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POLITICAL ECONOMY
Walker's World: The bad math that lost jobs
by Martin Walker
Paris (UPI) Apr 22, 2013


disclaimer: image is for illustration purposes only

Back in the 1920s, an Austrian newspaper won the honor for headline of the decade with a front-page story that read, "Archduke Franz Ferdinand Found Alive; Great War Fought By Mistake."

We now have something similar in the field of economics. The headline should read: "Harvard Professors Get Sums Wrong; Millions Lose Jobs By Mistake."

The 1920s headline was a spoof. The case of Professors Carmen Reinhart and Kenneth Rogoff is too true for comfort. The paper they co-authored in 2010, which suggested that countries whose debt levels reach 90 percent of gross national product will start to see their economies shrink, turns out to have been marred by a mistake in a spread sheet.

Instead of such countries seeing a contraction rate of 0.1 percent, as they suggested, the economies can still grow around 2 percent. That is less than less indebted countries but not a disaster.

Given the eminence of the two economists, who both worked at the International Monetary Fund, and Reinhart was chief economist at Bear Stearns and Rogoff was chief economist at the Fed, their paper was hugely influential.

British Chancellor of the Exchequer George Osborne met Rogoff on several occasions and cited their work to justify his own policy of austerity, slashing public spending to cut debt. The IMF and the European Central Bank and the leaders of the European Union were all able to point to the Reinhart-Rogoff doctrine to justify the draconian cuts they imposed on Greece, Cyprus, Spain, Ireland and Portugal as conditions for bailing them out.

It is not easy to put any precise price on the policies of austerity but something like 5 million jobs may have been lost in Europe as a result of the spread sheet error. It was exposed by Thomas Herndon, a doctoral student at the University of Massachusetts, who questioned the figures.

"It is sobering that such an error slipped into one of our papers," Rogoff and Reinhart said in a statement acknowledging Herndon's correction.

The mistake by no means destroys the economic case for restraint in public spending and the need to reduce debt. But it tears a giant hole in the political credibility of the political leaders who put their trust in the Reinhart-Rogoff argument and imposed draconian budget cuts.

Shortly before he took office, Osborne in a major policy address cited Reinhart and Rogoff by name and declared, "The latest research suggests that once debt reaches more than about 90 percent of GDP, the risks of a large negative impact on long-term growth become highly significant."

The discovery of the spread sheet error has given the political rivals to Osborne and others a potent new weapon.

"We warned that rapid fiscal tightening when the global economy is weak risked backfiring and that's what happened," charged Ed Balls, top economic spokesman for Britain's Labor Party.

This is the second such rethink to undermine the case for financial austerity. Last Oct. 15, this column reported that Olivier Blanchard, chief economist at the IMF found that budget cuts could do more harm than good.

That column read: "Blanchard's team addressed the effect of cuts in government spending on gross domestic product growth. We know that cuts will reduce output, since there will be less money in the hands of the public to buy products and thus less incentive for manufacturers to make more. But it is hard to calculate how much the knock-on effects of the cuts bite into growth.

"This is called the fiscal multiplier. Usually, we try to calculate this another way, by asking how much extra growth will a certain amount of extra government spending produce. For the past decade and more, the IMF (and almost all government economists around the world) have assumed that the multiplier effect of spending cuts is 0.5; that is to say, cut public spending $100 billion and you cut growth $50 billion.

"The new IMF research says this was wrong, and the multiplier effect is much greater -- somewhere between 0.9 and 1.7. That means that cuts of $100 billion means growth reduced $90 billion-$170 billion. Wow! If that is right, the IMF is saying that the more you cut government spending the more your overall output will shrink -- and you will never get out of the hole. Your economic output just continues to decline, which is precisely what we have seen happening in Greece."

Combine these stories, of the fiscal multiplier and the debt effect, and the conventional economic thinking that has been in power for the past three years looks to be seriously and damagingly mistaken, as they were in the Great Depression of the 1930s. John Maynard Keynes, who argued then that governments should invest to create jobs rather than slash spending and cut them, looks as if he is being vindicated all over again.

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