It has been a while…now I’m in thesis modus, and drowning in papers, books etc. Short reviews will help me to organize my ideas and may be of use to somebody else. So, let us start with Mark Blyth’s Austerity: The History of a Dangerous Idea (New York, NY: Oxford University Press, 2015), which I recommend as a thorough overview of the idea of austerity, especially to readers who are not familiar with economics as well as to economics freshmen, given the non-technical language.
The ingredients of the crisis
Blyth stresses how it was the private sector that put the governments in a distressed situation by gambling and causing the worst crisis since 1929, not the other way around. In his account four elements are key:
- The US repo market, “the generator” of the crisis;
- Derivatives, “the amplifier”;
- Correlation of the different tranches of CDOs, the search for liquidity and the self-fulfilling-prophecy-effects of CDS;
- Flaws in economics, the reliance on financial engineering and the victory of market fundamentalism with its efficient market and rational expectation hypotheses.
Reading in parallel Minsky’s Stabilizing an Unstable Economy and Hudson’s The Bubble and Beyond, I am not convinced that this is the right way to tell the story. Minsky highlighted how every financial crisis – 1966, 1970-71, 1974-75 and 1980-81, has at its center a different financial instrument. It is not about the instruments or markets themselves because there always will be new ones thanks to “financial innovation”. It is the intrinsic tendency of capitalism to cyclical crises. Hudson, in my opinion, completes the picture. He maintains there is a qualitative difference between consumption and investment debt. The idea behind is that credit to investment will essentially pay for itself since it serves to create new wealth, contrary to consumption credit that will bid up prices of existing wealth. If there is too much of the latter, a bubble originates and fuels itself until it bursts because the debt burden has become unsustainable.
This is not to deny the importance of the repo market, CDOs, CDS, or the flawed economic theory, but to recognize that they are not the underlying factors explaining not only the GFC but all the financial/economic crises.
Europe, not an imported crisis
In short, the European banks were gambling more than their American counterparts. Their bailout, together with a dysfunctional monetary union and reactionary economics ideas, are the root of the Old Continent’s crisis.
Austerity as idea
To me, the most interesting part of Blyth’s book is his history of the “dangerous idea”, from Locke, Hume, Smith, Mill, and Ricardo, to Liquidationism, the Treasury View, Ordoliberalism, the Austrian School, and Neoliberalism.
The “Father of Liberalism” lays the foundations of the right of property – or more correctly the right of appropriation -, which derives from the labor we put into something, while the issue of distribution is dealt with by assuming abundance. Money serves as a store of labor in excess of what we consume. The government, thus, has no right to spoil the people of their property, the fruits of their labor, levying taxes, and should stick to its basic functions.
With David Hume, we get right to the “crowding out” argument that has survived to today. He criticizes public debt, or more correctly the King’s debt, which is a convenient expedient to postpone tax hikes otherwise needed to cover increased outlays. In doing so the government will compete with private enterprises and bid up interest rates, and once it can’t find funds at home it will turn to foreigners, enslaving the country. Eventually, there would be insolvency. Sounds familiar?
[government debt will] banish gold and silver from the commerce of the state […] and by that means render all provisions and labour dearer thatn otherwise they would be.
With Smith comes the moral touch. Since there are no leakages in the economic circuit and saving leads to investment, frugality is a virtue and prodigality is a sin (“Parsimony, not industry, is the immediate cause of the increase of capital”). While individuals are naturally inclined to save, states are not and on the contrary will pile up debt, which is paper money produced over and above what the domestic economy can absorb fuelling imports of, probably, consumption (not investment) goods.
Liquidationism, the view that inspired President Hoover’s inertia in the face of the Great Depression, prescribes austerity for a different reason. Boom and bust cycles are a fact of life, crises are beneficial in that they liquidate the losers. Government intervention not allowing the process to play out and manipulating the price system would be harmful and undermine the investors’ ability to pick the winners. On the contrary, the government should balance the budget and engage in procyclical policies.
The Treasury View reiterated Hume and Smith’s arguments and is best exemplified in this passage:
when the Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprises, and in the process raises the rent of money to all who have need of it.
Winston Churchill in his 1929 budget speech
Ordoliberalism is Germany’s, and today also the EU’s, economic doctrine, according to which only the rules guaranteeing a healthy, functional and competitive economic environment matter. A central bank with a strong anti-inflationary stance, strict antitrust rules, and a government that does not engage in Keynesian policies are needed. Social welfare is accepted only because “stability and security [of] the working class was a prerequisite to securing the market economy”. Of course, this model works as long as you have an export-led economy (with importing countries using exactly the Keynesian policies Ordoliberals bash).
As to the Austrians, Blyth says:
When there is a financial bust, there are (mainly) four ways to adjust: inflate, deflate, devlue, or default. Deflation, cutting wages and pried so that the economy can adjust to the real values is, according to the Austrian school, the right ting to do […]
It’s all about the banks producing clycles of boom and bust that are always made worse by the government getting involved either through central-bank-base monetary policy or though simulative fiscal policy.
Then, Blyth goes on explaining how Neoliberalists, which he conflates with Monetarists, and “the Bocconi boys” contributed to the austerity policy prescription.
Here, then, lie the roots of today’s public and economics discourse holding that public debt is a threat to economic growth. In all honesty, I cannot blame Locke, Hume, and Smith. The state’s budget was the King’s budget, spent mainly on luxuries and expensive, capital-destroying wars. Plus, we hadn’t entered the era of industrialization, the economy was based on agriculture and the exploitation of colonies, translating in diminishing returns, in limited “natural growth” and fiscal multiplier probably much smaller than 1 (if it makes any sense to speak of fiscal multiplier in this context). However, this is not the economic system we live in today, where the government delivers vital services, invests, and creates new markets, and the productive capacity makes it possible, and yes necessary, for it to step in and stimulate aggregate demand to reach full employment, without major adverse consequences.
Austerity as policy
Finally, Blyth analyses the cases in which austerity was adopted as policy in the 1920-30s in the US (presidents Hoover and, in 1937, Roosevelt), in Britain, in Sweden, in Germany, in Japan, in France, in the 1980s in Denmark and Ireland, and in more recent years in East Europe, foremostly Latvia.
For economics students, there are some empirical papers that deal with the supposed “growthsterity” in post-WWII: The Boom Not the Slump: The Right Time for Austerity, which reviews the findings by Alesina and Ardegna; and Will It Hurt? Macroeconomic Effects of Fiscal Consolidation, Successful Austerity in the United States, Europe and Japan, Expansionary Austerity New International Evidence, and Coping with High Debt and Sluggish Growth by the IMF.