Wednesday, May 22, 2013

Local Austerity

The Wall Street Journal had a really heart-warming article, Europe's Recession Sparks Grass-Roots Political Push  about groups taking over local governments in southern Europe, and cleaning out years of mismanagement. An excerpt
At her inauguration Ms. Biurrun [the new mayor of Torroledones, Spain] choked up before a jubilant crowd.

Then she began slashing away. She lowered the mayor's salary by 21%, to €49,500 a year, trimmed council members' salaries and eliminated four paid advisory positions.

She got rid of the police escort and the leased car, and gave the chauffeur a different job. She returned a carpet, emblazoned with the town seal, that had cost nearly €300 a month to clean. She ordered council members to pay for their own meals at work events instead of billing the town.

"I was so indignant seeing what these people had been doing with everyone's money as if it were their own," Ms. Biurrun said.

Those cuts, combined with savings achieved by renegotiating contracts for garbage pickup and other services, helped give a million-euro boost to the city treasury in her first year in office.
Great, no?

But wait, isn't this all "austerity?" Isn't cutting spending  exactly the kind of thing that Keynesian macroeconomists, as well as the reigning IMF-style policy consensus decries, saying we need stimulus now, austerity later?

Keynesian, and especially new-Keynesian economics wants more government spending, even if completely wasted. Those trimmed salaries, fired "advisers," cleaning bills, restaurant spending, overpaid contracts are, in the standard mindset, all crucial for "demand" and goosing GDP.  If stimulus advocates were at all honest, they would be writing blog posts decrying Ms. Birrun and her kind.

Of course they don't. Abstract "spending" sounds good, and touting abstract "topsy-turvy" model predictions sounds fine.  But when it is concrete, it's so patently absurd that you don't hear it.
The Greek city of Thessaloniki cut costs after Yannis Boutaris, a businessman-turned-politician, took office in late 2010 and ended City Hall's relationship with a few selected providers. Competitive bidding has saved the city 80% of its previous spending on accounting, 25% on waste disposal trucks and 20% on printer paper. The savings have allowed Mr. Boutaris to spend more on social services, even while cutting taxes and paying down City Hall's debt to suppliers.
How sad. So much "demand"-destroying "austerity."

(Of course, the main point of the articles is about a political realignment, in which local governments are becoming responsive to local voters, transparent, and efficient, rather than being cronyist machines of national political parties. I can't imagine anyone not feeling warm about that!)

Update: Courtesy Marginal Revolution, I found this nice story about the new Spanish $680 million submarine that will sink if put in water.  MR snarkily asks "did this help Spain or hurt Spain." $680 million of government spending raises Spanish GDP by nearly $1 billion, so this is great, right?


  1. What superficially looks as austerity is in fact the re-allocation of funds from those with a low MPC to those with a high MPC. Even if the overall budget shrinks, there can be a net stimulative effect.

    This coincidentally is why tax cuts are a poor form of stimulus, but spending on social services is a good form of stimulus.

    1. I'm not seeing how the government employees had a lower seems to me that is was obviously higher

  2. "Keynesian, and especially new-Keynesian economics wants more government spending, even if completely wasted"

    I don't think this is accurate. This pops up in your writings once in a while. The point is to prevent mass unemployment, which is the very feature that makes that spending not wasteful. The idea is not to send all the money to one contractor selected by one corrupt govt official - that's just corruption which has nothing to do with keynesian economics.

    Imagine that a project generates -Y dollars in NPV but it employs tons of people. The idea is that this is good, temporarily and under certain conditions, because those people being unemployed for too long will destroy > Y of human capital NPV

    1. I think Paul Krugman did a great service with his example, that the government should fake an alien invasion so we can spend a lot of money building useless defenses. I call that "wasted," you say no, because if the Keynesian model works the money creates so much GDP. Fair point. But this is semantic. I think we understand each other.

      Actually, sending money to thieves is great in the Keynesian model. Thieves and corrupt officials have very high MPC.

    2. Right, but having a project with a NPV of -Y doesn't imply that future negative cash flows won't happen. Many, actually. Take a look at Portugal. Tons of useless and duplicate highways built, payments deferred, deficits accumulated and an explosive public debt that needs to be paid. Furthermore, while private investment can be more or less easily liquidated so that capital can be put to better use (i.e., more rentable activities), you can't reconvert public capital so easily. You can't just sell a bridge or a square mile of pavement. You have to keep on throwing money at it. Like Keynes suggested. Just make sure you wrap it in a nice package.

      Now that I think of it, economic growth models Barro/Futagami/Lucas-style should incorporate a friction in public capital, since it doesn't work in the exact same way as private capital and it can't be easily reconverted into something useful, that is, that maximizes consumption or whatever measure of utility.

    3. John, it's not semantics - it is the crucial question of our time:

      is fighting unemployment a hugely NPV positive project or not?

      you make an assumption that it is not. But what is the evidence for this assumption? why should this assumption be true? it could be true if private sector always took up all NPV positive projects and employed everyone that should be employed. That does seem to contradict common sense and real world experience of most people

    4. He does make an assumption that fighting unemployment the Keynesian way is not a NPV project. But, that is not why he calls it wasteful government spending. By 'wasteful' he means the direct spending is wasteful. Digging a hole and filling it, or fighting a fake alien invasion, are 'wasteful' government spending projects. They may have a net positive effect (Cochrane would disagree), but the point of Keynesian stimulus is that the initial spending can be not productive at all.

  3. The debate over fiscal "austerity" in much of the Eurozone is rather pointless, they're not considered good credit risks so the "borrow and spend" option is not really available as it might be in the U.S. The real room for manuevering is at the worst institution in the world, the ECB. The UK (despite some major "real"/supply problems), Sweden, Switzerland and the U.S all have lower unemployment rates than the Eurozone because they have independent monetary policies. Even Iceland has had significant recovery thanks to devaluation, and Japan is starting to stir again under Abenomics. Germany isn't doing too badly under the status quo, so they don't want the ECB to change its stance, but the same tack is completely inappropriate for the periphery. And as heartwarming as a few local stories may be, I don't think most of these places are going to reform enough to become good credit risks again. See Bryan Caplan's "The Idea Trap".

  4. Professor Cochrane,

    You are trying to pull a fast one by saying it is "patently absurd" that these cutbacks would hurt GDP. I think many Keynesians would openly decry these budget cuts. For all I know they have. I appreciate that you disagree with New-Keynesian theory on this issue, but to call it "patently absurd" only hurts your argument. Do you not buy evidence of sticky prices? Do you think it's simply ridiculous to believe there is a demand shortfall in Europe? Maybe you are just trying to combat the verbal assaults from Krugman. In that case, fair enough.

    1. Let's assume there are sticky prices and sticky wages. How will having a bloated and inefficient government wrought with corruption help the economy move forward given sticky prices? How will these things help increase demand?

      How will giving money to cronies help increase demand? How will the sand in the gears of the government help the economy grow? Sure, you can pump money into an economy by increasing government spending, but what's the MPC of a crony?

      In the case of Greece that Prof Cochrane shared, I'm pretty sure that spending on social services is a much better increase in AD than letting cronies get fatter. Tax cuts at the very least wash out the spending cuts if not increase AD further. Paying down debt today means less expected taxes in the future (going on a little bit of Ricardian Equivalence here) which means businesses and consumers would more likely spend now which further increases AD.

      So yeah, this unique take on "austerity" probably helps AD much better than lining the pockets of the politically connected.

      And hell, maybe we aren't boosting AD, but think of all the marginal benefit not captured by GDP that these people are getting. Sure, their GDP isn't up, but their utility probably is after throwing out the jerks in their government. And at the end of the day, I think people care a bit more about their utility than their potential GDP.

  5. This comment has been removed by the author.


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.