The amazing discrediting of one of the most influential research papers of our time—Kenneth Rogoff and Carmen Rinehart’s 2010 “Growth in a Time of Debt”—has mobilized opponents of austerity around the globe.
As we wrote last week, the paper, which found that economic growth in developed economies goes negative once public debt exceeds 90% of GDP, was a key rationale for austerity policies in Europe and the United States, just as the Laffer Curve justified supply-side economics.
But now, Rogoff and Rinehart have admitted to an embarrassing computational error which produced that negative result. Their corrected spreadsheets showed that at debt ratios above 90% of GDP, economies still grew, albeit at a slower pace.
That undercut the urgency behind austerity, which can have counterproductive effects, especially in a recession, its opponents argue.
The European Union in particular has enforced austerity policies on Greece, Spain, and Portugal, exacerbating those countries’ already deep recession. David Cameron’s government in the UK has done it voluntarily. In the US, the Tea Party movement that has taken over the Republican Party has forced $3 trillion of deficit cuts, including the current “sequester.”
But the International Monetary Fund has been railing against austerity for weeks. Its chief economist, Olivier Blanchard, said the UK in particular was “playing with fire.” And Managing Director Christine Lagarde declared: “We need growth, first and foremost.”
Keynesian Nobel Prize economist Paul Krugman, austerity’s chief critic—he favors massive government stimulus spending until the economy recovers—has been taking a restrained victory lap all week.
But Henry Blodget, Business Insider’s editor in chief, did the crowing for him:
Last week, a startling discovery obliterated one of the key premises upon which the whole austerity movement was based.
Once the error was corrected, the “90% debt-to-GDP threshold” instantly disappeared. It also, in my opinion, settled the “stimulus vs. austerity” argument once and for all.
The argument is over. Paul Krugman has won. The only question now is whether the folks who have been arguing that we have no choice but to cut government spending while the economy is still weak will be big enough to admit that.
I don’t think they will be, and I don’t agree that Krugman has won the argument.
On the first point, I don’t think leaders like David Cameron or German Chancellor Angela Merkel will change their positions. Merkel reflects the views of the German people, who believe southern Europeans should tighten their belts the way Germans do.
The British people will go to the polls in 2015, when Ed Miliband, an Old Labour throwback to the pre-Margaret Thatcher days, may well win a de facto referendum on Cameron’s austerity.
Here in the U.S., Tea Party Republicans and fiscal conservative leaders like Rep. Paul Ryan are too deeply dug in to reverse themselves on spending cuts and austerity.
And second, I disagree on the implications of what happened.
The new data reduces the urgency for cuts in discretionary spending, of which we have had plenty. The short-term cuts we’ve had are sufficient, as Goldman Sachs projects deficits of only 2.75% of GDP by 2015.
But long-term entitlement programs are another story. The estimated unfunded liabilities for Medicare, Social Security and federal employee retirement plans are $50 trillion, 300% of current GDP, not 90%.
While that bill doesn’t come due all at once, it has a cumulative, corrosive effect on our economy. With 8,000 Baby Boomers retiring every day for the next two decades, the crunch is coming soon.
That’s where I think Krugman and the Keynesians fall short. By kicking the can down the road instead of formulating a long-term plan to address entitlements now, when interest rates are near zero, they’ll miss a big opportunity to solve a problem that will be much bigger even in a decade.
At that point, errors on some academics’ spreadsheet will be the least of our problems.