By Anatole Kaletsky
NEW YORK Dec 6 Absurd wishful thinking. This is
how most finance ministers describe criticism of their tough
budget policies designed to control government debt and reduce
borrowing. Britain, even more than Germany, has been in the
vanguard of this austerity movement, as Chancellor of the
Exchequer George Osborne demonstrated again in this week's
"Confronted with tough economic conditions, some say we
should abandon our deficit plans, and try to borrow more - they
think that by borrowing more, they can borrow less."
For Osborne , this reductio ad absurdum seemed so conclusive
that there was no need to justify his controversial economic
To claim that a government should borrow more when its debts
are already too high is ridiculous - as ridiculous as suggesting
in the 16th century that the earth moves around the sun or that
humans evolved from monkeys.
While economics does not deserve to be called a science on
par with physics or biology, it is supposed to be a systematic
and objective analysis of empirical evidence about the way the
world works. The goal of such rigorous analysis is to find
insights that are not obvious, and may sometimes even seem
ridiculous to casual observers.
Several counterintuitive insights are now nearly universally
accepted among economists - for example, that a country can
usually gain more wealth by reducing trade tariffs than by
increasing them. Others are still very much in dispute. Perhaps
the most important of these, especially in the present global
context, concerns public borrowing. Should governments try to
reduce borrowing during an economic slowdown, or should
governments borrow more or less without limit until economic
activity revives and full employment is restored?
This is a complex and subtle question on which opinions
among serious economists can reasonably differ and change over
time. What cannot be described as reasonable, much less as
serious economics, is the claim routinely made by politicians,
including finance ministers and central bankers who ought to
know better, that this is a simple question to be answered with
the commonsense aphorisms beloved by Osborne and his
counterparts in the German government and the U.S. Tea Party:
"You can't cure debt with more debt."
This may seem obvious. But isn't it equally obvious from our
perspective that the earth is flat? There is a parallel between
the debt cliche and the flat-earth cliche. Both seem obvious at
close quarters but break down when the world, whether economic
or geographic, is viewed as a whole.
The world economy is very different from an individual
company or a household. When individuals spend less than they
earn, the savings they put aside give them a claim on the
incomes of other people, allowing them to hire workers and make
businesses grow, and this makes them richer.
But this cannot be true of the world as a whole. The world
cannot spend less than it earns, because one country's spending
is another country's income. So if the whole world tries to
spend less than it earns, the result is not an increase in
savings but rather a reduction in total income.
To make matters worse, the world as a whole cannot lay claim
to anyone else's income, unless extraterrestrial workers arrive
from Mars. The only way to increase global prosperity is by
investing in technology and management. But businesses are
reluctant to make new investments when they see consumer
spending in decline.
The upshot of these arguments and others like them is the
central conclusion of Keynesian economics: If private businesses
and households collectively are determined to spend less than
they earn, then government must spend more than it collects from
taxes to make up the difference. If government instead tries to
do the opposite, reducing its debts at the same time as the
private sector, incomes will collapse - and government borrowing
will paradoxically go up.
There are, of course, many caveats. One country can spend
less than it earns if others do the opposite and spend more than
they earn, thereby increasing their trade deficits.
Alternatively, government austerity can reduce interest
rates and boost confidence, prompting more consumption and
Such arguments justify genuine debate about how governments
should respond to economic weakness - and serious economists
reach different conclusions depending on the the conditions.
In 2010, Britain's incoming conservative government believed
it could boost confidence by accelerating the budget
consolidation that the previous Labour government had begun. Two
years later it is clear that this bet did not pay off. Growth
and deficit reduction have both been deeply disappointing,
especially in comparison with the U.S., despite much bigger tax
increases and spending cuts. In fact, there would be almost no
reduction in Britain's deficits over three years - last year
(121 billion pounds), this year (120 billion pounds) and next
year (112 billion pounds) - if it were not for the new gimmick
of transferring Bank of England profits to the Treasury at
exactly the rate required to keep apparent deficits on a
Can the additional austerity imposed by the Conservatives in
2010 be blamed for this grim performance? Maybe not. But in 2010
the economy hovered between recovery and relapse into recession.
As with a finely balanced seesaw, where a small amount of
pressure has a big effect, economics becomes a path-dependent
process, with outcomes even harder than usual to predict.
In such circumstances, governments are bound to keep missing
economic forecasts and targets. But they could try to limit the
risks by basing policies on serious economic analysis, not
oversimplified cliches and appeals to common sense that are just