Opinion and Analysis

Counterintuitive economics can help politicians

Absurd wishful thinking. This is how most finance ministers describe criticism of their tough budget policies designed to control government debt and reduce borrowing. Britain, even more than Germany, has been in the vanguard of this austerity movement, as Chancellor of the Exchequer George Osborne demonstrated again in this budget statement:

“Confronted with tough economic conditions, some say we should abandon our deficit plans, and try to borrow more – they think that by borrowing more, they can borrow less.”

For Osborne, this reductio ad absurdum seemed so conclusive that there was no need to justify his controversial economic beliefs.

To claim that a government should borrow more when its debts are already too high is ridiculous - as ridiculous as suggesting in the 16th century that the earth moves around the sun or that humans evolved from monkeys.

While economics does not deserve to be called a science on par with physics or biology, it is supposed to be a systematic and objective analysis of empirical evidence about the way the world works. The goal of such rigorous analysis is to find insights that are not obvious, and may sometimes even seem ridiculous to casual observers.

Several counterintuitive insights are now nearly universally accepted among economists – for example, that a country can usually gain more wealth by reducing trade tariffs than by increasing them. Others are still very much in dispute. Perhaps the most important of these, especially in the present global context, concerns public borrowing.

Should governments try to reduce borrowing during an economic slowdown, or should governments borrow more or less without limit until economic activity revives and full employment is restored?

This is a complex and subtle question on which opinions among serious economists can reasonably differ and change over time. Government austerity can reduce interest rates and boost confidence, prompting more consumption and investment.

Governments are bound to keep missing economic forecasts and targets. But they could try to limit the risks by basing policies on serious economic analysis, not oversimplified cliches and appeals to common sense that are just plain wrong.

Kaletsky is an award-winning journalist and financial economist.