Stimulus and austerity

I've been reading a few things on the matter of great economic debate of stimulus versus austerity.

First, Justin Wolfers says that survey results show that top flying American economists are nutty outliers (my wording, not Wolfer's) if they hold the position that the Obama stimulus of 2009 didn't help the economy.  They are more divided on whether it was worth the cost, but even then it runs more than two to one in favour of "yes, it was worth it."

Secondly, I stumbled across this article by Florian Schui which I thought gives a nice succinct summary of the intersection of politics and economics on this issue:

This is an evolutionary argument familiar from radical liberal thinkers such as Wilhelm von Humboldt and Friedrich Hayek. Crucially, their perspective does not give great prominence to questions of economic efficiency. Indeed, free societies a likely to experience periods of economic waste: periods of low growth may leave labour, capital and other resources underused. But free societies do better in the long run because they are better at evolving and adapting. The political aim must therefore be to contain the size of the state in order to leave space for the creative forces of society. That remains true even if cutting back the state hurts growth and economic efficiency in the short term. If you accept this view, it makes no sense to adapt the size of the state to the cyclical fluctuations of the economy. Rather, what is needed is a permanently smaller state to unleash the creative powers of society.

This argument has its merits but from an economic perspective there are some substantial problems associated with the Olympian perspective adopted by thinkers like Humboldt and Hayek. Mainly, they do not say how long the long run is. Other approaches to economic policy allow the public to verify concrete results after a few quarters or after a couple of years at the latest and decide whether to continue with a specific set of policies or not. But it is not clear when we can undertake a similar evaluation of the results of this kind of radical laissez faire. Every crisis no matter how long or deep may be interpreted as an unpleasant but necessary stretch on a superior evolutionary path. In practice, this means that economic results become irrelevant as a yardstick against which to judge economic policy. This is exactly what is happening in the case of austerity. There simply is no economic outcome that can convince proponents of austerity that they are on the wrong track. Their cause is not about economic efficiency but about a political goal: the preservation of liberty.

There are also social problems associated with the Olympian perspective of the likes of Humboldt and Hayek. Prussian aristocrats and tenured professors are in a position to look at economic crises, even if they lasts a decade or longer, as a mere transitory phase of hardship that is part of a superior evolutionary trajectory. More ordinary citizens may not be able to afford this kind of detached perspective on the economy. A longer crisis can ruin the life plans of individuals and lead to the collapse of social and political systems. That is why Keynes warned that the ‘long run is a misleading guide to current affairs’.

One may object that there is nothing wrong with giving priority to political values over the pursuit of economic maximisation and social welfare. Why should the defence of freedom not trump economic and social considerations? After all maximising growth and maximising human happiness can be two rather different things and most people would agree that the latter is more important. The preservation of liberty may very well warrant austerity policies that cut the state to size, even if they hurt economically.

While this is a valid argument it is questionable whether the trade-off between the size of the state and individual liberty really exists. The historical experience of Humboldt and Hayek certainly gave them reason to think of states as the enemies of individual freedom. In Humboldt’s time, towards the end of the 18^th century, absolutist states such as his native Prussia and republican states such as France were extremely ambitious in expanding their sphere of action, often at the expense of individual liberty. The same is true of the authoritarian states in Europe that Hayek witnessed in the 1920s and 30s.

However, a more complete vision of history also reveals the shortcomings of the simple equation of a larger state with greater oppression. Hayek predicted in the 1940s that planned economies would set mankind on a road to serfdom. In actual fact, the vast expansion of states across the western world in the post war decades coincided with an equally substantial increase of liberty for many contemporaries. Women and black people acquired more freedom than ever before and despite evident lapses western countries did rather well at protecting the individual rights of their citizens.

I think this sounds quite convincing, and goes along with my increasing feeling over the last few years that it is the small government ideologues who are truly ignoring history.   

And finally, this article in The Economist, which I've possibly linked to before, seems to give a very fair and balanced take on the matter.