Arthur Laffer you’re embarrassing yourself

During George W. Bush’s years as president I most say that I lost a lot of respect for Paul Krugman. It was very clear that he was suffering from what Charles Krauthammer called the “Bush Derangement Syndrome” (BDS). BDS undoubtedly made Krugman write crackpot articles about all kind of subjects. Krugman for example on numerous occasions has argued in favour of protectionism – something the pre-Bush Krugman would never have done.

Unfortunately, this President Derangement Syndrome (PDS) has infected a number of US right-wing economists who used to be clever economists, but today seem to have forgotten everything about economics – mostly as a result of an apparent hatred of President Obama. I am no fan of President Obama, but I do not let that change my view of economics.

I have earlier highlighted that I think that Allan Meltzer who is one of my great monetarist heroes seems to have forgotten everything about monetary theory that he once preached exactly because of PDS. Unfortunately he is not the only right-wing US economist to suffer from PDS. The latest example is supply-side hero Arthur Laffer who frankly is embarrassing himself in a recent Wall Street Journal article.

The stated purpose of Laffer’s article is to show that “in country after country, increased government spending acted more like a depressant than a stimulant.”

Anybody who reads my blog would know that I am certainly no fan of “fiscal stimulus” and that I believe that fiscal policy can not “overrule” monetary policy. Hence, I believe in the so-called Sumner Critique. Furthermore, I strongly believe that there is good empirical evidence that a larger government is a drag on the economy and that more government spending in general will tend to reduce productivity growth in the longer run. Hence, I strongly agree with Laffer in terms of the overall view that fiscal stimulus is unlikely to be helpful in getting us out of this crisis and in the long run a larger public sector is likely to hamper growth.

However, even though I agree on Laffer’s skeptical view of fiscal stimulus I nonetheless find his “analysis” to be shockingly bad.

In his analysis Laffer compares the change in real GDP growth from 2006-2007 to 2008-2009 with the change in government spending in the same period in different OECD countries. (By the way look Laffer’s numbers look very odd – David Glasner discusses that in his post on Laffer here.) Here is Laffer’s somewhat surprising conclusion:

“The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth.”

Are you joking Art?? Estonia? Biggest stimulus program? You can’t seriously think so. I think Prime Minister Ansip of Estonia would be rather upset that you say that his government apparently has conducted some kind of Keynesian fiscal stimulus. I know for a fact that Mr. Ansip has no respect for Keynesian fiscal stimulus. In fact his government has rightly been praised for its conservative fiscal stance.

Mr. Ansip’s government has since the crisis hit in 2008 (in fact it already started in 2007 in Estonia) passed significant austerity measures such as cutting public sector wages and pensions. Mr. Ansip’s government has shown an enormous commitment to reducing the budget deficit and reining in the public debt. In fact by saying what you are saying Mr. Laffer you are making a mockery of the truly remarkable fiscal consolidation in Estonia.

I don’t know where Mr. Laffer has been recently – didn’t he notice that THE KEYNESIAN Paul Krugman has been highly critical of Estonia’s fiscal consolidation and that has upset Estonian policy makers a great deal (and rightly so). Mr. Laffer would of course have known this if he had read the WALL STREET JOURNAL!!!

Estonia by far has the lowest debt-to-GDP ratio in the OECD area so how Mr. Laffer can claim that Estonia is an example of an evil Keynesian experiment is somewhat of a puzzle to me. The limit for public debt in the EU is 60% of GDP. Estonia’s public debt is 6% (!) of GDP. And Estonia is running a public finance SURPLUS!

But ok, lets say that Mr. Laffer made one mistakes in his assessment. The three other countries have to be irresponsible countries. No! They are certainly not. In fact Finland and Slovakia are both in the group of the most fiscally conservative countries in the EU and the markets agree. Just look at Finnish and Slovakian bond yields. In fact few market participants would question the creditworthiness of Finland. After all Finland has a BETTER credit rating than Germany! Finnish government bond yields is basically at the same level as German bond yields.

So how about Ireland? It is true that the country has seen a sharp rise in public debt since 2008. However, that can hardly been seen as a result of “fiscal stimulus”. The rise in public debt is mostly due to banking rescues in 2008 and 2009, which of course can be questioned whether that has been a good idea, but you can hardly say that Ireland has conducted keyensian style fiscal stimulus. Furthermore, after the sharp rise in public debt consecutive Irish governments have put a lot of effort into fiscal consolidation and Ireland has rightly been praised for its effort to curb public debt. As a result Ireland is generally perceived more positively by the markets and credit rating agencies than the other so-called PIIGS countries.

So we can easily conclude that Arthur Laffer got it completely wrong. So why is that? Well, maybe he never heard about cyclically adjusted government spending. It should be no surprise to anybody who just spent one hour reading an intermediate textbook on public finances that government spending tend to increase in cyclical downturns and tax revenues drop when the economy slumps.

Estonia in 2007-2010 went through a Great Depression sized collapse in economic activity and hence it is no surprise that that led to an increase in public spending as outlays to unemployment benefits and other social benefits rose sharply. To its credit the Estonian government reacted to this worsening of public finances by putting through significant austerity measures. Mr. Laffer, however, in his eagerness to badmouth President Obama’s fiscal policies forgets this and knowingly or unknowingly trashes the heroic fiscal performance of Mr. Ansip’s Estonian government. I think an excuse would be in order.

I am sorry to say it, but Mr. Laffer’s article is yet another example of right-wing US economists that for the sake of partisan politics completely trash all economic logic. That is too bad, because Mr. Laffer could instead have told the story of the great example of Estonia, a country that is gradually coming out of this crisis WITHOUT fiscal stimulus. He could also have told the story about Greece’s and Spain’s fiscal stimulus packages of 2009 that did a lot to increase these countries’ public debt levels. He could also have told the story about how fiscally conservative policies have ensured that Finland is the country in Europe with the best credit rating.

I strongly believe that less public spending is positive for long-term growth (and that is a supply-side argument Mr. Laffer!) and I doubt that fiscal stimulus (without monetary stimulus) will do much to increase growth in the short-run, but I have far better arguments than Mr. Laffer.

I think it is about time that my fellow free market economist friends in the US start to behave as economists rather than playing party politics. That would strengthen the case for free markets and less government intervention. By playing party politics economists like Allan Meltzer and Arthur Laffer are not doing the cause much service.

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PS I use the term “right-wing” economist above to mean an economist who generally is in favour of free markets and generally opposes government intervention in the economy. In that sense I am obviously a right-wing economist myself.

PPS I also suspect John Cochrane and Casey Mulligan of suffering from PDS.

Update: Brad DeLong also has a comment on Laffer’s WSJ piece. I am getting tired of agreeing with him and Krugman in their criticism of (certain!) “right-wing” economists.
Update 2: Karl Smith joins the debate.
Update 3: And here is Matt O’Brien on the same topic – with a golden quote: “He really is the anti-Keynes. When the facts change, Laffer changes the facts back, so he won’t have to change his mind.”

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