Saturday, January 12, 2013

Economy: IMF Pleads Guilty But Insists on Austerity

By Julio Godoy* | IDN-InDepth NewsAnalysis

BERLIN (IDN) - Under different conditions, the recent admission by the head economist of the International Monetary Fund, Olivier Blanchard, that the Fund was dead wrong when it prescribed tough austerity measures to countries trapped in a sovereign debt crisis and in recession, would be a reason for satisfaction. But the price paid by the youth in Greece, Italy, Portugal, and Spain, to name only the European victims of the IMF ill advices, is too high for celebrating being right.

The IMF ‘mea culpa’ has been making the rounds in global economic forums since last October, after the Fund’s 2012 World Economic Outlook (WEO) admitted the miscalculations. IMF said that it had underestimated the multiplier effects of the austerity measures it had been preaching since decades.

Until October, IMF assumed that, roughly speaking, the multiplier of fiscal cuts was 0.5 percent. In other words, the Fund estimated that cutting government spending by one percent of gross domestic product would lead to a drop of 0.5 percent of economic activity.

Theoretically, small fiscal multipliers allow states to cut public spending without sacrificing economic growth. Conversely, if fiscal multipliers are large, austerity measures attempting at consolidating the fiscal situation of a given country with large deficits are deemed to be self-defeating, leading to an even larger deficit and to an acceleration of economic downturn.

In the title of the now famous box 1.1. of the 2012 WEO, IMF authors rhetorically asked: "Are we underestimating short-term fiscal multipliers?" In the subsequent text, they answered right away: Yes, we are! "A number of policy documents, including IMF staff reports, suggest that fiscal multipliers used in the forecasting process are about 0.5," they said. "In line with these assumptions, earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009." But they were wrong, for the 2012 WEO results "indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession."

To put it bluntly: The austerity therapy IMF applied since the 1980s and until the summer of 2012 was based on a wrong reading of the world's economic history, which, however incorrect, fitted very well into the basic tenets of neoliberalism, that public spending is evil and must be consistently curtailed. Only by October 2012, that is, more than three years since the European sovereign debt crisis broke out, and with youth unemployment reaching 50 percent in the affected countries, the Fund came to realise that the negative multiplication impact of austerity actually was two or three times higher; that is, that a fiscal cut of one percent of GDP would make the economy shrink by up to 1.7 percent.

By so doing, IMF wiped out its own long-cherished anthem, which preaches that cuts in public and social expenditure are sine qua non to fiscal consolidation and sustainable economic growth. Worse still, IMF also found out that during economic downturns, the expenditure multipliers are up to ten times larger than tax multipliers. That means that during a recession, cuts on public spending lead to a dramatic worsening of the fiscal situation of a country in question, instead of helping to consolidate its state accounts.

As if that wouldn't be bad enough, IMF also concluded that the multipliers in the Euro zone were actually higher that the above-mentioned estimates: A fiscal squeeze of one per cent of GDP operated in an economic downturn and based on expenditure cuts, leads in the Euro zone to a further economic shrinking of 2.5 per cent, thus strengthening a vicious circle of recession, austerity, and impoverishment.

Recipe for economic and social catastrophe

Under such assumptions, austerity measures imposed by the IMF in complicity with the European Union and governments in Northern Europe, especially that in Berlin, upon the Mediterranean country members of the Euro zone, which demanded fiscal cuts well over one percent of GDP, constituted a recipe for economic and social catastrophe.

Such warnings had been issued by numerous economists and commentators – practically since the beginning of the crisis in late 2009. And these had been proved by factual economic development in Greece, Italy, Spain, and Portugal.

The undeniable fact is that austerity measures applied during the recession have strengthened the recessionary tendencies of the economy, leading to a skyrocketing unemployment, without bringing forth a positive perspective that fiscal consolidation can be achieved within a sensitive period of time.

But the IMF, the EU, and leading economists and officials in Berlin, did not want to listen, either deafened by their ill-advised neoliberal dogmas, or maybe intentionally, to squeeze the modest prosperity reached during the last two decades out of the Southern European peoples.

Earlier this month, IMF again released another working paper on fiscal multipliers and austerity, focused on the Euro zone, and co-authored by Olivier Blanchard, the Fund’s top economist .The new paper repeats the admission that the Fund has since decades consistently underestimated the fiscal multipliers – a 'mea maxima culpa', so to speak.

"Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation," Blanchard and co-author Daniel Leigh, another IMF fund economist, write in the paper.

Blanchard and Leigh also admit that they could not actually determine what multipliers the IMF economists at the country level were using in their forecasts. As Blanchard and Leigh put it, "Forecasters do not typically use explicit multipliers, but instead use models in which the actual multipliers depend on the type of fiscal adjustment and on other economic conditions. Thus, we can only guess what the assumed multipliers, and by implication the actual multipliers, have been during the crisis."

The emphasis is mine. The IMF officials used the low multiplier as given, for it fitted the neoliberal assumptions that cuts in public spending are indispensable for fiscal consolidation and sustainable growth, and not as a variable that needed to be examined and revised and adjusted based on national circumstances.

Too late

Obviously, the IMF's mea culpa comes too late, for at least two reasons. Not only have the policies its wrong reading of economic history inspired, damaged the European economies for years to come, provoking what can be called a lost decade, similar to the one Latin America suffered in the 1980s (also under the ill advice of IMF). These policies have in fact condemned a whole European generation to unemployment, poverty, and to emigration.

Additionally, other centres of economic analysis have long ago confirmed what many assumed since the very beginning of the crisis, and the IMF has been too late in drawing appropriate lessons. For instance, the National Institute for Economic and Social Research (NIESR), a London-based research organization, estimated last October that the ratio of debt to gross domestic product will be around 5 percentage points higher in both the UK and the Euro zone because of the spending cuts and tax rises pursued from 2011 to 2013.

The NIESR study implicates that the current austerity strategy being pursued by individual member countries, as well as the EU as a whole, is fundamentally flawed and is making matters worse.

"Not only would growth have been higher if such policies had not been pursued, but debt-to-GDP ratios would have been lower," the report, written by economists Dawn Holland and Jonathan Portes, said. "It is ironic that, given that the EU was set up in part to avoid coordination failures in economic policy, it should deliver the exact opposite."

But, if you expected that the IMF would rethink its position on austerity after learning that the basic assumptions underlining it were false, than you were as wrong as the Fund: Blanchard and Leigh still argue in favour of cuts in spending, regardless of their economic and social consequences:

"Our findings that short-term fiscal multipliers have been larger than expected do not have mechanical implications for the conduct of fiscal policy," they say. "Some commentators interpreted our earlier box as implying that fiscal consolidation should be avoided altogether. This does not follow from our analysis. The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single economy."

Blanchard and Leigh obviously believe that the long-term unemployed youth in Spain, Greece and Portugal will certainly appreciate IMF's short-term analysis.

*Julio Godoy is a free-lance journalist and a member of the editorial board of IDN-InDepthNews. [IDN-InDepthNews – January 11, 2013]

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