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QE2, U.K.’s austerity measures, and economists

One thing that few non-economists realize about economists is that they light a candle to economic crises. This is mainly because suddenly their opinions matter. When the economy is doing well only those who are part of the central economic policymaking unit matter. But, when the economy is doing badly everyone’s opinions are welcome; and the more extreme the better, since they get more attention. So, you can appreciate just how much of a gift the recent crisis has been to economists. Recessions give economists the rare opportunity of either taking credit for some of the measures that were taken or to attack national policies simply because their so-called scientific views were ignored.

And, of course, the current economic malaise, and especially due to its longevity, is more than economists could have dreamed of. They attack the European Central Bank for being too aggressive in withdrawing liquidity from the system, the U.K.’s new coalition government for introducing extreme austerity measures that could break the economy, and of course the U.S. for putting the final nail into the dollar’s reserve currency status coffin.

It is remarkable how economists can claim with such confidence that they know exactly why the measures taken in the U.K. are too hard and why those of the U.S. are too soft. It is as if there is an optimal level of response that can be accurately measured, and they can measure it. If anyone has followed the last 2 recessions, they would have learned that the only thing that is certain is that economists do not have a clue about what is going on in today’s global economy, if they ever did, due to its tremendous complexities, and that they rarely, if ever, apologize when they get things woefully wrong.

So, permit me to use QE2 and U.K.’s austerity measures to illustrate my point.

With regards to the so-called QE2, it is true that no one has any idea about whether it will work, whether it is enough, and what happens, and needs to be done, if it does not work. The list of people who have written on each of these aspects runs into hundreds. However, it is also true that the measures taken so far have been ineffective in getting the economy back on track. I personally believe that so long as people do not feel confident about their future job prospects that any new injection of capital would simply be kept as an additional buffer against the risk of being, or remaining, unemployed. Right now, few have the confidence to go and spend their way out of the current economic malaise, and until they feel confident about their jobs and the economy they will be very careful about how they spend their savings. However, irrespective of whether that is correct or not, one thing is for sure, if any other country was able to do what the U.S. is doing they would have done the same. If your trading partner, in this case China, refuses to strengthen its currency, continues to have huge trade surpluses against you as a result, and has a huge amount of your national debt as reserves, what would you do to make them sit up and listen? You would do exactly what the U.S. is doing. You would print more money to reduce the value of the debt they are holding and depreciate your own currency. There is, of course, a risk, but I do not believe for a second that the risk is that the dollar will be replaced as the global reserve currency. Its only other remotely close competitor, the euro, is living on borrowed time; it is hardly in a position to challenge the authority of the dollar. Whether that is the reason behind QE2 or not, it is a potential implication. However, more importantly, no one can determine its implications with any degree of certainty.

So, when I read just how confidently economists describe the implications of QE2, it only makes me laugh. Especially since now the commentaries on the U.S. economy are intertwined with those of the U.K. government’s austerity measures. Just as they believe the U.S. is being too lax they feel that the U.K. is being too rigid. Well, the same so-called experts made similar predictions when Mrs. Thatcher introduced her own version of austerity measures back in the 1980s. 360 of the most respected economists published a letter in the Times of London attacking Mrs. Thatcher’s policies and asked her to change them immediately. Most of us are familiar with Mrs. Thatcher’s response to that letter: "You turn if you want to, but this lady is not for turning." She stuck with the policies of her economic advisor, Professor Sir Alan Walters, and we all know what happened next. However, I don’t seem to recall any of those economists taking out adverts in the Times acknowledging that they got it badly wrong. It’s the tails I win, heads you lose situation with economists.

To end this bulletin, and illustrate my point, I would like to share with you the obituary delivered for Professor Sir Alan Walters by John Blundell, the IEA’s Distinguished Senior Fellow, to the Mont Pelerin Society in Sydney, Australia, on 15 October 2010, which is available on the Institute of Economic Affairs’ website.

“When 364 Brit economists wrote a letter to the Times criticising Margaret Thatcher’s economics and therefore Alan [Prof. Walters], then Labour leader Michael Foot challenged Margaret in Parliament. He waved the newspaper at her across the dispatch boxes, which are a gift of New Zealand and modelled on the Australian boxes:

Michael Foot: “Can she name two economists who support her?”

Margaret Thatcher: “Yes, Alan Walters and Patrick Minford” she spat back.

In the car back to Number 10 she confided to her aide: “Thank goodness he didn’t ask for three!”

The moral of the story is that economists must remember that the subject they teach and practice is nothing more than hit and miss and that they need to be a little more humble about the advice that they dish out. Economists are not scientists and they should stop acting as if they are. If students are taught economics in a way that they are informed of its limitations maybe the next generation would be a bit more realistic about whether, and how, they can influence national economies.

Comments

The need for growth as a vlcihee that would take Greece out of the current crisis is tautological. Yet, what is for debate and needs to be debated is how a country like Greece that has been suffering from serious structural problems in its recent and not so recent economic history can achieve growth. The debate about whether to remain or not in the euro zone is important, but it will remain academic unless there is a concerted effort (with the help of the EU in this case) to fight corruption. To do that most of the energy and effort has to be spent on reforming the judiciary. The rules of the game are such that whoever “screams the loudest” has better access to the media and the benefit of the judiciary system that is inherently incapable of ensuring a framework on which economic reforms can take place. Without contracts that are enforceable for all the parties involved, it will be futile to introduce reforms. The latter will be unravelled by the inability of the courts to enforce these contracts. For the new reality to become understood as something that requires new bold reforms to open up highly regulated markets and allow for productivity convergence between the public and private sectors, people need to be convinced that the rules of the game apply to all concerned. Until now as we speak, any attempt to bring individuals to justice who have either stolen public funds by not returning huge sums of collected VAT to the government, let alone the known income tax evaders, only results cases that are pushed into the future as these individuals are allowed to walk. The excuse here is that the judiciary is too overburdened to deal with these cases effectively and promptly. I am afraid that unless this government or any government deals with that aspect of the broken system, any reforms will never be implemented. To have any chance of success, let alone any chance to reach a climate for economic growth, there has to be a framework for enforcing contracts that is recognized and respected by all by imposing stiff penalties to all those who violate their side of the contract, whether public officials involved in corruption cases or entrepreneurs not returning the sums of VAT that they have collected on behalf of the government.One may counter, that Greece was growing until 2008 at reasonably healthy rates with the same judiciary and the same lack of contract enforceability system. Yet, even though we all recognize the reasons behind this consumption led growth engineered by easy credit, which led to the current crisis, it is the asymmetry between the upturn and downturn that obscured any need for reform. An expanding economic pie conferred benefits to all, even though these benefits also created “built in” destabilizers that now confront us all. I think, given the state of corruption as the result of lack of contract enforceability, the main reform that at this point that needs to take place, is the reform of the judiciary, for anything else to have any chance of success.

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