“The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists” – Joan Robinson
People of my generation will remember a very early article about Simon and Garfunkel in which an American journalist, introducing the singers to an unknowing public, starts by saying “the title makes them sound like attorneys, but they aren’t”. Well, here are two other mid-European names that sound like attorneys, but aren’t – Reinhart and Rogoff. And they have been making big news on the economic front, but almost nowhere else, for the past six weeks or so. Before you switch off, or whatever else it is that people do when reading a blog, here’s my take on why every voting citizen should know about them, and avoid being deceived.
In 2010, two economists called Carmen Reinhart and Kenneth Rogoff released a paper, “Growth in a Time of Debt.” Their most influential claim was that rising levels of government debt are associated with much weaker rates of economic growth, indeed negative ones. The “main result is that…median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.” Countries with debt-to-GDP ratios above 90 percent have a slightly negative average growth rate, in fact. They understood why governments had not initiated deep cuts as the recession first hit, but told us that “ the sooner politicians reconcile themselves to accepting adjustment, the lower the risks of truly paralysing debt problems down the road. … Countries that have not laid the ground work for adjustment will regret it.” Later in 2010, Rogoff wrote another article in the Financial Times in which he reiterated: “The risks of rising debt, while apparently far off, cannot be lightly dismissed”, and added, “in this environment, measures to gradually stabilise debt burdens—to restore normality—surely make sense.”
This paper has been one of the most cited stats in the public debate during the Great Recession. Right wing politicians on both sides of the Atlantic have used it to justify their austerity policies. The American congressman and Vice Presidential nominee Paul Ryan’s published budget proposals – called Path to Prosperity – quoting their study as finding “conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” In February 2010, George Osborne, the soon-to-be Chancellor of the Exchequer, cited the authors several times by name in a key speech laying out his policy proposals and calling for big cuts in government spending. Here are some excerpts:
So while private sector debt was the cause of this crisis, public sector debt is likely to be the cause of the next one. As Ken Rogoff himself puts it, “there’s no question that the most significant vulnerability as we emerge from recession is the soaring government debt. It’s very likely that will trigger the next crisis as governments have been stretched so wide.”
The latest research suggests that once debt reaches more than about 90% of GDP the risks of a large negative impact on long term growth become highly significant. If off-balance sheet liabilities such as public sector pensions are included we are already well beyond that. And even on official internationally comparable measures of debt, we are forecast to break through 90% of GDP in just two years time…
To entrench economic stability for the long term, we need fundamental reform of our fiscal policy framework….As I have made clear, our aim will be to eliminate the bulk of the structural current budget deficit over a Parliament.
The Washington Post editorial board took it as an economic consensus view, stating that “debt-to-GDP could keep rising — and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth”. There were some dissenting voices at the time – mostly from people saying the relation between debt and slow growth was the other way round, and that when that economies get into trouble government deficits rise as tax receipts fall and welfare funding rises. A correlation is not a causation: umbrella sales rise in rainy weather, but they don’t cause it. Josh Bivens and John Irons made this case at the Economic Policy Institute, and economist Arindrajit Dube found significant evidence that reverse causation is the culprit. But those dissidents were the normal Keynesian numpties like Paul Krugman, with his bloody Nobel Prize, so who needs to listen to them. The paper remained very influential, and lay behind the European and British deficit reduction policies, and the Republican opposition to any reflation by the Obama administration. After all, as a New Yorker article pointed out, ninety per cent wasn’t just any old figure. “With large budget deficits and debt-to-G.D.P. ratios in the range of sixty to eighty per cent, many advanced countries, including the United States and Britain, were fast approaching the threshold of doom, or so it seemed. If you took Reinhart and Rogoff’s findings at face value, as many people did, it was hard to argue with the Hooveresque logic of, say, Osborne”.
And then …
Thomas Herndon, a Ph.D. student at Amherst College in Massachusetts was given an assignment as part of his course, which was to run through the statistical background to the R&R paper. He wasn’t the first to try, but others had been refused access to the R&R workings. He was, however, given access to the famous spreadsheet. And he found an extraordinary range of errors and omissions that make then work extremely suspect. For a start, there was a cock-up in the simple construction of the Excel spreadsheet. He asked his girlfriend to check, and she thought he was right. Then he checked with his professors, and they thought he was right too. They (Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts at Amherst) then published their findings in a paper called “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,”. They find that three main issues stand out, and I am indebted to an article by Mike Konczal that explains it for the layman. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. The deeply suspicious factor involved here is that all three of these errors cause the study to move in favour of their result, and without them you don’t get their controversial result. Let’s investigate further:
Selective Exclusions. Reinhart-Rogoff use 1946-2009 as their period, with the main difference among countries being their starting year. In their data set, there are 110 years of data available for countries that have a debt/GDP over 90 percent, but they only use 96 of those years. The paper didn’t disclose which years they excluded or why.
Herndon-Ash-Pollin find that they exclude Australia (1946-1950), New Zealand (1946-1949), and Canada (1946-1950). Now, as Stephen Colbert magnificently said on his TV show, if ignoring New Zealand, Australia and Canada were an offence, most Americans would be on death row. However, when studying international data, this has consequences, as these countries have high-debt and solid growth. Canada had debt-to-GDP over 90 percent during this period and 3 percent growth. New Zealand had a debt/GDP over 90 percent from 1946-1951. If you use the average growth rate across all those years it is 2.58 percent. If you only use the last year, as Reinhart-Rogoff does, it has a growth rate of -7.6 percent. That’s a big difference, especially considering how they weigh the countries.
Unconventional Weighting. Reinhart-Rogoff divides country years into debt-to-GDP buckets. They then take the average real growth for each country within the buckets. So the growth rate of the 19 years that the U.K. is above 90 percent debt-to-GDP are averaged into one number. These country numbers are then averaged, equally by country, to calculate the average real GDP growth weight. In case that didn’t make sense, let’s look at an example. The U.K. had 19 post-war years (1946-1964) with above 90 percent debt-to-GDP with an average 2.4 percent growth rate. New Zealand has one year in their sample above 90 percent debt-to-GDP with a growth rate of -7.6. These two numbers, 2.4 and -7.6 percent, are given equal weight in the final calculation, as they average the countries equally. Even though there are 19 times as many data points for the U.K. It’s like finding the average height of your family and a leading basketball team by taking one figure from the Chicago Bulls and five from you. Once this error is taken out, the results disappear. Jonathan Portes tried to find them. “In an effort to reconnect myself with the facts, I consulted Rogoff and Reinhart’s own database. Among G7 countries, their statement is false for the UK, US, Canada, France and Italy. They do not have data for Germany or Japan for the World War 2 peak. More importantly, the way that these very high debts were reduced was primarily by growth, not by rapid fiscal consolidation at a time of weak private demand”. Oh, and Reinhart-Rogoff don’t discuss their methodology, either the fact that they are weighing this way or the justification for it, in their paper.
Coding Error. As Herndon-Ash-Pollin puts it: “A coding error in the RR working spreadsheet entirely excludes five countries, Australia, Austria, Belgium, Canada, and Denmark, from the analysis. [Reinhart-Rogoff] averaged cells in lines 30 to 44 instead of lines 30 to 49…This spreadsheet error…is responsible for a -0.3 percentage-point error in RR’s published average real GDP growth in the highest public debt/GDP category.” Belgium, in particular, has 26 years with debt-to-GDP above 90 percent, with an average growth rate of 2.6 percent (though this is only counted as one total point due to the weighting above).
Being a bit of a doubting Thomas on this, Mike Konczal said “I couldn’t believe unless I touched the digital Excel wound myself. One of the authors was able to show me that, and here it is”. You can see the Excel blue-box for formulas missing some data:
This error is needed to get the results they published, and it would go a long way to explaining why it has been impossible for others to replicate these results. If this error turns out to be an actual mistake Reinhart-Rogoff made, well, all I can hope is that future historians note that one of the core empirical points providing the intellectual foundation for the global move to austerity in the early 2010s was based on someone accidentally not updating a row formula in Excel. And how can a paper by two authors – eminent people with graduate students to help them with their workings – let an error like this slip in ?
So what do Herndon-Ash-Pollin, the analysts from Amherst, conclude? They find “the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim].” Going further into the data, they are unable to find a breakpoint where growth falls quickly and significantly. It was all tosh.
There is actually another learned article that the austerians lean on, one that says that economies will expand if you contract government spending – not Reinhart/Rogoff this time, but Alesina/Ardagna on expansionary austerity. They claimed
Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.
This has also proved to be total rubbish – even the IMF has disowned it. So shall we wait to see whether the officials of the European Central Bank, or HM Treasury, or the serious people in the US Republican Party will now change policies as the backing to their ideas has proved to be simply wrong. The answer is no, because those people are not interested in engendering a recovery in a way that corresponds with best knowledge. If they were, they would be working out how to put in place public spending and tax cuts that will boos the economy. They are interested in shrinking the size of the state and taking entitlements away from poor people. That is also what lies behind the extraordinary idea that people are unemployed as a result of a lifestyle choice. The recession, an event caused by the misbehaviour and miscalculations of rich people, is being used by the same sad unprincipled bunch, to increase their power and reduce their obligations. And they will seize on any gimcrack piece of academic nonsense to back them in their task, and will not change when that research is shown to be wrong. As the great Krugman said, “the really guilty parties here are all the people who seized on a disputed research result, knowing nothing about the research, because it said what they wanted to hear”.
Grumpy Wisdom 