EU austerity hawks shrug off criticism of flawed academic paper

Despite a new paper detailing flaws in the Rogoff-Reinhart study that has been used to argue in favor of austerity policies, Europe's austerity advocates are holding course.

In April, when several errors were discovered in a high-profile paper on the effect of government debt on economic growth, the fierce debate on austerity was once again ignited in Europe. Critics of budget slashing during the continent's recession were quick to say it was proof that misguided policies were making the situation worse.

But has there been much change in response? So far, hardly none, though the flap has increased European distrust of official economic projections.

Harvard economists Kenneth Rogoff and Carmen Reinhart's 2010 study has been one of the key pieces of evidence for austerity backers around the globe. The paper concluded that government debt-to-GDP ratios exceeding 90 percent were associated with a marked drop in economic growth.

As a result, its conclusions have been used repeatedly by high-profile austerity advocates – including 2012 Republican vice presidential candidate Rep. Paul Ryan and EU Commissioner for Economic Affairs Olli Rehn – to support debt-targeting policies.

Errors in Rogoff-Reinhart?

But last month three researchers from the University of Massachusetts Amherst released a paper critical of the Rogoff-Reinhart piece, arguing that it had accidentally excluded five rows of data from their calculations, excluded data, and used "unconventional" averaging methods.

When those problems are corrected, the researchers said, the 90 percent debt-to-GDP threshold that seemed to cause a marked drop in economic activity disappears. And countries appear to be able to generate growth even if they have a high government debt – though they grow less than low debt countries.

Although Mr. Rogoff and Ms. Reinhart contested the researchers' findings – they agreed with only some of them – the criticism of their paper sparked new debate over the role of austerity in resolving the economic woes of the US and Europe.

But so far, it has had little effect on EU policy, in part because the European Union was already loosening the reins – for instance, allowing several countries to temporarily overshoot their deficit targets in an attempt to revive growth.

"The [European] Commission’s economic policy recommendations are not based on any single piece of research," EU Commissioner Rehn wrote on his blog. A "pertinent policy conclusion from this academic debate," he added, is that "to achieve sustainable growth, the rising public debt must be contained with consistent, medium-term fiscal policies, aiming at a gradual adjustment."

The use of words such as "gradual" and "medium-term" reflects the slight change in EU policy over recent months. The softening of austerity has been primarily triggered by worsening economic conditions in the countries affected by the crisis, but several scientific studies – including the criticism of the Rogoff-Reinhart paper – might have accelerated the policy change.

More caution over studies

But the Rogoff-Reinhart saga also appears to have fueled a growing distrust among EU policy-makers in the science of economics.

"There has been a marked increase in skepticism regarding economics as a hard science. Governments are a lot more reluctant to take studies at face value," says a German government official, who asked for anonymity as he has not been authorized to speak on the matter. "To devise policy now you need more common sense, and long-term memory."

Even before the start of Europe's debt crisis in 2010, the ability of economists to forecast economic activity in turbulent times had been criticized. But the ongoing recession has amplified that criticism, after initial, optimistic forecasts fell short.

In 2010, for instance, the IMF forecast that by 2012 the countries collectively known as the PIIGS – Portugal, Ireland, Italy, Greece, and Spain – would on average be growing by 1.5 percent a year by 2012. But the actual data turned out to be far lower, with the PIIGS' economies instead contracting by 2.7 percent last year.

The loss of faith in economics, and what its numbers mean, is also highlighted by the fact that there is a large disagreement among European politicians on austerity's success so far.

For example, the German official says, "reforms in the Euro peripheral countries are working, as evidenced by the decline in labor costs and the increase in exports from those countries." And in his blog, Rehn wrote that "Europe is making headway" with regard to structural reforms.

But other policymakers disagree. "You do not need to be an expert to see that there were mostly tax increases and very few actual reforms," says Claudio Morganti, an Italian member of the European Parliament.

Although expert views on reforms in Europe vary, most agree that the reforms enacted so far have only partially filled the gap of what needs to be done.

"Governments and taxes are not the solution. We need more competitiveness and small businesses," says Sampo Terho, a Finnish member of the European Parliament. "This is a problem in both southern and northern European countries."

New Eurostat data released earlier this week suggest a recovery is still a ways off: the EU statistic bureau found that the eurozone's GDP dropped 0.2 percent in the first quarter of 2013.