Austerity Stumbles

It’s not often that an academic paper makes the headlines. Researchers and professors typically write on obscure topics that are read, if they’re lucky, years later, by a handful of graduate students who are working on their own obscure and imminent-to-be-ignored academic works. Ken Rogoff and Carmen Reinhart were superstars in this respect.

The Rogoff-Reinhart paper, entitled “Growth in a Time of Debt”, was the stuff of legend. Policymakers around the world referenced it when making the case for budget cuts and austerity measures, arguing that running budget deficits would cripple economic growth. In particular, they claimed that when debt crosses the threshold of 90% of GDP, national economies would begin to shrink.

The United States has already crossed that threshold (we’re beyond 100% actually), but our economy continues to grow. It’s growing at a flimsy rate and in a way that does not benefit the country as a whole, but grow it does.

Enter UMass Amhert economics grad student, Thomas Herndon, who did what nobody else did (yeah – the paper was not peer reviewed) and looked over the numbers used by Rogoff and Reinhart (check out the interview between Herndon and Stephen Colbert). It seems R&R forgot to include 5 countries (Australia, Austria, Belgium, Canada, and Denmark) in their final analysis. If you include these countries, economic growth crawls along at about 2%, which is to say that they somehow omitted the countries that maintained high growth in spite of high debt. It turns out the R&R committed a simple Excel spreadsheet error (visual approximation below). Unfortunately, this error led to the false conclusions that were used as ammunition to sell austerity measures all over the world! RandR Excel error

This is all very embarrassing for R&R and those who cited their paper, but if you think this means much in term of policy, think again. John Maynard Keynes once wrote:

“The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”

Although I respect Keynes, I think we’d disagree on the extent to which economists and their ideas are pawns of politicians. I’ll tell you why tomorrow.

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4 thoughts on “Austerity Stumbles

  1. Thanks for writing on this…listening to BBC Radio 4’s “More or Less” podcast this morning (http://www.bbc.co.uk/podcasts/series/moreorless) which examines and analyzes this whole saga, I was struck (yet again) by the lack of rigour in readiness to accept a suitable justification (remember WMDs?)…and just to note, it wasn’t just the lack of peer review, or exclusion of five countries in an Excel formula error, which would be bad enough in themselves. More significantly it appears it was also how post-war data was averaged and weighted, meaning that one bad year for a small economy like NZ was put on the same level as 20 years of another country residing in the high public debt category.

    1. And like the WMD lead up to the invasion, one has to wonder to what extent the misinformation was a result of errors, or the result of deliberately leaving out inconvenient bit if information.

      Brings to mind a fantastic documentary (http://www.youtube.com/watch?v=VgA98V1Ubk8 ) that shows how even the best and brightest can deceive themselves when arguing their case.

      This of course assumes that people were deceiving themselves. We shouldn’t rule out the possibility that they were straight up lying.

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