Krugman's Austerity Alarms Miss Depression Lessons: Amity Shlaes

Dec. 15 (Bloomberg) — So it's official. The New York Times, or at least columnist Paul Krugman, has declared us to be in a worldwide depression. And just in time for Christmas.

Democracy is at stake, Krugman alleged in his Dec. 11 column, and Europe, economically and socially, will tip into fascism if it doesn't cease pursuing "ever-harsher austerity, with no offsetting effort to foster growth."

Those are big assumptions and scary forecasts. But Krugman is comfortable making them, he says, because he has evidence. His evidence that European democracy is teetering in favor of repression is the case of Hungary, which is a member of the European Union but still has its own currency, the forint. There, the governing Fidesz party is pursuing policies that suppress free expression, judicial independence and the news media.

As for the theory of austerity slowing growth, Krugman evokes the Great Depression. Doing so has an authority all by itself, because the Great Depression is mysterious and its hold on the public imagination is strong.

The columnist frequently references the standard three-stage narrative of what happened. In the late 1920s or early 1930s, President Herbert Hoover committed a fatal error and imposed austerity in the form of tax increases and budget cuts. The U.S. economy failed. President Franklin Roosevelt came in and spent, and we commenced recovery. After 1936, Roosevelt hesitated and tightened the government's belt — austerity again. We plunged back into depression. The economy didn't return to its 1929 rate of growth until the spending run-up to World War II.

Counterfactual Adventures

Not all of us agree with the details of this storyline. Hoover, for example, increased spending. But to argue that austerity, pursued consistently enough, would have promoted growth and brought recovery in the 1930s is to embark on the vulnerable adventure of the counterfactual.

There is evidence that austerity did lead to growth in the past, and that it did not cause fascism. These examples may be less known, but they suggest that austerity can bring recovery faster than spending can.

A strong example in U.S. history is the recession of the early 1920s. Responding to a downturn, the federal government didn't spend; it cut itself in half. Recovery followed so rapidly few people even remember that recession. To follow Krugman's model of picking a single country, we can look at Australia in the 1930s. In the early part of the decade, Australia, like the U.S., suffered deflation and severe unemployment. National income shrank each year from 1925 to 1932. That year, unemployment reached 19.7 percent. The government considered replacing the gold standard with a "goods standard," pegged to commodities.

Australians wondered if spending might bring recovery. The powerful premier of New South Wales, J.T. Lang, sought to focus his voters on a public-works project, the great Sydney Harbour Bridge, which was completed in 1932. Many officials thought yet more liquidity was the answer to Australia's problems.

But as the author Anne Henderson points out in a new biography of Joseph Lyons, the prime minister at the time, the Australian national government turned away from spending and toward austerity.

Victory for Austerity

Beginning in 1932, Lyons led the country in a budget-cutting campaign that aimed to reduce all discretionary government expenditures by 20 percent, including public-sector salaries. Lyons and other leaders committed to paying Australia's debts under the so-called "premiers' plan."

"Australia converted huge loans in London" and brought debt down "to assure moneylenders of Australia's sound policy," Henderson e-mailed me. Taxes were increased in an all-out campaign to turn a federal deficit into a surplus. Australia permitted itself only one year of deficit.

At first, people said Lang, not Lyons, was right. From 1933 on, however, Australia began to recover. By 1936, unemployment had declined to about 11 percent. And it continued to drop. Australia recovered far faster than the U.S.

In 1935, a triumphant Lyons sailed to the U.S. on the Italian liner Rex to report his government's success: "We had to cut down salaries and pensions ruthlessly during the height of the Depression," Lyons told reporters at the pier in New York. But now the government was restoring pensions. By cutting back, Australia gave its economy a chance to grow and gave its currency crucial credibility. Lyons may have praised Mussolini, but Australia didn't go fascist.

Others tell the Australia story differently. They emphasize the depreciation of the Australian pound and the improved terms of trade that resulted. Or they argue that Australia, tiny, and the U.S., a mighty country, aren't comparable.

But the point is that such data points, from Hungary or Australia, are worth serious scrutiny. The accepted storylines aren't always the right ones.

And they aren't always analogous to the present. The austerity experiment of David Cameron, the prime minister of the U.K., is too new to declare a failure. The recovery may be slow, as Australia's was. But sooner rather than later Britain will see benefits from the relative competitiveness its cutbacks create. Money avoiding the uncertain euro area will flow to the U.K.

In short, just because someone evokes the Great Depression doesn't mean a new fascist era is upon us. Or that it's time to suspend disbelief.

(Amity Shlaes is a Bloomberg View columnist and the director of the Four Percent Growth Project at the Bush Institute. The opinions expressed are her own.)

© Copyright 2011 Bloomberg

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To book Amity Shlaes for a speaking engagement, contact Jamie Brickhouse at the Red Brick Agency, 646.281.9041.
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