The Paradox of Thrift

Over the course of his debate on the Estimates and, later, the Budget, Arnhim Eustace introduced a novel, seemingly oxymoronic, economic concept:

The Election-Austerity Budget.

On the one hand, during debate on the Estimates, Mr. Eustace accused the Government of presenting an Election Budget. He pointed to its size ($911 million), which rivaled that of previous election-eve budgets. He commented on the “bunching” of major Government projects, many of which seem slated for completion or commencement this year. He said that optimistic revenue expectations were based on accounting sleight of hand. All indicia of pork-filled election budgeteering.

On the other hand, he claimed that the 2014 Budget was a Spartan exercise in blatant austerity belt-tightening. To support his argument, he relied primarily on the assertion that the Budget makes no provision for salary increases, continuing a “wage freeze” that will be entering it’s third year. Low projections and ambitions, particularly in the agricultural sector, were also highlighted as austerity indicators. Northern Grenadines MP Godwin Friday, for his part, singled-out cuts to the tourism Estimates as evidence of misplaced priorities, if not austerity.

With the exception of Germany, politicians do not present austerity budgets as a pre-election inducement. Election budgets are typically generous and goodie-packed, with the squeeze coming in the budget that immediately follows the polls. Around the world, austerity budgets cause protest, force early elections, and get governments removed from office.

To table an Election-Austerity Budget, as Eustace suggested, would either be an act of extreme political hubris or schizophrenia. Entire post-graduate theses could be written on the concept of an Election-Austerity Budget. It’s a shame that the Opposition didn’t seize the opportunity to develop the concept further during the Budget debate. I, for one, was intrigued.

Prime Minister Gonsalves did not take great offence at the accusation that this was an election Budget (hint, hint), but was robust in his defense against the “austerity” charge. How can a budget that added jobs, increased the wage bill, expanded and strengthened the social safety net, and began major infrastructural works be accused of austerity, he asked. How can this be austerity when, in addition to largely maintaining current levels of spending, you are also introducing a farmer’s support fund ($6 million), rehabbing the South Leeward Highway ($46 million), redeveloping Little Tokyo ($2 million), implementing the CARCIP ICT infrastructure project (the $2.1 million), expanding the one-laptop-per child programme ($13 million), introducing the Support for Employment and Training (SET) programme ($1.5 million), and spending $9.5 million on the modernization of the health sector, asked the Prime Minister. He described any cuts or restraints appearing in the Budget as “prudence,” and juxtaposed it with evidence of State “enterprise” in other sectors.

More importantly, for the purpose of this particular blog posting, was the debate of the efficacy and desirability of austerity as a growth strategy, particularly in the context of Small Island Developing States like SVG. Despite his recent finger-pointing, Mr. Eustace is on record as a pro-austerity disciple, famously asking the Prime Minister “what’s wrong with austerity?” a couple years ago, and predicting the growing need for austerity in SVG each time extreme cuts are imposed by various regional and international governments.

The Prime Minister, by contrast, is unabashedly anti-austerity, calling it “a dangerous idea.” He is most proud of his record of “counter-cyclical” budgetary expenditures (increased State spending when the economy is contracting, i.e. using stimulus to spend your way out of a recession). His usual retort to Mr. Eustace’s charges of budgetary excess is to challenge the Opposition Leader to specify what sectors should be cut: Jobs? Wages? Welfare? Education? Health? I can’t recall Mr. Eustace ever responding explicitly to that particular challenge.

In any event, count me as standing squarely in the anti-austerity camp – not for political reasons, but for macroeconomic ones. Austerity has proven to be much more than a dangerous idea. It has been disastrous in practice, and it has become apparent that the economic underpinnings of austerity policy are grossly incorrect. In the practical context of small island economies like SVG, in particular, where the State plays an outsized role in growth and development, austerity is a particularly ruinous prescription.

[Caution: Boredom alert! This blog may drone on in a slightly wonkish manner from this point onward. Feel free to disembark the blog at the previous paragraph].


In October 2012, over the course of three pages of charts and graphs in their World Economic Outlook, the IMF made a startling admission that sent shockwaves through the economic world:

“Sorry, we were wrong about austerity.”

Keynesian economists and academics did a smug victory lap of I-told-you-sos. Mainstream press outlets like Bloomberg, the Economist, Business Insider, the Washington Post and the New York Times weighed in on the stunning mea culpa. However, for whatever reason, the IMF bombshell didn’t cause a ripple in our regional press or academia, even though the not-so-invisible hand of the IMF is tightly around the throat of many Caribbean economies, imposing austerity prescriptions based on assumptions that the IMF itself is calling invalid.

Those of you so inclined should take a peek at “Box 1.1: Are We Underestimating Fiscal Multipliers?” on pages 41-43 of that 2012 World Economic Outlook. In summary, the IMF confession is based on their misreading of the size and impact of fiscal “multipliers.” Economists try to figure out the effect that particular types of spending or consolidation will have on GDP. If the multiplier is small, then austerity is not that painful and stimulus is not that effective. If the multiplier is large, then the opposite is true.

For example, if you have a big multiplier, of, say, 1.5, it would mean that if you increased government spending by 1%, GDP would increase by 1.5%. This would be a pro-stimulus multiplier, because the GDP would grow at a rate that exceeds government spending. However, the IMF had been basing its economic prescriptions and projections on a multiplier of about 0.5. This meant that if you reduced spending by 1%, your GDP would only shrink by half that much. With a multiplier of 0.5, there is a mathematical argument in favour of austerity. The closer the multiplier gets to, or exceeds, 1, the weaker that mathematical argument becomes (this is ignoring all of the broader economic, ideological, social and political anti-austerity arguments). Similarly, with a multiplier of 0.5, stimulus isn’t that efficient, because a 1% rise in government spending would only get you a measly 0.5% increase in GDP.

Well, it turns out that the IMF multiplier estimate of 0.5 was completely off base, and groundless. In the October 2012 World Economic Outlook, they confess that “our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession.” Other economists have suggested that, in current conditions, the multiplier is actually around 2. Simply put, the IMF’s unjustified and uninformed assumptions abut multipliers forced a counterproductive austerity on countries, which deepened and lengthened the global crisis.

This is an absolutely stunning admission of guilt by the IMF, and one that reinforces Keynes’ famous statement in every Economics 101 textbook that “the boom, not the slump, is the right time for austerity at the Treasury.”

But the IMF goes further. It concludes its mea culpa by saying “More work on how fiscal multipliers depend on time and economic conditions is warranted.” In other words, multipliers (and by extension, the impact of austerity) depend on context, and the IMF doesn’t have the necessary contextual data. Can any of the pro-austerity advocates in SVG and CARICOM point me to any serious analysis of fiscal multipliers in small, open, island economies with a limited production base, inability to dictate terms of trade, small private sector, and large public service – all within the greatest global economic recession in living memory? What about multipliers in the OECS region, where individual governments do not control their own monetary policy?


The IMF followed-up the October 2012 World Economic Outlook with an even more shocking piece of self-analysis. In a June 2013 paper called Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement, the IMF took a look back at the debacle that was their 2010 austerity package, which almost completely destroyed a Greek economy already battered by the economic crisis. After recognising the “notable failures” of the IMF package, the paper looks into why their proposed prescriptions almost killed the patient. One of the main reasons that the Greek policy failed, according to the paper, was that the IMF grossly underestimated just how much economic damage would be caused by austerity in that context. (Interestingly, their other main finding was that they (and the EU) should simply have acknowledged from the start that Greece would not be able to repay its debt, and that major debt forgiveness should have been in place from the outset). Here is a New York Times article on this IMF admission.


A 2013 IMF Working Paper called “The Challenge of Debt Reduction during Fiscal Consolidation” makes an interesting, if obvious point:

Studies suggest that fiscal multipliers are currently high in many advanced economies. One important implication is that fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output.

What this means is that austerity is a highly questionable course of action in the current economic climate for countries with high debt levels. What will happen, essentially, is that imposing cuts in this climate will result in an INCREASE in the debt to GDP ratio. The reasoning, stripped from the mathematical mumbo-jumbo, is basic and intuitive: Austerity will shrink weaker economies and reduce the GDP (see earlier multiplier section). Smaller GDP means greater debt to GDP ratio.

The impact of this worsening debt to GDP ratio is potentially calamitous. According to the IMF:

[Raising the debt ratio] could be an issue if financial markets focus on the short-term behavior of the debt ratio, or if country authorities engage in repeated rounds of tightening in an effort to get the debt ratio to converge to the official target.

Imagine that you are the minister of finance of a small, indebted country, with a weak economy, in the midst of the current crisis. Imagine that you subscribe to an austerity programme with the goal of reducing debt and/or increasing investor confidence. According to the IMF, a very real possibility is that the opposite will happen: Your economy may shrink too rapidly, resulting in a deteriorating debt ratio. That shrinking economy and ballooning debt will make financial markets and credit ratings agencies jittery, resulting in credit downgrades and less favorable loan terms. The financial markets will then tell you, as minster of finance, that your debt-to-GDP is out of whack because of “structural” problems in your economy. You will also be told that your problem is a “lack of investor confidence.” The solution that they may well propose: More austerity. Thus, the spiral begins, and “repeated rounds of tightening in an effort to get the debt ratio to converge to the official target” becomes a grim socioeconomic and political nightmare.

Austerity, Structural Adjustment and the Washington Consensus were largely unchallenged conventional wisdom when these policies were being applied to strangle growth and ferment social unrest in poor and developing countries. When the global economic and financial crisis hit, the expectation was that these same policies would be applied with equal strictness to “advanced” economies in Europe and Asia. However, all of a sudden, when the problems of austerity showed up in the cities and governments where IMF economists actually lived and worked, the IMF suddenly became introspective, reflective and rigorous in testing its assumptions and formulae. The “revised” conclusion is now that austerity may not be such a good thing after all. Of course, the IMF economists try to insulate themselves by saying austerity is not a good thing “in advanced economies,” suggesting that the concept may still have utility in the developing world. But that distinction is also false, and born of a paternal arrogance that assumes profligacy and corruption in developing countries, and that values a rich European’s economic discomfort as more real and tragic than the suffering of poor peoples.

Prudence and enterprise

Stimulus has to be of a certain size to be effective at spurring growth. In a prolonged global crisis like this one, now in its seventh year, countries like SVG do not have the economic space to continually spend their way out of trouble. However, what is equally clear is that it is impossible to cut your way out of trouble. Austerity will not work in the Vincentian, or indeed Caribbean context. As Jamaica may soon learn, the only prize awaiting the successful completion of their current IMF standby agreement is their qualification for a new standby agreement, which will impose further economy-weakening cuts in the name of “discipline” and “investor confidence.”

A partial solution lies in the mix of “prudence and enterprise” being proposed by Prime Minister Gonsalves. “Prudence,” as I understand it, means eschewing extravagance, and being particularly cautious with the public purse. It does not mean across-the-board budget cuts. If it is possible to achieve genuine savings in various sectors, then by all means do so. But those savings, and other monies, should be devoted to “enterprise:” targeted Government spending on areas most likely to stimulate growth and/or development (“growth” and “development” are two very different – and not always related – concepts, although the terms are often used interchangeably in our local discussions). If the monies dedicated to this targeted “enterprise” spending are generated using grants or soft loans from political allies or understanding development partners, then so much the better.

Is our current “enterprise” spending large enough? Is it targeted with sufficient precision? Is it possible/advisable for us to borrow even more money to engage in further countercyclical spending? Are the priorities reflected in the new Government projects (Agriculture, Infrastructure, Education, Jobs, Health, Technology) the correct ones? Are we doing enough to develop new revenue streams or maximize existing ones? These, I believe, are all appropriate and urgent questions that merit further debate and reasoned analysis. These are all questions that, regrettably, weren’t raised or posed during the recent, abortive Budget debate.

However, the question of austerity, and its usefulness in the Vincentian context, is one that we should shelve until we are well into the post-2016 growth spurt predicted by the World Bank. Until then, any austerity advocacy is born of ideological, not economical convictions. The 2014 Budget is not an austerity budget, in whole or in part. Nor should it be. There is no mathematic or economic support for the idea that austerity can work in this place and time. On the contrary, the recent evidence says that it would be a disaster.

Even the IMF says so. And I almost never agree with them.


7 thoughts on “The Paradox of Thrift

    • They know after the fact 🙂 Just a little spotty on predicting the future. There is a quote that says “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”

  1. This is the best researched and argued piece I’ve seen coming out of the region in months, if not years. I hope our leaders and opposition leaders in the region take heed. There should be serious repercussions flowing from the IMF’s admission of its failed formula imposed on desperate countries.

    • Thank you Lora, but if that’s true, either you don’t read enough in the region, or the region doesn’t write enough, lol. Repercussions for failures of economists? Since I gave the other commenter an Economist quote, I’ll give you one too: “Economists, like royal children, are not punished for their errors.” Keep reading 🙂

  2. very well researched articles and a good read. this was “economic heavy drugs” lol , but, i enjoyed the read and it give me even more clarity as it relates economics. It also highlights that Economist just constantly predicts and give articulated explanations to why their prior predictions didn’t work haha.

    • @ Emanuel – thanks for wading through the heavy sludge, lol. It can be said a lot better, with greater brevity and clarity… but I get paid by the word, lol. There’s a lot I could say about economists, but “some of my best friends are economists” lol.

  3. Camillo Gonsalves I am very proud of you. Your understanding of things is far more superior than the opposition. The apple didn’t fall far from the tree. You have my support in your endeavors. Peace my brother……

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