Home > Uncategorized > Edmund S. Phelps, Nobel laurate in economics, stumbles and falls when assessing the dire causes and dire consequences of austerity in Greece

Edmund S. Phelps, Nobel laurate in economics, stumbles and falls when assessing the dire causes and dire consequences of austerity in Greece

Edmund S. Phelps, 2006 Nobel laureate in economics, makes and understandable but basic and grave statistical mistake when trying to understand recent macro economic events in Greece. This mistake leads him to misunderstand what’s happening in Greece and to downplay the absolutely dire consequences of austerity. Contrary to his ideas, the data show that record Greek austerity did coincide, and prefectly so, with the extreme increase in unemployment and the extreme decrease in employment. It is hard to understand that somebody of his stature can misread the data to the extent he did. And I do not understand why a presigious blog like Project Syndicates publishes such an op-ed, riddled with mistakes which even a freshman in economics should not be allowed to make.

What caused his failure? Think of it this way: when a corrupt dictator transfers government money to a private Swiss bank account to improve his balance sheet this should not be added to the part of government expenditure which increases the flow of (nominal) spending, work and (nominal) income. It’s a kind of capital transfer. And when a Troika forces the Greek government to transfer 24,4 billion euro of capital to the Greek banks in 2012 and 2013 alone, to restore the balance sheets of these banks, this money does not enhance spending, work and income in Greece and should be subtracted from total government expenditure to gauge the consequences of austerity. In economic terms: restoring balance sheets is about financial stocks, not about flows. And ‘stock transactions’ should be excluded from government expenditure to estimate their consequences (though they of course do lead to higher government debt and lead to tighter budget restriction for the government – in my view this ‘starve the beast’ argument is one of the reason why the Troika forced Greece to transfer that much money to the banks). Mr. Phelps, however, does not do this. Which leads him to the next, mistaken remarks:

Much of the decline in employment in Greece occurred prior to the sharp cuts in spending between 2012 and 2014 – owing, no doubt, to sinking confidence in the government. Greek government spending per quarter climbed to a plateau of around €13.5 billion ($14.8 billion) in 2009-2012, before falling to roughly €9.6 billion in 2014-2015. Yet the number of job holders reached its high of 4.5 million in 2006-2009, and had fallen to 3.6 million by 2012. By the time Greece began to cut its budget, the rate of unemployment – 9.6% of the labor force in 2009 – had already risen almost to its recent level of 25.5%.These findings weigh heavily against the hypothesis that “austerity” has brought Greece to its present plight. They indicate that Greece’s turn away from the high spending of 2008-2013 is not to blame for today’s mass unemployment.

He is very wrong about the Greek government expenditure data (and not just because he includes capital transfers to the banks). When we subtract capital transfers from government Greek expenditure it turns out that:

A) between 2006 and 2009 Greek government expenditure increased from 98 billion Euro a year to 124 billion  but declined afterwards to 106 billion in 2012 even including capital transfers (these data do not square with those of Phelps but are obtained from Eurostat, table gov_10a_main, I have no idea of his source).

B: When we subtract capital transfers (all capital transfers, I do not have Eurostat data for transfers to the banks alone) the decline in ‘GDP-related’ (a flow variable) government expenditure becomes even more outspoken.

How can anybody – and not just a Nobel laureate in economics – even think that Greek austerity only started after 2012… .

Phelpy

The extreme increase in unemployment started after the third quarter of 2009 (when Greek austerity started in earnest as it became clear in october 2009 that government deficit data had been deliberatedly understated by quite a bit), just like the extreme decline of employment while the increase and decrease went on till… 2013. Only when, in 2014, government expenditure did not decline anymore and tourism increased at a double digit rate the Greek private sector was able to generate net new jobs again. Mr. Phelps is, i.e., totally wrong about Greek government expenditure and, thus, about the relation between austerity and unemployment while, being an economist, he should not have been.

Indeed, the increases up to 2009 were large. But (despite the deflation of the last years) at this moment the price level is still about 15% higher than in 2006, which means that ‘real’ government expenditure declined even more, compared with 2006, than nominal expenditure. And severely messing up Greek government statistics is not the only grave mistake mr. Phelps makes. He misdefines ‘aggregate demand’ as he excludes (net) export demand. He also states that: “Some economists overlook the modern idea that a country’s prosperity depends on innovation and entrepreneurship”. But this is not really a modern idea as somebody of his age and education should know. Read Jules Verne, read Edgar Allan Poe. A marked characteristic of the twentieth century (and, on a global scale, the twenty first century up till now) has however been that government production clearly enhanced prosperity: think of education, think of health, think of environmental activities.In his article, he also more or less equates these ‘some economists’ with ‘left’ economists. Mister Phelps, please be serious. If it’s Paul Krugman (who has a much, much better grasp of economic metrics like the price level or government expenditure, by the way) or Yannis Varoufakis or Clarence Ayres or Thorstein Veblen (or me) – all of them stress the importance of entrepreneurship and innovation (though ‘entrepreneurship’ should of course not be restricted to private companies – think of the new Suez Canal, households which invest in (Chinese) solar cells on their roof or the USA government which improved USA health insurance. Anyway – the determination of employment and unemployment in Greece is clearly not just caused by (lack of) innovation but surely also by epic austerity. Maybe, however, Phelps and I agree about the fact that capital transfers to banks would have been better spent on subsidies to households to enable them to invest in solar cells, therewith cutting their energy expenditures, lowering CO2 emissions and improving the Greek trade balance. After all: innovation can sometimes be a win-win-win situation, in the case of energy production as well as in the case of health insurance.

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  1. cms
    August 9, 2015 at 10:45 am

    Although, to be precise, there is no Nobel Prize for Economics – just the Sverige Riksbank Prize in Economics in honour of Alfred Nobel…

  2. August 9, 2015 at 2:27 pm

    This critique of Edmund Phelps is right on target , helping to puncture the sophistries of narrow , myopic economics . The larger frameworks beyond economics and its illusions of abstraction are vital in analyzing today’s crises , as I point out in my “Mapping the Global Transition to the Solar Age “, ICAEW,(London, 2014) . Greece’s misery at the hands of economists like Phelps are part of the same intellectual scandal as the Bank of Sweden’s misappropriation of the Nobel Prize , fought by me and others including lawyer Peter Nobel, the founder’s grandson for decades. Our TV series ” Ethical Markets” began in 2004 with ” Redefining Success ” exposing this phony ” Nobel” ( http://www.films.com for classroom use or free at http://www.ethicalmarkts.tv )

  3. August 9, 2015 at 4:31 pm

    My mom gave me a subscription to NY review of books—phelps has an article in the current one (and i class him as part of the muth/lucas type school). he has a noble prize and a new book on ‘mass flourishing’. i guess this is how you get a Noble prize in econ. he may be able to tie his shoes, but he doesn’t seem to understand economics—though of course he knows how to make money. i imagine his view of ‘mass flourishing’ (he promoties everyone wok themselves to death since its what we want to do—‘innovate’)—is a sort of factory farm which provides him subsistence.

  4. August 10, 2015 at 11:12 am

    I heard Phelps speak in Lindau last year. In fact I heard him twice, because his first presentation was so rambling and contained such obvious errors that I went to a second, hoping it would be better. It wasn’t. I fear his mind is not what it was. Unfortunately no-one has the authority to tell such a luminary that he should stop, so Phelps continues giving presentations, writing books and articles and teaching young economists. And unfortunately people listen to him because of his previous achievements. He’s like a famous singer who continues to give performances long after his voice has gone. It’s tragic.

    • merijnknibbe
      August 10, 2015 at 7:43 pm

      Thanks for sharing this information. Once I googled Phelps and learned he is 82 the thought of course crossed my mind. But, long story short, I remember when an 80 year old very close relative became extremely angry at me when, after some fruitless talks about the fact that he could not be allowed to drive anymore, I took his car away. Still, it was the right thing to do.

  5. August 10, 2015 at 12:39 pm

    Greece has always had a surplus recycling problem, in other words closing the loop so that money can cycle around the economy. Before the Euro the gap was mainly tax avoidance and it was closed by persistent deficits and monetary inflation. After the Euro the gap manifest as trade deficit and was closed by borrowing to buy imports. In 2010 that stopped, and the gap is just a gap. Money stopped flowing. The anti-austerity camp is seeking to revive money flow somehow, and stop it from simply leaking out of Greece.

    A short stay in Greece will also reveal that it’s a country filled with small end medium-sized owner-manager businesses. This is no bad thing. To prosper, Greece needs to turn these SMEs from domestic to international focused. Greece needs to become a boutique economy. This is about enabling new businesses. The key is changing attitudes about venture capital, risk, real investment, employee relations, and the like. Reforming public enterprises and Greece’s few large legacy firms, which may be inefficient, is mostly irrelevant.

  6. Francisco-Javier Braña
    August 11, 2015 at 4:43 pm

    The reason is due to that, as “cms” has pointed out, “there is no Nobel Prize for Economics – just the Sverige Riksbank Prize in Economics in honour of Alfred Nobel…”. If even alternative economists like “merijnknibbe” make these mistakes, showing the enormous ideological power of mainstream economics, everything can be explained.

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