disaster works? Is it not the case that rising debt may be a symptom of an economic crisis. Just remember that before 2008 Spain’s government debt to GDP was modest, amongst the lowest in Europe; low enough in fact to make Germany look positively profligate.
But let’s put that snag to one side. A new paper produced by Thomas Herndon, Michael Ash, and Robert Pollin from the University of Massachusetts has … how can one put it politely? … corrected Reinhart and Rogoff’s spreadsheet. One can be impolite, and say it has devastated Reinhart and Rogoff’s findings, but let’s not be rude, and say that.
For one thing, it appears the original data put unusual weighting on downturns relative to growth. So in their paper Reinhart and Rogoff, or so it is now being said, assigned the same weighting to one year of bad economic performance as to several years of good performance. It appears that in the original paper some countries, such as New Zealand, which suffered from high debt but strong economic performance were excluded from the data. When the report looked at low US growth immediately after World War II it did not take into account, or so say the critics, that millions of women opted to leave the work-force, after working during the war, thus reducing output.
Apparently, or so say the critics, once these factors are taken into account, very different conclusions are the result.
This does not mean the economic underpinning of austerity economics is dead. But right now, it sure looks to be in intensive care.
For more see, Dean Baker’s piece: How Much Unemployment Was Caused by Reinhart and Rogoff’s Arithmetic Mistake? and Paul Krugman in the ‘New York Times’: Holy Coding Error, Batman
© Investment & Business News 2013