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… .
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.