By Ben Cohen: The field of economics is often referred to as a ‘junk science’, mostly because it tries to explain human behavior in mathematical terms. This is almost impossible – humans are emotional and irrational, thus predicting their behavior accurately is harder than predicting the weather. But there are some basic truths when it comes to mathematically modeling the buying and selling behavior of people, and amazingly, they are ignored by many actual economists.
Let’s take the theory that governments should enact austerity measures to pull a country out of recession. The theory goes something like this: A country is losing jobs, seeing a decline in economic activity, and as a consequence, its debt spiraling out of control. In order to maintain a good credit rating and borrow money, governments must control debt, otherwise interests rates go up and they lose their ability to borrow. Therefore the government must slash spending in order to reduce debt. Many countries in Europe (Spain, Britain and Greece for example) are enacting these policies in order to cut their debt and increase their credit rating.
The results have been a complete disaster, with dismal projections for economic growth for the foreseeable future, continued unemployment and no ability to borrow money at better rates. And there is a very simple reason: The theory is completely bogus.
When economic activity declines and jobs disappear, economies can collapse quickly. If people’s wages are cut, they are less likely to go shopping and spend money. If shops stop selling products, jobs disappear at the shops themselves and from the industries that supply them. In climates like this, banks do not like to lend money to create new jobs for a very good reason: They fear they won’t get their money back. It’s a vicious cycle and if left unchecked, it can be devastating.
This is why it is absolutely necessary for government to step in and stimulate demand. By injecting money into a paralyzed economy through unemployment benefits, government jobs, low interest business loans etc, it encourages economic activity. When private lending dries up, only government can restore order and create stability and certainty. We saw this during the banking crisis in 2008 when the private banking system collapsed and the public assumed the debt and borrowed its way out of trouble. The bailouts worked and the economy did not disintegrate.
When governments then cut spending, economic problems are compounded, and recessions can drag on for years, sometimes decades (take Japan – a country that implemented austerity measures after its economic implosion in the early 90’s and has still yet to recover).
Why is this basic economic truth ignored by mainstream economists in academia and in government? Europe continues to teeter on the edge of another major financial crisis and the US has had one of the slowest recoveries in post war history.
There is a pretty simple explanation for this: Government austerity measures often help the rich. When economies collapse, the wealthy can consolidate their power by buying up assets on the cheap. Let’s take the US as an example – a country where the political system has been largely bought out by the wealthy, particularly the Republican party. When the economy imploded and the rich lost their money, the Republican party enacted and supported government spending to re-stimulate the economy. Once the danger had passed and the rich were safe, they went back to being deficit hawks and insisting on slashing welfare. After the crisis, government became the enemy again and private capital the answer to every problem – an obvious function of the GOP’s complete subservience to the needs of the wealthy.
We’re seeing this pattern play itself out over and over again with devastating consequences. Spain’s unemployment rate is running at almost 25% with no end in sight, and the UK’s economy is at a standstill, yet the rich keep accumulating wealth.
The results are plain to see, and even the IMF, one of the original sources of ‘austerity at all costs’ policies, has admitted it isn’t working.
Sadly, it is working for the rich, so we’re stuck with it.
(Image courtesy of 401kcalculator.org)
Ben Cohen is the editor and founder of The Daily Banter. He lives in Washington DC where he does podcasts, teaches Martial Arts, and tries to be a good father. He would be extremely disturbed if you took him too seriously.