The Organization for Economic Cooperation and Development (OECD) recently released a report that seeks to deal with “underlying global trends relating to growth, trade, inequality and environmental pressures” over the next half-century. Titled “Policy Challenges for the Next 50 Years,” it is ambitious in its scope. But it is nevertheless weighed down with the conventional wisdom of yesteryear. It recognizes the new problems that are facing many economies around the world but insists on viewing them through old, largely discredited theories.
The report makes two faulty assumptions. The first is the idea that national economies, left to themselves for long enough, will automatically rebalance and generate full employment. The second is that current government debt levels are somehow causing economic problems and are in some sense unsustainable.
These myths blind the OECD and other international economic organizations to the real solutions needed to improve the global economic outlook.
Although the report raises the problem of unemployment, it does not appear to be a key focus. The OECD assumes that as long as central banks maintain low interest rates, unemployment should disappear in the coming years even if governments engage in austerity.
The evidence simply does not bear this out. In Europe, for example, interest rates have been extremely low since mid-2009, and yet according to Eurostat figures, unemployment rates rose from 9.5 percent of the workforce in 2009 to 12 percent in 2013. Low interests rates, when combined with austerity, have clearly failed to improve the employment situation. It is surprising that the OECD report misses this.
The report repeatedly warns that current debt levels are unsustainable. It states that governments must have a debt of no more than 60 percent of GDP but provides no reason they should target this particular number or why larger debts are unsustainable.
The reality is that countries with central banks that issue currency can run fiscal debts of any size for as long as they see fit; this excludes the eurozone, whose monetary system was constructed to limit member states’ ability to self-finance. True, such deficits might lead to inflation, but only when the economy returns to full employment. The report, however, seems to assume without justification that economies, when left to their own devices, will eventually return to full employment. A more sober analysis says that we would be lucky to return to full employment under current policies.
Many government officials behind the scenes understand this well. Former Deputy Secretary of the U.S. Treasury Frank Newman, for example, said that “the term ‘national debt’ is a very strange term, and it implies that we’re going to have to have taxes in the future to pay it off, but that has never been the case in the history of this country.” Former Chairman of the U.S. Federal Reserve Alan Greenspan also noted this when he said that “the United States can pay any debt it has because we can always print money to do that, so there is zero probability of default.” The issuance of national debt and even the printing of money will have negative economic effects only when the economy is at full employment. When there are idle resources and unemployed peple looking for work, government borrowing and spending leads to increases in employment and economic growth. The fact that the OECD economists do not recognize this suggests that they are woefully behind a basic understanding of the policy issues.
Inequality and instability
Like many commentators today, the authors of the report focus on income inequality. They rightly note that income inequality can lead to economic instability. When wealth accumulates among the rich, it is not infused back into the economy and is instead held in reserve or used to speculate in financial markets. This in turn creates a shortfall of demand for goods and services in the real economy and generates speculative bubbles in the financial markets.
The authors of the report do not seem to notice, however, that the policies of fiscal austerity that they promote throughout the paper actually worsen income inequality. The OECD’s own data are clear in this regard. Below is a chart showing the percentage change in annual average wages in Greece, Ireland and the U.S.
After the economic crisis of 2008, the United States passed a massive fiscal stimulus. Barack Obama’s administration held off on austerity measures. The results have been that average annual wages maintained growth until 2012, when they fell slightly because the economy generated lower-quality jobs as the effects of the stimulus petered out. Ireland, by contrast, had no fiscal stimulus and immediately engaged in austerity, and in the ensuing years it saw substantial declines in annual average wages.
Greece is famous for having engaged in the most extreme austerity programs, at the behest of those running eurozone policy in Germany and Brussels. After these extreme austerity programs were implemented, wages fell massively. This does not even take into account massive tax hikes on working people and the cuts in government assistance that austerity requires. Falling wages, then, are inextricably linked to austerity. Aiming at debt-to-GDP ratios of no more than 60 percent, as the OECD report recommends, would likely require extreme austerity programs like those undertaken by Greece. This would have an enormous depressive effect on wages and, by extension, exacerbate income inequality.
Despite these serious shortcomings, the OECD report does put forward some good ideas. It advocates increasing public funding for higher education, which is urgently needed in the U.S. and the U.K., where student debts are reaching dangerous levels. It also suggests that taxes should be shifted from labor and capital onto land. This would mean reining in taxes that stymie economic growth like payroll taxes and taxes on real business investment and increasing taxes on land based on its value. Such a measure would almost certainly decrease income inequality and promote economic growth. It is an inherently progressive form of taxation because richer people own more valuable land, and it would promote growth because land, unlike labor and capital, is not a key productive asset in modern economies.
Nevertheless, the main thrust of the report would only worsen some of the key problems it highlights. If governments the world over were to listen to the OECD report, their main focus over the coming decades would be to reduce their debt-to-GDP levels, under the assumption that the economy would somehow automatically return to full employment. We have already seen this attempted in Europe, and the results have been disastrous. Unemployment has increased massively, and far-right-wing parties are on the rise because the public feels as though traditional politics have failed them.
Unfortunately the current political dynamic across Europe and elsewhere is ensuring that most governments focus on their debt-to-GDP ratios rather than on employment and economic growth. What is instructive about the OECD report is that it gives us a sense of where a good deal of the economics profession, especially those involved in policymaking, stand on the issues of the day. In policymaking circles around the world, economists are giving the same destructive, haphazard pseudo-solutions that exacerbated the Great Depression in the 1930s.
Economic policymakers have been singing off this hymn sheet for over 30 years; the results have been precisely the problems that the report highlights. A new approach is needed if the world is to prosper in this century, and it now seems clear that institutions like the OECD are incapable of formulating that approach.