System Deterioration: The Impact of Universal Austerity and the Requirements of Covd-19 Recovery

So-called austerity, the stoic injunction, is the path towards universal destruction. It is the old, the fatal, competitive path. Pull in your belt is a slogan closely related to ‘gird up your loins,’ or the guns-butter metaphor.

– Wyndham Lewis

This post has been adapted from a 2014 paper that did not address the unique economic challenges of Covid-19.

In the 2001 Planet of the Apes remake, the spacecraft that crash-landed thousands of years previously starts up on the first try. While this is useful to move a storyline forward, the real world seldom seems to work this way:

• If you leave your car in the driveway for a year, and then expect it to start, you are likely to be disappointed.

• If you do not go to the gym for a month, and expect your physical performance to match what you could do previously, you might hurt yourself.

• If you are out of the workforce for 10 years – or 1 year – your work skills decline. More importantly, people who are involuntarily unemployed suffer from challenges of motivation and confidence, and employers value them less, so finding new employment is more difficult. These people are certainly not flourishing. 

Flourishing requires activity. An inactive human cannot flourish. And because this activity occurs in a wider economic ecosystem, high levels of flourishing require high levels of economic metabolism.

So when we apply a little system thinking to the likely impact of universal austerity – that is, a decision to rapidly reduce the level of a major source of activity, government spending – we would expect the result to be a deterioration in economic system performance, a reduction in economic metabolism, and a reduction in flourishing. Resources become idle, people are discouraged and deskilled, and we just can’t get off the ground.

None of this is surprising. And yet, in 2010 it was certainly the economic orthodoxy that Europe could revive its economic metabolism through a series of massive reductions in government spending across the Eurozone (the UK adopted a similar strategy).

We see this as a striking example of faulty system thinking. As a healthy individual who is stretched financially, I can certainly improve my situation by continuing to work as hard (or harder) – ensuring a continuation of income – while reducing expenditures. But improving my situation in this way requires both that I have the kind of employment that allows more work for more money (fairly uncommon) and that others to continue to spend, since their spending is my income. ¹⁾Both Canada and Sweden reduced government spending in the 1990s and ended up with much better economies. But they were lucky enough to have their crises when other economies were booming. The Clinton-era boom allowed Canada to come sailing out of its crises.  As they say, timing is everything.

But if we all start reducing our spending, aggregate demand and output are reduced. And this is precisely what happened in Europe for the PIIGS after the financial crisis of 2008 ²⁾PIIGS = Portugal, Ireland, Italy, Greece, and Spain:

Figure 1: GDP growth 2008-2012 for PIIGS, year by year. ³⁾“GDP Growth.” The World Bank, 2013.

2009 was a particularly difficult year, as GDP declined in all PIIGS countries (close to 6% in Italy and Ireland) and declined 7 straight years in Greece, to 2016 after which it has been up and down (like everyone else, it is significantly down in 2020 due to Covid-19). This translated into massive increases in unemployment, particularly among young people.

Figure 2: Unemployment rate for PIIGS, Germany, France for 2007 and 2012. ⁴⁾“Unemployment Rate.” The World Bank, 2013.

Figure 3: NEET rates. ⁵⁾“Young People Aged 18-24 Not in Employment and Not in Any Education and Training, by Sex and Nuts 2 Regions (from 2000 Onwards) – Neet Rates.” Eurostat, 2013.

So, all in all, we had an unmitigated disaster measured both in terms of orthodox GDP and in terms of flourishing, and a young person who is in NEET-status (“Not in Employment, Education or Training”) had long-term challenges to achieve flourishing.

Why would such a destructive idea – that universal austerity would put the UK and Europe back on the road to economic health – take hold?

It did so because orthodox economics conflates 2 separate concepts:

1. The economy has self-adjusting economic mechanisms – that is, economic actors adjust behaviour to circumstances.

2. The system effect of the totality of adjustments by economic actors will be an improvement in whatever metric we are pursuing (flourishing for us, GDP in orthodox economics). 

It certainly is true that individual actors in the economic ecosystem react to signals and conditions and change their behaviour – so 1 is correct. If my income declines and I’m not sure it will recover, I spend less. But there is no a priori presumption ⁶⁾Well, there is this a priori assumption in orthodox economics, arising originally from Smith’s invisible hand and codified in mathematical proofs developed by Walras, Arrow, and Debreu among others. But we take nothing for granted, and whether concept 2 is correct is an empirical question. that this mechanism will lead to better system outcomes – whether and how the existing self-correcting mechanisms improve the economy is an empirical issue. So 2 is not necessarily true – it is an empirical question shown to be false for some circumstances.

In the aftermath of the GFC, this confusion in economic orthodoxy lead to the belief that if the government reduced spending, including reducing transfer payments, economic actors would re-balance to the private sector to restore high economic metabolism. But in the case of the severely depressed aggregate demand after the GFC, this was not the case.

In October 2012, the IMF published a paper saying basically that it had severely underestimated the fiscal multiplier – the total effect of fiscal spending – because of course the recipients of the initial spending go out and spend, also, and so on (my consumption is your income). ⁷⁾“Developments suggest that short-term fiscal multipliers may have been larger than expected at the time of fiscal planning… Research reported in previous issues of the WEO finds that fiscal multipliers have been close to 1 in a world in which many countries adjust together; the analysis here suggest that markers may recently have been larger than 1…” International Monetary Fund, World Economic Outlook, October 2012. Accessed on February 17, 2014. Fiscal Multipliers. The impact of underestimating the fiscal multiplier was to underestimate the impact of fiscal contraction in the eurozone, basically prescribing austerity policies that produced much more economic and human misery than necessary. I will spare the reader the sanitized – and opaque – language the IMF used to describe this mistake.⁸⁾Page 41 of the report has the relevant analysis (Fiscal Multiplier) At a presentation to Governor Sanusi of the Central Bank of Nigeria (who won the award for top central banker in the world in 2010), the Governor and Andrew had a spirited discussion that ended with the Governor saying, ‘You see, Andrew, basically all the successful economies in Asia have pretended to listen to the IMF, but done the opposite.’ Stiglitz – former Chief Economist of the IMF – wrote a scathing attack on the impact of IMF policies. It seems that in GFC, the IMF did not learn much.

The important point is simply that mainstream economists made massive policy errors after 2008 that negatively impacted people’s lives. With the still more profound national and personal economic catastrophe of Covid-19 on our hands, we must remain aware that it is now, for many, impossible even to get to the gym – either metaphorically or literally – to generate metabolism (physical or economic). It is now for many impossible to keep work skills honed or economic engines started. Strong governmental stimulus is needed both to place-hold economic life and to drive recovery once vaccines are available to all Canadians.

This is not a time for government austerity – and it appears the Canadian federal government will at least attempt to act on this, although much-needed UBI, universal prescription drug coverage, and dental health care do not yet seem to be on offer. Longer-term lowered incomes will stretch much farther in the marketplace if these basic needs are covered by government, providing a universal, rather than a piecemeal stimulus that focuses with one policy only on parents, or with another only on the elderly, thus missing ordinary Canadians whose incomes are diminished. These basic programs, after which specific groups can be considered, are critical to a flourishing Canada in the time of Covid-19.