I am really sorry to dissapoint all the hardcore geology fans but there is nothing about geology in this post. I will try not to repeat this mistake any time soon.
There is a long-fought battle between those who favor spending to exit economic downturn and those who think that austerity is eventually the right choice. I do not want to choose a side yet, I think it depends on context, but I am clearly different from Paul Krugman, one of the most influential spending advocates, who thinks that government spending is always the solution and if it does not work, then the sum of money was too small. Well, you can not argue with arguments like that, can you? I’ve read his statements for several years and have always wondered how wrong one man can be. One of his latest predictions about two or three months ago was that Greece will be kicked out of Eurozone in a month. Well, that has not happened so far. What amazes me now are his recent attacks on my home country, Estonia.
Estonia entered severe economic depression 2008/09 after real estate boom and the collapse of Lehman Brothers in the USA. Government responded to that by cutting spending to lower the budget deficit. According to Krugman, this is very wrong thing to do. However, Estonia is recovering reasonably well. Its economic growth rate is again fastest in EU which obviously irritates Krugman. He is even asking “this is the best people can do to demonstrate the wonders of austerity?”. By saying that he points to the fact that we are still below the level (in terms of the size of the economy) we achieved at the peak of the boom.
I think that this discussion is severely flawed in many ways. First, you can not compare tiny country like Estonia and the USA. Our internal consumption is rather weak. We rely on our exporting partners to whom we sell our stuff. It makes not much sense to just stimulate domestic consumption. Our currency was pegged to euro which means that we can not print money (meanwhile we have adopted euro). Hence, we have to borrow the money to stimulate and we know that our children must pay this money back to our creditors (with interests, of course). USA has a freedom to print money endlessly. USA has a freedom to generate worldwide inflation and that way rob money even from those who have to live with $2 a day. We all are facing ever-increasing food and fuel prices because Krugman, Obama, Bernanke, etc. have found an ingenious way to make the whole world pay back US debt. I don’t know how long this lasts but it can not last forever. There are no free lunches.
But I actually did not want to write about that. I wanted to say why Krugman is so utterly wrong. Many people know that he is badly mistaken in most things he is saying but it amazes me that they do not point to the main weakness of his hypotheses. This is his failure to understand that successful country must be almost always run in the way that maximizes its long term gain, not short term gain. What do I mean by saying that? There is a tradeoff between long- and short-term gain. Let me give you an example: your child demands very loudly in a shop that you have to buy him this colorful toy. Now you have two choices. First, you buy it because then he will be satisfied for a moment. Second, you refuse to buy because you never intended to do it, especially after such behaviour. In a first occasion you are maximizing your short term gain which will bring along long term pain because next time you will go to a shop the same happens. If you choose not to buy it, you have to suffer short term pain because he will behave very badly right after that but in the long run he will understand that such a behaviour will not bring him anything good. I have found many similar tradeoffs in everyday life, science, and economy. In the long run, of course, the strategy that brings along long-term success should be preferred.
Similar tradeoffs are well known in ecology. Different organisms have adopted different reproduction strategies. Those who live a short life do not need to invest into their health. In an evolutionary sense it pays to invest it into reproduction. Those that live longer, however, need to invest (or waste) lots of their resources into themselves. They must maintain a long-term vision. Which organisms are countries resembling? To me, it seems clear that countries should almost always seek solutions that increase its success in the long-term because countries are designed to last as long as possible. What is government spending in the case of an economic downturn? Is it pleasant in the short term? Yes, it definitely is. It is so sweet thing to do for politicians. Hence, it has to be wrong in the long run because there is an unavoidable tradeoff.
Why did I say that countries should seek long-term gain not always but almost always? Because there are exceptions. If the very existence of a country is threatened (in case of war), it should spend heavily and right now to protect itself as efficiently as possible. If needed, money should be borrowed in large amounts. But this is extreme situation. There is no excuse to do anything like that in an economic downturn because we simply did not want to slightly cut back our spending. However, I am not against some stimulating if it comes from the resources collected in good times. Most countries, unfortunately, prefer to run deficit even in good times.
In the long run, those who preferred long-term gain (which means moderate short term austerity) will gain because they do not have a constant burden of debt with interests. I remember one British MP saying that every year UK has to pay to its creditors the sum of money as an interests that equals their yearly expenditures on the whole educational system. I think it is absolutely awful if this is true. It is well known that long-term economic growth comes from investments to education and science (not from governmental stimulus packages). Great Britain could theoretically invest twice as much money into science and education than it is doing now.
Now it should be obvious why it irritates me when Krugman points to Estonia and asks “this is the best people can do to demonstrate the wonders of austerity?”. It simply is not fair because Estonia clearly chose long-term gain (by having almost no foreign debt and balanced budget). This gain is not obvious yet. I readily admit that stimulating supports economy in the short run and countries that did so could be better off few years later but I can not see how that can be true in the long run. It is simply against common sense and the fundamental laws of nature.