When you don't want to be this right...

(image via libcom.org)

Last year, Jacopo Ponticelli and I wrote a paper looking at the link between austerity measures and unrest. We found a close one. The dramatic images from yesterday - with wide-spread rioting in Athens, building burning, etc. could not bear out our thesis with more force. And there is no question that this was about austerity, either ... normally a tough nut to crack in this context is the question if the link is really causal. Of course, academics always enjoy being able to say "I told you so", but this time, I would have preferred it if the Greeks had proven us wrong.

While there is a lot of understandable frustration with Greece's unwillingness or inability to implement reforms, the riots illustrate that austerity is reaching its limit. How many more budget bills can the government and the troika push through parliament? And what is the implication for the rest of Europe? For the moment, bond markets are a bit calmer, and equity markets are in party mood. The pictures from Greece tell us that the cheer of markets thanks to more austerity is bought in an unsustainable fashion. It's not the most likely scenario, but we may very well see a rapid deterioration in the growth outlook in Spain and Portugal, thanks to all the cuts and tax hikes being implemented now. If this produces yet more deficits and another round of austerity, the Greek scenario is beginning to look much more likely; somewhere along the way, the bond market will panic, and the mother of all bailouts could be on the agenda by mid-summer. Let's hope I am wrong. Even Wolfgang Schaeuble, whose pleasure in forcing austerity on deadbeat ClubMed countries has a been a constant at EU summits, seemed to hint last week that he is starting to change his mind. 

Austerity and Unrest Over the Long Run

With riots in London last night and the heavy smell of tear gas still lingering over the Acropolis, Jacopo Ponticelli and I thought we'd look at the connection between budget cuts and unrest more systematically. The working paper is now out. We look at the extent to which riots, demonstrations, political assassinations and general strikes increase as governments cut expenditure in Europe, 1919-2009. Here is the abstract:

Does fiscal consolidation lead to social unrest? From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble cross-country evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor. We also analyse interactions with various economic and political variables. While autocracies and democracies show a broadly similar responses to budget cuts, countries with more constraints on the executive are less likely to see unrest as a result of austerity measures. Growing media penetration does not lead to a stronger effect of cut-backs on the level of unrest.

And here is our answer, in one slide:

The bars show the number of incidents - CHAOS aggregates them all, and then you have the components -- demonstrations, riots, assassinations, and general strikes. As the bars get darker, cuts get deeper. Once you cut expenditure by more than 2% of GDP, instability increases rapidly in all dimensions, and especially in terms of riots and demonstrations.

Sure, there are many incidents that can lead to an eruption of violence– from the killing of Mark Duggan in London last Saturday to a high-speed pursuit gone wrong (in the case of the Rodney King riots in LA in 1992). The more interesting question is -- why are cities at some points in time more akin to a tinderbox? Why does it only take one incident for massive violence, riots, or anti-government demonstrations to erupt? Even if there is something else that provides the spark, you want to know why there is so much dry wood around that you get a conflagration. Here, our results suggest that the role of budget measures is important.

We also use some additional, more detailed data on the causes of each demonstration to confirm our hypothesis that the link is causal. Incidentally, the same pattern is apparent in Latin America since 1937.

So, if you ever found yourself reading papers by Alesina and co-authors arguing that i. budget cuts can be good for growth ii. there is no punishment at the polls for governments cutting expenditure, and wondering why governments don't engage in more austerity - maybe here is your answer. Even if (and it's a big if, given the IMF's latest research) Alesina et al. are right, and growth can follow cuts, the pain may be concentrated amongst some groups. If these become massively unhappy... it can start to look pretty ugly out there in the streets, and I doubt that that'll be good for growth. As a matter of fact, Nick Bloom of Stanford has a bunch of fantastic papers showing just how painful uncertainty shocks are in terms of subsequent economic performance.