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The theory on which austerity is built is now shown to be false

Two years ago the Harvard economists Carmen Reinhart and Kenneth Rogoff published their best-selling book This Time is Different which purported to show that one natioanl debt exceeds 90% of GDP, economic debt declines rapidly. It was seized on by Right-wing governments, media and academic pundits generally to justify a policy of extreme cutbacks in public spending in order to keep debt below the watershed level of 90% at all costs.

The theory, according to the Right’s mantra, was that high debt levels can crowd out economic activity and entrepreneurial dynamism, and thus hamper growth. Though it profoundly satisfied policy-makers who believe it counter-productive that governments should spend money in a recession and that a pro-cyclical austerity is more plausible than a Keynesian response, it turns out that the Reinhart-Rogoff thesis is quite wrong, first about the threshold and second about causality.

Their figures have been re-worked by three researchers at Massachusetts who found no structural break at 90%, nor indeed at anywhere else, but rather a smooth negative relationship between growth and debt. The 90% has no foundation in reality – any more than the 3% of GDP limit on annual budget deficits which so obsessed the EU as the basis for stability – but was simply conjured up as a device to frighten the horses of economic policy into a sharp spasm of deflation.

Then there is the point that causation can go either way: high debt may cause low growth (the conclusion the economists immediately leapt to), or low growth may cause high debt, or something else might cause both, or the supposed relationship may just be wrong.

As it happens, the Reinhart-Rogoff thesis has already been put to the test – and failed. The US debt level has already passed 90% of GDP, yet growth is markedly better there than in the EU which has largely kept below the 90% ceiling. Britain after the Second World War had a debt level around 220%, yet embarked on a period of sustained growth for a quarter century.

But even without such examples the UK experience, where debt is still below the 90% ceiling, demonstrates how flimsy the Reinhart-Rogoff theory is. Expenditure and benefit cuts have sharply cut UK economic demand which has contracted the economy, and the consequential fall of government tax receipts has then exceeded the spending cuts, thus unleashing a vicious circle of ever lower growth or indeed negative growth.

The truth of course is that Right-wing economic postulates like Friedman’s monetarist theory of inflation, Thatcher’s NAIRU (non-accelerating inflation rate of unemployment which refers to a level of unemployment below which inflation is alleged to rise) and Reinhart-Rogoff’s alleged debt-growth relationship provide a handy rationale for deflationary solutions which serve the (undeclared) ideological objectives of shrinking the State and gutting the public sector. Now that this academic crutch has been kicked away, the nakedness of austerity theory has become ever more starkly revealed.

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