This is a cross post from dear friend of Lady Economist, Jeffrey Michler, on Red Egg Review. RER is a new online Orthodox Christian journal doing something quite refreshing to a cynical liberal secular Jewish feminist such as myself – “What you’ll find, we hope, is something else: a living faith, secure enough in its traditions to be constantly engaged with the world around it.” It is a project worth checking out on the whole, but this post in particular is interesting since it addresses the applicability of certain metaphors, in this case the household, in economics to understanding both theory and policy.
Austerity and the Metaphors that Bind
Jeffrey D. Michler
The most insidious and misguided of metaphors currently in use in public discourse is the comparison of public finance to household finance. Insidious because the metaphor of nation as household is longstanding and well attested. Who will argue with Lincoln’s description of a nation where “brother fights against brother” as “a house divided?” Misguided because what makes the metaphor true in one instance does not make the metaphor true in all instances. What is true for a nation “engaged in a great civil war” may not be true for a nation trying to balance its checkbook.
The value of any metaphor is in its ability to enlighten, to provide new insight through the comparison of two apparently unrelated objects. By foregrounding a familiar object, the rhetorician sheds light on a less familiar object, though these objects need not share any similarities. A nation is not particularly like a household, but we all know the unhappiness and pain when a household is pitted against itself.
Furthermore, in Lincoln’s case, his audience would have been familiar with the Biblical passage he co-opted. Citizens of Illinois might have had no experience with slavery and little interest for politics in Washington, yet by comparing the nation to a household they could be made to see how the existence of slavery and the decisions made by others in the far off capital would bring unhappiness and pain upon them. With metaphor, the politics of other people and other places are brought to the hearth.
But our nation is not a household and we are prone to forget this. Thus, while apparently intuitive, the comparison of a household’s finances to a nation’s finances is not, strictly speaking, accurate. The mere statement of a comparison does not make it useful.
First, it may be helpful to remind ourselves why a nation is not like our households. A nation is many magnitudes larger than our households. A nation can print its own money; our households cannot. A nation, once constituted, can conceivably live forever; our households are mortal. This is because a nation, being primarily a philosophical and legal construct, is more than the sum of its constituent parts. There is no correspondence between the citizens of the United States in 1850 and the citizens of the nation today. Yet the nation endures. Households, as traditionally conceived, require such correspondence. The household of my great grandfather, though related to, is not the household of which I am a member. Thus households terminate; they break up and are redefined.
Given how different a household is from a nation, it is not at all obvious what the finances of a household have to teach us about the finances of a nation. At most the comparison is metaphorical. The question before us, then, becomes, is the metaphor a useful one? Does the vehicle of a household’s finances provide any information on the tenor of a nation’s finances?
As the last five years have made painfully clear to many of us, a household cannot in perpetuity live beyond its means. As the saying goes, the only certainties in life are death and taxes, and, for all households, the former is the binding constraint. A household may manage its debt well or poorly, it matters little. For when death comes, the heirs must first use their inheritance to settle all outstanding debts. In life, a household can borrow money to finance a house, education, a car, a television, or the daily morning coffee at Starbucks. A well-managed household will keep its debt servicing to a manageable level. It might pay off the coffee and television debt at the end of the month. It might wait three years to pay off the car and ten years for the education. With interest rates low, a mortgage may be kept indefinitely, or nearly so. For once death comes, the bank will come looking for repayment. The books will be balanced, one household will end, and the heirs will constitute new households. The great truth of household finance is that death makes it impossible for a household to live forever beyond its means. There is a great day of reckoning for soul and wallet.
The first lesson we are often meant to learn by those who claim that a nation is like a household in its finances is that a nation cannot forever live beyond its means; a government must only spend what it takes in. It is foolish for a household to use debt to finance its spending when the income is not enough. Therefore, it is also foolish for a government, the head of a nation as surely as a man is the head of a household, to finance its spending when tax revenue is not forthcoming.
However, the great truth of the inevitability of death that demands a household provide full recompense to its debtors on a given day does not apply to governments or nations. The reason it is foolish for a household to live beyond its means is that someday all debts will be called in. Since such a date does not exist for nations it is far from obvious what we are meant to learn from the metaphor. True, the vehicle and tenor of a metaphor need not be related, but the lesson learned from the former must provide insight into the latter, or the metaphor is useless. What insight the knowledge of human mortality provides to the debt or wealth of nations is not at all clear.
A second lesson we are often meant to learn from the metaphor of a nation as a household is that austerity can rectify financial imbalances. While there are other justifications for national austerity, the metaphor of household for nation is not one of them. Again the metaphor fails because of the deathless nature of the state. But it also fails because of the relative size of household to nation. When a household spends more than it takes in, a quick and easily way to restore balance is to reduce expenditure. When a household chooses to live more frugally it reduces the GDP of the nation. But a single household is so comparatively small it matters little. Additionally, since a household will eventually have to pay all of its debt, there are few other options open beyond austerity.
None of this is true for the nation. When a government institutes austerity, because of its relative size, it has a large impact on GDP. In the United States government expenditure is 30% of GDP. The years 1937-8, 1946-7, and 1957-8 are all perfect examples of government austerity driving a recession in the United States. More recently, British Treasury documents leaked to The Guardian in 2010 showed that austerity measures could destroy 1.3 million jobs. While household austerity only affects the household, government austerity affects all households.
The experience of Latin American countries in the 1980s and 1990s is a particularly dramatic example of what government austerity can do to a national economy. The OPEC embargo and Fed Chairman Paul Volcker’s interest rate hike in the early 1980s precipitated a debt crisis in Latin America not unlike the one currently ongoing in Europe. The risk of default by 18 countries threatened American banks, particularly Citicorp, with financial insolvency. To keep the Latin American fiscal crisis from triggering a North American and European financial crisis the U.S. Treasury Secretary James Baker and his successor Nicholas Brady devised first the Baker Plan and then the Brady Plan. These plans called for partial debt forgiveness in exchange for “market-based” reforms in debtor nations, specifically trade liberalization and government austerity. The idea was that the combination of these reforms would spur economic growth in the debtor nations while limiting losses to American banks. While approximately 40 percent of country debt was forgiven and trade was liberalized, countries that agreed to either plan saw little to no growth and instead suffered years crippling recession.
While austerity was not the primary cause for Latin America’s “Lost Decade,” it deepened the recession. Between 1981 and 1990, per-capita GDP across Latin America declined to mid-1970s levels. Inflation increased 26 times over the decade. Real minimum wage declined and unemployment increased. As a result, the incidence of poverty increased. Public expenditures on social services were cut, leaving the population of Latin America poorer in 1990 than they were in 1980.
Fiscal austerity also retarded recovery, resulting in the “Lost Half-Decade.” Economic growth remained weak throughout the 1990s and in 1998-2002 was just 0.3 percent. This resulted in 20 million people falling below the poverty line in countries where austerity plans precluded adequate social safety nets.
Nearly two decades of overzealous attempts to rein in spending and balance the budget in Latin America led to drastic reductions in government spending, reduced investment, shrinking GDP, declining living standards, deteriorating health, and deepening poverty. Now Europe and the United States are told to follow a similar program, and given the justification that as households cannot live long beyond their means, neither should governments.
Beyond the direct effect of government austerity or spending on the economy, there is an indirect effect. When the government increases spending it uses that money to purchase privately produced goods. This money becomes revenue for corporations who pay salaries to their workers. These workers in turn spend that money, further adding to GDP. This is known as the Keynesian Multiplier effect. The idea is that single dollar spent by the government increases GDP by more than a dollar. A recent study from the National Bureau of Economic Research, using historical data going back to 1980, estimated that the multiplier in the United States was 1.8. This means that in the last quarter century, every dollar the U.S. Government spent resulted in a $1.80 increase in GDP.
While generally discussed as a justification for increased government spending, the multiplier works in the opposite direction too. Government austerity means fewer government jobs, which means those laid off must become austere, reducing their consumption and thus reducing their private contribution to GDP. A reduction in government contracts has a similar indirect effect on the private sector. While the adoption of austerity by a single household has no noticeable effect on GDP, the adoption of austerity at a national level can drive the country back into recession. When a household adopts austerity it reduces expenditure with no effect on its income. When a government adopts austerity, the resulting recession reduces the income of a nation, thus reducing tax revenue (government income), and requiring further austerity measures in order to balance the books. National austerity can become a race to the bottom, as austerity in expenditure results in reduced taxes or income, which leads to further austerity measures.
An alternative to national austerity is fiscal expansion. By increasing expenditure the government creates more jobs and contracts, increasing its direct contribution to GDP. The indirect effect on GDP, the Keynesian Multiplier, means that government monies trickle down as income for private citizens who spend their new wealth, increasing the private sector’s contribution to GDP. A household cannot spend its way out of debt because a household’s spending has no effect on a household’s income. Furthermore, each additional dollar spent is a dollar it must pay back upon death. A nation, though, is not bound by these restrictions. When government increases expenditure, that money is income for some individual and that individual will return a portion of that income to the government in taxes. Thus, unlike a household, a government’s spending influences its income. Additionally, since nations do not die, the debt incurred by fiscal expansion can be rolled over indefinitely. As long as the cost of servicing the debt does not get too high, a nation can forever roll over its debt, never paying the principal since the principal may never come due.
The value of a metaphor is in comparing two objects in order to provide new insight about one of them. It is not necessary that the two objects be similar in any way. Thus, it is not critical to the metaphor that a nation be like a household. What is critical is that what we know about households can teach us something about nations. However, when it comes to finances, the lessons we learn in balancing our checkbook do not apply to the balance sheet of a nation. The dissimilarities are too great; the lessons non-transferable.
It is important to remember that when people talk about how nations are like households this can only be true metaphorically. Instead of adopting standard rhetorical tropes that appear intuitive but teach us nothing, we must focus on the particulars of national finance. How do we increase wealth for all citizens and not just transfer funds from one group to another? How do we encourage consumer confidence and business investment? How do we increase our welfare support system during recessions without encouraging hysteresis? A household faces none of these issues and therefore our knowledge of home finances provides no guidance. We must seek solutions specific to the peculiar problems of our nation, that deathless idea that binds us as family.