Category Archives: Econ Data

An Update on the Impact of the Austerity Programs in Europe and a Higher Tax on Consumption in Japan: Still No Growth

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GDP Growth in Eurozone, Japan, and US, 2008Q1 to 2014Q3

A.  Introduction

With the release last Friday by Eurostat of the initial GDP growth estimates for most of Europe for the third quarter of 2014, and the release on Monday of the initial estimate for Japan, it is a good time to provide an update on how successful austerity strategies have been.

B.  Europe

As was discussed in earlier posts in this blog on Europe (here and here), Europe moved from expansionary fiscal policies in its initial response to the 2008 downturn, to austerity programs with fiscal cutbacks starting in 2010/11.  The initial expansionary policies did succeed in stopping the sharp downturn in output that followed the financial collapse of 2008/2009.  European economies began to grow again in mid-2009, and by late 2010 had recovered approximately two-thirds of the output that had been lost in the downturn.

But then a number of European leaders, and in particular the leaders of Germany (Chancellor Angela Merkel and others) plus the then-leader of the European Central Bank (Jean-Claude Trichet), called for fiscal cuts.  They expressed alarm over the fiscal deficits that had developed in the downturn, and argued that financial instability would result if they were not quickly addressed.  And they asserted that austerity policies would not be contractionary under those circumstances but rather expansionary.  Trichet, for example, said in a June 2010 interview with La Repubblica (the largest circulation newspaper in Italy):

Trichet:  … As regards the economy, the idea that austerity measures could trigger stagnation is incorrect.

La Republicca:  Incorrect?

Trichet:  Yes. In fact, in these circumstances, everything that helps to increase the confidence of households, firms and investors in the sustainability of public finances is good for the consolidation of growth and job creation.  I firmly believe that in the current circumstances confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.

So what has actually happened since the austerity programs were imposed in Europe?  The chart at the top of this post shows the path of real GDP for the larger Eurozone economies as well as for the Eurozone as a whole, plus Japan and the US for comparison.  The data for Europe (as well as the US) comes from Eurostat, with figures for 2014Q3 from the November 14 Eurostat press release, while the data for Japan came most conveniently from the OECD.  Real GDP is shown relative to where it was in the first quarter of 2008, which was the peak for most of Europe before the 2008/09 collapse.

In a word, the results in Europe have been terrible.  Real GDP in the Eurozone as a whole is basically the same as (in fact slightly less than) what it was in early 2011, three and a half years ago.  To be more precise, real GDP in the Eurozone fell by a bit more than 1% between early 2011 and early 2013, and since then rose by a bit over 1%, but it has basically been dead.  There has been no growth in the three and a half years since austerity programs took over.  And Eurozone output is still more than 2% below where it had been in early 2008, six and a half years ago.

Since early 2011, in contrast, the US economy grew by 8.6% in real terms.  Annualized, this comes to 2.4% a year.  While not great (fiscal drag has been a problem in the US as well), and not sufficient for a recovery from a downturn, the US result was at least far better than the zero growth in the Eurozone.

There was, not surprisingly, a good deal of variation across the European economies.  The chart shows the growth results for several of the larger economies in the Eurozone.  Germany has done best, but its growth flattened out as well since early 2011.  As was discussed in an earlier post, Germany (despite its rhetoric) in fact followed fairly expansionary fiscal policies in 2009, with further increases in 2010 and 2011 (when others, including the US, started to cut back).  And as the chart above shows, the recovery in Germany was fairly solid in 2009 and 2010, with this continuing into 2011.  But it then slowed.  Growth since early 2011 has averaged only 0.9% a year.

Other countries have done worse.  There has been very little growth in France since early 2011, and declines in the Netherlands, Spain, and Italy.  Spain was forced (as a condition of European aid) to implement a very tight austerity program following the collapse of its banking system in 2008/09 as a consequence of its own housing bubble, but has loosened this in the last year.  Only in France is real GDP higher now than where it was in early 2008, and only by 1.4% total over those six and a half years.  But France has also seen almost no growth (just 0.4% a year) since early 2011.

C.  Japan

The new figures for Japan were also bad, and many would say horrible.  After falling at a 7.3% annualized rate in the second quarter of this year, real GDP is estimated to have fallen by a further 1.6% rate in the third quarter.  The primary cause for these falls was the decision to go ahead with a planned increase in the consumption tax rate on April 1 (the start of the second quarter) from the previous 5% to a new 8% rate, an increase of 60%.

The Japanese consumption tax is often referred to in the US as a sales tax, but it is actually more like a value added tax (such as is common in Europe).  It is a tax on sales of goods and services to final consumers such as households, with offsets being provided for such taxes paid at earlier stages in production (which makes it more like a value-added tax).  As a tax on consumption, it is the worst possible tax Japan could have chosen to increase at this time, when the economy remains weak.  There is insufficient demand, and this is a straight tax on consumption demand.  It is also regressive, as poor and middle class households will pay a higher share of their incomes on such a tax, than will a richer household.  With its still weak economy, Japan should not now be increasing any such taxes, and increasing the tax on consumption is the worst one they could have chosen.

With recessions conventionally defined as declines in real GDP in two consecutive quarters, Japan is now suffering its fourth recessionary contraction (a “quadruple-dip” recession) since 2008.  This may be unprecedented.  Japan’s output is still a bit better, relative to early 2008, than it is for the Eurozone as a whole, but it has been much more volatile.

Prime Minister Shinzo Abe was elected in December 2012 and almost immediately announced a bold program to end deflation and get the economy growing again.  It was quickly dubbed “Abenomics”, and was built on three pillars (or “arrows” as Abe described it).  The first was a much more aggressive monetary policy by the Central Bank, with use of “quantitative easing” (such as the US had followed) where central bank funds are used to purchase long term bonds, and hence increase liquidity in the market.  The second arrow was further short-term fiscal stimulus.  And the third arrow was structural reforms.

In practice, however, the impacts have been mixed.  Expansionary monetary policy has been perhaps most seriously implemented, and it has succeeded in devaluing the exchange rate from what had been extremely appreciated levels.  This helped exporters, and the stock market also boomed for a period.  The Nikkei stock market average is now almost double where it was in early November 2012 (when it was already clear to most that Abe would win in a landslide, which he then did).  But the impact of such monetary policy on output can only be limited when interest rates are already close to zero, as they have been in Japan for some time.

The second “arrow” of fiscal stimulus centered on a package of measures announced and then approved by the Japanese Diet in January 2013.  But when looked at more closely, it was more limited than the headline figures suggest.  In gross terms, the headline expenditure figure amounted to a bit less than 2% of one year’s GDP, but the spending would be spread over more than one year.  It also included expenditures which were already planned.  It therefore needs to be looked at in the context of overall fiscal measures, including the then planned and ultimately implemented decision to raise the consumption tax rate on April 1, 2014.  The IMF, in its October 2013 World Economic Outlook, estimated that the net impact of all the fiscal measures (including not only the announced stimulus programs, but also the tax hike and all other fiscal measures) would be a neutral fiscal stance in 2013 (neither tightening nor loosening) and a tightening in the fiscal stance of 2.5% of GDP in 2014.  The fall in GDP this year should therefore not be a surprise.

Finally, very little has been done on Abe’s third “arrow” of structural reforms.

On balance, Abe’s program supported reasonably good growth of 2.4% for real GDP in 2013 (see the chart above).  There was then a spike up in the first quarter of 2014.  However, this was largely due to consumers pulling forward into the first quarter significant purchases (such as of cars) from the second quarter, due to the planned April 1 consumption tax hike.  Some fall in the second quarter was then not seen as a surprise, but the fall turned out to be a good deal sharper than anticipated.  And the further fall in the third quarter was a shock.

As a result of these developments, Abe has announced that he will dissolve the Diet, hold new elections in mid-December with the aim of renewing his mandate (he is expected to win easily, due to disorder in the opposition), and will postpone the planned next increase in the consumption tax (from its current 8% to a 10% rate) from the scheduled October 2015 date to April 2017.  Whether the economy will be strong enough to take this further increase in a tax on consumption by that date remains to be seen.  The government has no announced plans to reverse the increase of 5% to 8% last April.

Japan’s public debt is high, at 243% of GDP in gross terms as of the end of 2013.  Net debt is a good deal lower at 134% (debt figures from IMF WEO, October 2014), but still high.  The comparable net debt figure for the US was 80% at the end of 2013 (using the IMF definitions for comparability; note this covers all levels of government, not just federal).  Japan will eventually need to raise taxes.  But when it does, with an economy just then emerging from a recession due to inadequate demand, one should not raise a tax on consumption.  A hike in income tax rates, particularly on those of higher income, would be far less of a drag on the economy.

The Government Debt to GDP Ratio is Falling

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Fed Govt Debt as Share of GDP, 2006Q1 to 2014Q3

The US federal government debt to GDP ratio is falling.  A few years ago, conservative critics (such as Congressman Paul Ryan) argued that if drastic action were not taken immediately to slash government expenditures, consequent rapidly rising federal government debt would stifle growth and spiral ever upwards.  Liberals (such as Paul Krugman) argued that the federal deficit and debt were far less of a concern than these critics asserted:  With the recovery of the economy, both would soon start to fall.  And the detailed projections from the Congressional Budget Office backed this up, with projected falls in the debt to GDP ratio for at least a few years.  There would be a rise later if nothing further is done, in particular on medical costs, but the question at issue here is whether the debt to GDP ratio could fall in the near term without drastic cuts in government expenditures.  Conservatives asserted it would not be possible.

But these were projections and assertions.  The chart above shows the actual data.  With the release this morning by the Bureau of Economic Analysis of its first estimate of 2014 third quarter GDP (growth at a fairly solid 3.5% real rate), one can now see that there has been a downward turn in the debt to GDP ratio.  The ratio peaked at 72.8% of GDP in the first quarter of 2014, and dropped to 72.2% as of the third quarter.

The federal government debt figure used here is the debt held by the public.  There are also various trust funds (most notably the Social Security Trust Fund) that formally hold government debt in trust, but this reflects internal accounting within government.  The figures come from the US Treasury, with quarterly averages taken based on an average of the amounts outstanding each day of the quarter.  This average is then taken as a share of nominal GDP for the quarter (nominal GDP since debt is also a nominal concept).  And since nominal GDP reflects the flow of production over the course of the quarter, taking the daily average debt outstanding over the course of the quarter will better reflect the debt burden than simply taking debt as of the end of the quarter and dividing this by GDP (although this is commonly done by many).

There was an earlier downward dip in the public debt to GDP ratio in the third quarter of 2013, but this was due to special circumstances surrounding the delay by Congress to approve a rise in the statutory government debt ceiling.  Various accounting tricks were used to delay recognition of items that would add to the formally defined government debt in order to keep under the ceiling, which artificially suppressed the debt to GDP ratio in that quarter.  This carried over into the fourth quarter, with the Republicans forcing a shutdown of the federal government from October 1 by not approving a new budget.  The dispute was not resolved until October 16, when deals were reached to raise the debt ceiling and to approve a budget.  The debt ratio then returned to its previous path.

The fall in the debt ratio in 2014 is more significant.  Accounting tricks are not now being used due to debt ceiling disputes, and the fall reflects the continued fall in the fiscal deficit coupled with reasonably sound growth.  The deficit is estimated to have totaled $483 billion in fiscal 2014 (which just ended on September 30), or 2.8% of GDP.  This is sharply down from the $1.4 trillion (or 9.8% of GDP) of fiscal 2009, in the first year of the downturn.  The fiscal deficit has fallen primarily due to the recovery, but also due to cuts in federal government expenditures under Obama since 2010.  While not nearly as drastic as Congressman Ryan and other conservatives had insisted would be necessary, government spending has still fallen under Obama, in contrast to the increases allowed in previous downturns.

Note that the government expenditure cuts that were done do not represent what would have been the desirable path in deficit reduction:  As discussed in an earlier post on this blog, it would have been far better to follow a fiscal path similar to that followed by Reagan and others in earlier downturns, with government spending allowed to grow so that the economy could have more quickly returned to full employment.  Once full employment was reached, one would then consider fiscal cuts, if warranted, to address any debt concerns.

The path followed has thus been far from optimal.  But it has shown that the alarms raised by the conservative critics, that the debt to GDP ratio could not fall without drastic government cutbacks (far more severe than that seen under Obama), were simply wrong.

At One Time, You Could Work Your Way Through College – But Not Any More.

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Earnings from Min Wage vs. University Costs, 1963-2013

 

At one time, not that long ago, a student could work at a minimum wage job over the summers and during holidays, and be able to cover the total cost (including room and board) of attending a four-year state university.  That is now far from possible.

With students now returning to school, it is perhaps a good time to look at what has happened to the affordability of college in recent decades for middle class families.  The chart above provides one indicator.  It compares what a student could earn in a summer job at the minimum wage, or in year-round work at the minimum wage while attending school (i.e. during summers, holidays, and part time during the academic term), as a ratio to what it would cost to attend a four-year state university.

The state university costs are for in-state tuition and required fees, plus the cost of on-campus room and board.  The figures are from the National Center for Education Statistics of the US Department of Education (with figures for 2013 calculated based on the 2012 to 2013 growth in the College Board estimates).  The university cost figures are for four-year, degree granting, state colleges and universities (i.e. they do not include two-year community colleges), and cover all such state schools.  The cost of attending the elite state schools (such as Berkeley, UVA, or the University of Michigan) would be more.  The years shown on the chart are for the beginning of the respective academic years (i.e. 2013 is for the 2013/14 academic year), and the minimum wage rate used is that which was in effect in July of that year.

The chart indicates that one could have covered the cost of attending a state university in the 1960s and 70s solely through minimum wage work.  Based on just a 17 week summer break, one would have earned enough to cover an average of 82% of the full cost of attending school.  An industrious student working full time over the summer and during vacation breaks (such as Christmas), plus 10 hours per week during the academic term, would have been able to cover the full cost and more – an average of 143% of the cost of school.  Hence summer work plus a bit more during vacations would have sufficed to cover the full cost of college.  In terms of dollar figures, the full cost of attending a state university in 1963/64 would have been $929, in the then current dollars.  A student could have earned $782 just from working at minimum wage over the summer, or $1,357 by working at minimum wage over the summer, during vacations, and 10 hours per week during the academic term.

These are, of course, just simple indicators.  One might have been able to earn more than the minimum wage, and/or worked a different number of hours.  But the point is that in the 1960s and 70s, when baby boomers such as myself were going to college, it was possible for the student alone, simply by working at the minimum wage, to have paid for the full cost of attending a four-year state university.

That began to change in the 1980s, as Reagan took office.  The change is indeed striking.  Affordability then began to fall, and it has fallen steadily since, as seen in the chart above.  By 1986, a student working even full time over the summer and during vacation breaks, and 10 hours a week during the academic term, no longer would have been able to cover the full cost of attending school.

The share of schooling costs that could be covered by work then continued to decline (with some bumps up when the minimum wage was sporadically changed) until the present day.  By 2013, summer work would only cover a quarter of the cost of schooling, while more comprehensive work over the entire year would only cover less than half.  In dollar terms, the average cost of attending a state university (for tuition, room, and board) was $18,037 per year in 2013.  But a student working over the summer at the minimum wage would have only been able to earn $4,930, or only a bit over a quarter of the cost of attending school.  Working full time over the summer and during vacations, plus 10 hours per week during the academic term, the student could have only earned $8,555, or less than half the cost of attending school.

As a consequence, students must now rely on their parents (when their parents can afford it), or a scarce number of scholarships (highly limited, especially for state schools), or on student loans.  Otherwise, they must give up on attending university.

The result has been an explosion in student loan debt outstanding.  As of June 30, 2014, student loan debt totaled an estimated $1,275 billion (based on Federal Reserve Board estimates), or five times the level outstanding in 2003 of $250 billion (the earliest figures I could find on a comparable basis; the amounts were so small earlier, that the Fed did not separately break them out).  Student loans have long been common in the US (I had them when I went to school in the early 1970s).  But the amounts outstanding then were relatively small, were at low interest rates, and were for most of us easily manageable.  It is different now.  Student loan debts have exploded in recent years, with a five-fold increase over just the past decade.

The declining affordability of college by this measure is of course a consequence of what has been happening to the two components of the measure.  One has been the unwillingness of Congress to allow the minimum wage to keep up with inflation.  As noted in an earlier post on this blog, the minimum wage in the US has stagnated over the last half century, and is indeed lower now (in real terms) than it was in 1950, when Harry Truman was president.  Real GDP per capita is 3.5 times higher now than it was in 1950, and real labor productivity has increased similarly.  These are not small increases.  I find it amazing (and shameful) that the real minimum wage is lower now than it was then.

For the period since 1963 (the earliest date in the chart), real GDP per capita and real labor productivity are both now 2.7 times higher than what they were then.  But the real minimum wage is close to 20% less now than it was in 1963.

The fall in the real minimum wage fall since the 1960s is half the story.  Note that the inflation measure used for determining the real minimum wage is the general consumer price index (the CPI).  This is the price index for the overall basket of goods and services a US household will purchase.  But the price index is an average over all the goods and services that households buy, and individual items can have price increases that are more than, or less than, this overall average.

In particular, the cost of attending a state university has increased by a good deal more than the overall CPI.  Based on the overall CPI, the real cost of attending a state university (for tuition, room, and board) is now 2.5 times what it was in 1963.  The cost of the tuition component alone is now 4.5 times higher.  The basic cause has been the cutbacks in state budgetary support for their colleges and universities, with tuition and other charges then increased to make up for it.

As a result, the minimum wage has fallen in real terms (based on the overall CPI) since the 1960s, at the same time that the real cost of attending school (relative to the overall CPI) has increased sharply.  The two factors together account for the steep fall in the share of state university costs that one can pay for by working at the minimum wage.  The curves in the chart at the top of this post show that path.

It is important to recognize that this declining affordability of attending state schools was not inevitable, but rather the result of policy choices.  The minimum wage has not been adjusted to reflect general inflation, even though real GDP per capita and labor productivity have both grown substantially.  And as was discussed in another post on this blog, there is no evidence that raising the minimum wage by the modest amounts now being discussed would lead to adverse effects on employment.

Government support for state colleges and universities has also been scaled back, leading to tuition and other cost increases substantially higher than that reflected in the general price index.  This has also been a policy choice.  And it is a policy choice that has prioritized the present generation (with tax cuts a prime example) over the coming generation, that is denying many of the coming generation the educational opportunities we ourselves had.