The conversion to conventional, sound economic thinking by shadow treasurer Joe Hockey and Opposition Leader Tony Abbott in the last 24 hours has come two days after the key intellectual underpinning for “austeritiyists” that high debt is bad for growth, so cut spending, was badly undermined in the US.
Three US academics (one of whom is a student and the main driver of the counter argument) produced a paper that has shot numerous holes in the credibility of the paper called “Growth in a Time of Debt” by Carmen Reinhart and Kenneth Rogoff, which was published in 2010. It has been, since publication, perhaps the most important intellectual bulwark in support of austerity policies in the US and Europe and has been cited by the likes of Paul Ryan, the US Congressman (and Republican vice-presidential candidate in 2012), and George Osborne, the UK Chancellor (treasurer).
Rogoff and Reinhart found that in a sample of 20 advanced economies over the post-World War II period, that average annual GDP growth ranged between about 3% and 4% when the ratio of public debt to GDP was below 90%. But average growth collapsed to 0% when the ratio rose above the 90% level. That finding has provided the austerity policy of intellectual underpinning for slashing spending and raising taxes to get debt back under 90%. (IMF, EU and ECB in Greece, Ireland and Portugal, etc).
But this week it was revealed that Rogoff and Reinhart (who are two of the big names of international economics with stints at the IMF and the US Federal Reserve, Wall Street and academia before ending up at Harvard) had badly mis-evaluated their data, which was also incomplete. A paper by two teachers and a student at the University of Massachusetts Amherst found the Rogoff-Reinhart paper was flawed. Two of the authors, referred to collectively as HAP (for their initials of their surnames, Herndon, Ash and Pollin) explained in an article in the Financial Times:
“In a new working paper, co-authored with Thomas Herndon, we found that these results were based on a series of data errors and unsupportable statistical techniques. For example, because of straightforward miscalculation and unconventional method of averaging data, a one-year experience in New Zealand in 1951, during which economic growth was -7.6 per cent and the public debt level was high, ends up exerting a big influence on their overall findings. When we performed accurate recalculations using their dataset, we found that, when countries’ debt-to-GDP ratio exceeds 90 per cent, average growth is 2.2 per cent, not -0.1 per cent. We also found that the relationship between growth and public debt varies widely over time and between countries.
“Using Prof Reinhart’s and Prof Rogoff’s data, we found that for the years 2000 to 2009, the average GDP growth rate for countries carrying public debt levels greater than 90 per cent of GDP was either comparable to or higher than those for countries whose public debt/GDP ratios ranged between 30 and 90 per cent.”
Rogoff and Reinhart confirmed the reported inaccuracies, but claimed the new paper’s authors did not get “dramatically different results on the relatively short postwar sample they focus on” because they also found lower growth associated with periods of debt above 90% of GDP. “Put differently, growth at high debt levels is a little more than half of the growth rate at the lowest levels of debt,” they said in a reply.
“Herndon, Ash and Pollin accurately point out the coding error that omits several countries,” they said. But they “objected in the strongest terms” to the second criticism that they had missed several years of data and stood firm on the issue of unconventional weighting:
“The ‘gaps’ are explained by the fact there were still gaps in our public debt data set at the time of this paper … Our approach has been followed in many other settings where one does not want to overly weight a small number of countries that may have their own peculiarities.”
That was seen as a weak reply by critics, such as Nobel economic winner Paul Krugman, and the credibility of the paper (and no doubt their standing) has taken a major blow — it will place even more pressure on those supporting austerity to justify their policies. The IMF has already started turning, ruing countries (such as the UK) cutting to cut less and start spending to stimulate growth and demand. Abbott and Hockey would not have read this academic firefight, but others around the world have, and it’s on for young and old.