Welcome to the new austerity! Austerity plans have been adopted by governments in much of Europe and elsewhere around the world. Then America gets sequestered and joins the party. And more recently, we’re treated to the Reinhart and Rogoff controversy – back in 2010, pundits and conservative policymakers seized on R&R’s research that “median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise”. But next thing you know, their research is debunked and watching Nobel Laureates dueling over their blogs has never been so fun.

However, instead of arguing whether austerity or stimulus is better, let’s talk about the concept of good austerity vs bad austerity, and its counterpart, smart stimulus vs dumb stimulus.

The reality is that our elected representatives are forced to make significant economic decisions with imperfect data. We have Republicans who argue that it’s possible to contract your way to growth, and they really don’t care if “reverse causation” punches a hole in the data that supports their belief structure. We also have Democrats who point to several decades worth of data backing up a Keynesian approach, but the sad truth is that the country failed to launch an adequate stimulus plan in 2009 that had enough punch to prove the point.

The current approach to austerity isn’t working. The grand experiment that Europe has been pursuing for the past four years is showing pretty dismal results – Portugal’s economy shrank by 1.8 percent, Italy’s fell by 0.9 percent, and even the supposed powerhouse of the region, Germany, saw its economy contract by 0.6 percent. Nobody seems to read the history books either. Austerity was attempted as the cure for the Great Depression, called “Liquidationism” back then, and it simply didn’t work. A similar approach was pursued in Europe, which the U.K. called “the Treasury view,” which also failed, making their economy slump even further and even leading to World War 2. However, since whole world seems dead set on this course, let’s talk about finding a way to make austerity work.

America's Lost Decade

The reality is that America — like Japan in the 1990s — is now midway through a "lost decade" caused by deflationary price expectations. We lost the two greatest drivers of economic growth, which are a healthy IPO market and a robust housing market. The reality is that when people think that some tiny startup might be worth a billion bucks someday, investment into stocks will naturally flow. And when people think that a house will be cheaper next year, they’re gonna wait to buy. We’re not out of the woods yet.

And so, there are two ways to manage either a company or country during a downturn. One is a kneejerk reaction to cut costs, lay off people, and figure out a way to "batten down the hatches and ride out the storm" until better days. This usually requires that management breaks its promises to employees and find ways to restructure debt. For the corporation known as the US of A, that means to cut entitlements plain and simple.

The other path is based on hope and an unshakable belief in your own innovativeness. This brings to mind Steve Job’s success story at Apple. After John Sculley brought Apple to a state of near bankruptcy, Jobs didn’t try to package the company for sale… he led Apple to innovate its way back to health and stupendous success. And in this allegory lies the strategy for America’s return to better days -- we must learn the difference between good austerity and bad austerity, and between dumb stimulus and smart stimulus.

Let’s start with stimulus. Most Keynesians believe at any stimulation of the economy during a recession is good, but the more cautious and strategic Keynesians will seek to insure that stimulus is carefully targeted at kickstarting sustainable growth. No pork, only potential. Should President Obama be adept enough to wrangle one more stimulus bill out of Congress, it absolutely needs to be 100% “smart stimulus." Smart stimulus is the funding that, either intentionally or accidentally, funds the acceleration of a new giga-market -- aka, "the Next Big Thing" -- that can generate enough revenues to power a recovery.

Examples of smart spending and investment by the US government include federal funding that helped birth the microchip, the Internet, GPS, and Google. Think about it, would the iPhone have really happened if the National Science Foundation hadn’t funded some crazy grad student who thought up multi-touch interface? The U.S. aerospace industry could never have been born without government defense spending. All the terrific recent innovations in biotechnology actually owe their existence to the largesse of National Institute of Health. The raw material for “proto-innovation” usually comes from government, not private investment that is unable to bear the risk profile required. However, you’re going to fund nine losers for every hit, so stop using Solyndra as a political device.

As for austerity. Again, there is “smart austerity” and there is the kind you impose without thinking strategically. The sequester was essentially a device our elected representatives used to make cuts without taking responsibility for them – it was “the other guy’s fault” – and is a really good example of dumb austerity. As the physicist Ernest Rutherford once declared to his colleagues, "We haven't got the money, so we've got to think."

Smart Austerity

The key to smart austerity is going after the waste and pork first. For example, the Department of Defense’s Inspector General's report highlights some great places to cut: the DOD pays $284.00 for an $8 helicopter door part, the DOD racked up $720 million in late fees for shipping container leases by not returning the containers on time, there's a billion dollars in useless spare parts for the Stryker vehicle, that were obsolete when purchased. It all adds up to an estimated $60 billion in DOD waste and fraud related to the Iraq and Afghanistan wars alone. And let's not talk about cost-overruns for major weapon systems.

The hardest part of implementing smart austerity is figuring out what NOT to cut. With all those lobbyists out there controlling campaign funding, how could Congress possibly cut the pork… when the pigs are holding all the butcher knives? They had to implement the sequester and plead “not my fault!” But it’s actually kind of simple to see what shouldn’t be cut – stuff that insures that America can rebuild its economic infrastructure. Science, technology, education, communications infrastructure… these must be sacrosanct. Also, just as a company should keep its word about pension funds and health insurance, a country should also be very reticent to cut Social Security and healthcare.

In fact, despite all the grumbling that accompanies a capital crunch, lean years are actually good for new companies. Many major brands like 3M, General Motors, IBM, General Electric, Microsoft, and Sun Microsystems all got their start during the lean times of recession. The worst recession since World War II was from 1973 to 1975, when the country's gross domestic product dropped 3.1 percent. This is when both Microsoft and Apple were founded. The economic malaise we are caught in is therefore a perfect  time to create the next Microsoft or Apple.

Putting Our Hearts into It

More importantly, we -- as a country, together -- must put our hearts into it. We need to start looking at frugality as an opportunity. There’s a reason why great entrepreneurs work out of garages, and great painters live in cramped and drafty garrets. It’s good for the soul and mind to sacrifice for what you believe in. It creates focus, determination, and drive. World War II forced America to ration food and gasoline (you could only get 4 gallons a week), and Americans rose to the occasion, planting nearly 20 million Victory Gardens, growing enough fruits and vegetables to double commercial production. Women in America gladly gave up their stockings, so factories could manufacture parachutes instead. Scrap metal drives were instituted, to gather tons of materials like aluminum to build airplanes, but the reality was that only virgin aluminum could be used to manufacture aircraft. But these drives helped to increase morale so they kept doing them, because it is only by sacrifice that you can truly support something you believe in. America needs to see that its sacrifices are leading to better days, not to the prospect of short-selling Hawaii to China to get out of a bad mortgage.

Also, austerity often inspires creativity, because being broke is sometimes the best motivator for getting on the path to success. Consider the lives of great artists and writers, like Henry Miller and Paul Gauguin, who survived cold winters in garrets, in bitter poverty and despair... because great art demands sacrifice. Or the countless entrepreneurs who quit their comfy jobs and tightened their belts, to work diligently in their garages to turn their visions into breakthrough products. In any rags to riches story, you gotta start with some rags.

The bottom line is that we can approach our economic challenges in either one of two mindsets: We can see America as some has-been company in hard times, and looking to cut costs the easy way (without taking responsibility) and quietly searching for an M&A exit. OR we can do it like Steve Jobs did… innovate our way back to the top and hold the perspective that we are all, collectively, sacrificing for a better tomorrow. That means that every American has to pitch in and participate to earn our collective success down the road. How can we make this happen?

First, let's get serious and declare a ten-year tax holiday for investors in any new high-tech startup that hires more than 10 people. Make sure this includes crowd-funding and this will funnel a tsunami of investment by the middle class into high-tech startups to create millions of high-paying jobs. Otherwise, that money is flowing offshore to tax-haven countries. 

Second, even though we're broke, we need to sacrifice to put more money into higher education. The United States should take advantage of the fact that it is not saddled by the kind of institutional flaws that exist in the eurozone and that it can borrow for virtually nothing. Now is a good time for Washington to make useful and strategic investments. Here's an idea: If you absolutely want to cut Social Security entitlements voluntarily while insuring higher education, how about we offer a guaranteed interest-free student loan for the children and grandchildren of anyone who voluntarily agrees to a chained CPI? What grandmother wouldn’t agree to this?

Finally, politicians must take "The Science Pledge" – to invest courageously in technology infrastructure and science grants no matter what, and to govern by evidence-based rational thought instead of irrational beliefs and dogma. Don't kid yourself, you can't argue for intelligent design and against stem cell research, and secretly pray that your efforts won't slow down science in America. You have to make the hard choice and take the science pledge, because this is what is required to take to make sure the Next Big Thing happens in America.

We’ve pretty much scraped bottom on the recession, and if you want to accelerate the recovery, it’s time to start working together to fix things again... and get serious about innovation, science and sacrifice. 

A bit more reading for you --

A non-partisan review of whether the stimulus worked:


Results of the European austerity experiment:


And a few words of wisdom from our favorite Nobel Prize-winning economist: 


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