Thursday, April 25, 2013

The Embarrassing Error of the Empirical Economists

Austrian economics reject empirical data as a method to prove economic theory, for Austrians it is all about logical deductions. Thus, there is not much for Austrians to do, relative to the current Reinhart-Rogoff destruction at the hands of a U Mass graduate student, other than to grab some popcorn and watch with bemusement from the sidelines.

WaPo explains:
One of the more influential studies that’s often used to argue for austerity has come in for an extensive new critique[...]

The paper in question is Carmen Reinhart and Kenneth Rogoff’s famous 2010 study ”Growth in a Time of Debt,” which found that economic growth severely suffers when a country’s public debt level reaches 90 percent of GDP. That 90 percent figure has often been cited in the past few years as one big reason why countries must trim their deficits — even if their economies are still weak.

But a new critique (pdf) by Thomas Herndon, Michael Ash and Robert Pollin claims that this result may need revision. For one, the economists argue that Reinhart and Rogoff excluded three episodes of high-debt, high-growth nations — Canada, New Zealand, and Australia in the late 1940s. Second, they argue, Reinhart and Rogoff made some contestable assumptions about weighting different historical episodes.

Now, those are two methodological objections. But there’s also a third problem, as Mike Konczal details here. Reinhart and Rogoff appear to have made an error with one of their Excel spreadsheet formulas. By typing AVERAGE(L30:L44) at one point instead of AVERAGE(L30:L49), they left out Belgium, a key counterexample.
 Since Paul Krugman is anti-austerity and for big deficits, he is all over this:
  I’ve been cynical about the likelihood that the Reinhart-Rogoff fiasco would lead to any real change in policy, and I still have doubts. But reflecting on the debate so far, I’m wondering a bit if I have been too cynical — or at any rate, cynical in the wrong way. For my vague, unquantifiable sense is that the debacle is changing the conversation quite a lot, even among the guys in suits. And it was the coding error that did it. 
Now, the truth is that the coding error isn’t the biggest story; in terms of the economics, the real point is that R-R’s results were never at all robust, both because the apparent relationship between debt and growth is fairly weak and because the correlation clearly goes at least partly the other way. But economists have been making these points for years, to no avail. It took the shock of an outright, embarrassing error to shake the faith of the Very Serious People in a result they really wanted to believe.

As the Austrians see it (and no excel sheets required), every dollar taxed away by government takes a dollar away from the productive private sector.  Every dollar borrowed by the government crowds out private sector borrowing. Thus, government actions be they higher taxes promoted as "austerity" or government spending promoted as a Keynesian boost to the economy, are damaging the economy.

In other words, Reinhart, Rogoff, Herndon, Ash, Pollin and Krugman have a methodological problem at  a fundamental level that they ignore, which starts before they even start plugging data into their excel sheets.  


  1. The Keynesians are doing a victory lap claiming that we have “austerity” due to the Rogoff and Reinhart and that “austerity” has failed. Here's lying talentless liberal hack Stephen Colbert on his awful show misrepresenting the mistakes of Rogoff and Reinhart.!

    First, both Rogoff and Reinhart are establishment Keynesian hacks:

    Rogoff: Early in his career, Rogoff served as an economist at the International Monetary Fund (IMF), and at the Board of Governors of the Federal Reserve System.

    Reinhart: In the 1990s, she held several positions in the International Monetary Fund. From 2001 to 2003 she returned to the International Monetary Fund as Deputy Director at the Research Department.

    Second, there has been and will be no AUSTERITY. From Keynesian hack Mark Sadowski: "General government spending has barely changed in the eurozone, falling from 51.2% to 49.3% as a percent of GDP from 2009 to 2012 whereas in the US it has undergone a much larger contraction falling from 44.2% to 40.6% of GDP over the same time period. (Via the IMF database.)" Government spending at 40.6% of gross domestic product is only "austerity" to a communist from the Khmer Rouge.

    Third, growth rates are indeed lower when public debt/GDP ratios are over 90 percent, but not nearly as much as RR claimed. From the paper itself:

    "[C]ontrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower"

    "Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff" Thomas Herndon, Michael Ash, Robert Pollin - April 15, 2013

    In fact, as the paper’s Figure 1 graph shows, growth is over 4% when debt is under 30% and barely goes over 2% when over 90%. According to the Keynesians, THE DEBT CAUSES GROWTH. The fact that in these generic cases, the debt slowed down growth less than RR claimed does not show that DEBT CAUSES GROWTH.

  2. Funny to me because Krugman's entire frame of reference is nonemperical, unquantified, and almost aprioristic. It's his only unacknowledged contact with the real world and he can't see it.

  3. Of course, like you pointed out, they defined the argument as taxes vs. government debt. Way to leave out the alternatives! The statists narrowly define the edges of government theft A or B and then proclaim victory because government theft won!!

    Let's see what happens to growth when you significantly cut taxes, government borrowing, and government spending at the same time. Surely they defined the argument on their terms because addressing the latter issue is problematic altogether!

    Why don't we just take it all to the extreme?! If government theft and allocation of resources is so wonderful, why don't we just stop all private sector business and make public sector spending the whole state of the economy?!? Let's just have government's print and spend at will, no "Austerity" needed.

    If government knows best and money creation from thin air causes no harm, why does central planning fail? Shouldn't the former USSR, East Germany, and all the other ComBloc countries be rich beyond belief? What about all the dictatorships? Argentina? Cuba? Or what about Europe? Greece? Cyprus? Soon to be Portugal, Spain, and Italy?

    Why not justify the case for the "200% debt-to-GDP threshold" or why not the "1000% debt-to-GDP threshold?" Surely they can't stop at just 90%!! If debt creates wealth, then take it all to the extreme because the 1,000,000% debt-to-GDP threshold will make all countries who adopt that policy wealthy beyond imagination!

    Even better, extend the absurdities beyond government central planners. Guarantee each citizen $100,000,000 of debt, regardless of ability to pay or income. Spread the "wealth" to everyone, since debt is meaningless. We'll all surely spend our way to infinite riches!!!