The Folly of Biblical Economics: Lessons from Europe that Americans must heed

18/02/2014 by

Moralizing and generalization have always been terrible foundations for public policy.

Conservatives have a point: condemning people who want to get richer as ‘greedy’, and subjecting them to punitive taxation, is a sure path to keeping society dull, impoverished and unfair. Where they are wrong is in interpreting a recession as the inevitable retribution exacted upon a society of prodigal sinners, who must now re-pay their ‘debt’ through austerity. This biblical economic ‘tradition’ is a sure path to greater private losses and public debt.

While one’s view at a concert will certainly improve if one stands up, when everyone stands not only is there no benefit to any but, additionally, each ends up needlessly fatigued. Generalizing from an individually rational act, or even from a personal virtue, to a public policy recommendation ignores the simple fact that what is good for one may not work when everyone practices it.

Nowhere has this been more evident than in Europe. Following the bank bailouts, and the Great Recession that followed after 2008, private liabilities turned into skyrocketing public debt. European governments responded by tightening their belts all at once. The result was even higher debts for each. Just like the view-seeking concert audience that stood up in unison, Europeans realized that what seemed like a good idea individually was, collectively, self-defeating.

Politicians in the United States frequently warn that their opponents’ policies threaten the United States with a fate worse than Greece’s. Americans, therefore, should take a better look at that ancient land. Since 2010, the Greek government introduced the greatest austerity in peacetime ever: a combination of tax hikes and public expenditure cuts that have exceeded 15% of the nation’s GDP. The result? Greece’s public debt jumped from a high 113% of national income in 2009 to a ruinous 176% today. How could such a major, and much applauded, deficit reduction boost debt so much? The answer is simple: Austerity (from the Greek work for ‘strictness’) caused national income to fall by a quarter!

Besides austerity, Greece tried another policy supported by many in this country: a reduction in the minimum wage. The logic should be familiar to opponents of campaigns to raising the minimum wage for American workers: A minimum price for shoes will ‘produce’ unsold shoes. To get rid of any excess supply, of shoes or labor, get rid of the minimum price!

The only problem with this logic is that it is precisely wrong. Just like in the case of our hapless audience, what works for one does not work when universalized. One worker can find employment more easily if she is willing to work for less. But when all workers accept low pay, there is simply not enough demand for the goods and services they produce to keep them employed. Greece has proved this, as private sector employment fell faster once the minimum wage was cut.

Fortunately, America is not in danger of becoming Greece. One reason is that American democracy, despite the vociferous sirens of austerity, features checks and balances that render such austerity unlikely. A second reason is that many conservatives are beginning to recognize that a significantly increased minimum wage has two merits. First, it can help reduce public spending as it will reduce the number of Americans on benefits. Secondly, rather than an anti-competitive measure, minimum wages are as important in the labor market as capping electricity prices in an oligopolistic energy market. For the same reason that a low maximum electricity price optimizes the output of power generating companies, a higher minimum wage can boost employment.

The message to Americans who worry about the federal debt is simple: Ditch austerity and re-think minimum wages.

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