Dismal science indeed

It is somewhat of a mystery that economists remain devoted to demand as an actual mover of economies. There is, in fact, nothing less likely to cause anything to happen, either in production or employment, than raw desire for a product unbacked by an ability to offer something else in exchange. Money used to be received almost always in exchange for products sold so it was a near perfect proxy. Now money is often received in exchange for nothing of commercial value so is regularly diluted. Either prices rise, quality falls or, invisibly, the productive capital of the economy continues to crumble.

Debt and deficits are a problem that continues to bring ruin. Virtually none of this can be shown in the national accounts because it adds in public spending as if it were really value adding and the crumbling of the capital stock doesn’t show up for a period of years since the “G” in GDP stands for gross. There is therefore almost no means using official statistics to show the deterioration. Statistics using the national accounts are therefore poorly designed for capturing underlying movements in the economy. Which brings us to Reinhart and Rogoff.

The issue is summarised in this paper, It Just Gets More and More Dismal by Andrew Ferguson:

Consider the fate suffered in recent weeks by a pair of well-known economists, poor Carmen Reinhart and Kenneth Rogoff, both of Harvard. They are the authors of several scholarly papers, slightly fewer newspaper op-eds, and one big-selling book, This Time Is Different, which aim to prove scientifically that too much debt is bad for you. More precisely—and how could they be scientists if they weren’t precise?—they claim to have discovered that when a government’s debt rises to 90 percent of its country’s gross domestic product, the country’s economy contracts by (on average) one-tenth of one percent per year.

And so the counter attack from those who love that debt and those deficits:

Few challenged RR on methodological grounds until this April, when three economists—informally called HAP, an acronym of their last names—released a paper debunking the idea of a threshold. Fondling the same sets of figures that RR had used, HAP found that RR had neglected to include some important historical data in their calculations. When those figures were factored in, the threshold vanished. On the graphs, GDP no longer dropped like a plumb after the debt-to-GDP ratio reached 90 percent.

But as even HAP had shown:

The HAP graph shows a long slow decline in GDP under heavier and heavier debt loads. RR shows a dramatic drop at the threshold. The HAP graph is inherently more plausible precisely because RR’s is so dramatic. Cataclysms are rare in life; it’s why they’re so cataclysmic. Predictable cataclysms that happen on a regular schedule are even rarer. RR’s graph shows countries meandering along until .  .  . WHOMP! The HAP graph shows countries meandering along until .  .  . they keep meandering along, en route to more meandering along.

But at least he makes one brief mention of the problem with the approach of both RR and HAP:

RR made no distinctions between kinds of debt or their varying effects on growth. Not all debt works the same way. Money borrowed to build roads and bridges has enduring benefits that help an economy grow; money borrowed to invest in Solyndra .  .  . doesn’t. RR can’t tell us which countries had which kind of debt during which periods.

Yes, spending has to be value adding. Something of a throwaway line in the midst of the article. Hopefully one day it will come to be seen as the crucial issue that it is.

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