You supply the "reforms", we'll demand the revolution

There is a word that has been clasped with ideological zeal in the response to the current economic impasse, yet one with a decidedly retro feel: supply.

“It has now been more than thirty years since the supply-side revolution conquered Washington,” writes Thomas Frank in Pity the Billionaire, a book about the resurgent Right in the US. “And yet, as I write this, the most effective political response to these events is a campaign to roll back regulation, to strip government employees of the right to collectively bargain and to clamp down on federal spending.”

In Britain, there are the same rejuvenated supply-side obsessions: make millionaires and corporations richer and make it easier for employers to fire workers. All that is missing is a Spandau Ballet revival.

Supply has its familiar counterpart, demand. In simple terms, supply means the regulations and taxation affecting employers. Demand is the ability of people, mainly employees, to spend and consume.

But like a neglected sibling, demand is left to make its own way. While supply is lauded with gifts, demand is confronted with insurmountable obstacles. In the UK, real wages are dropping, benefits and tax credits are being cut and public spending is being slashed. The cost of gas and electricity has more than doubled in the past five years.

Only four years ago, demand, which had developed a chronic borrowing habit to keep pace with supply, faltered, plunging the Western world into economic crisis. But after a bracing cold shower, it obviously won’t make the same mistake again.

In economics, the conviction that if you nurture supply, demand will obediently follow, has a very long history. Back in the 1820s, it was known as Say’s Law – “supply creates its own demand”. But repetition doesn’t make it true. “All the supply-side solutions in the world will do little to aid recovery in the absence of growing demand for goods and services,” said the economist Ann Pettifor of George Osborne’s budget. “Nothing will happen if customers (of banks, firms, shops) simply cannot or will not walk through the door.”

The supply reflex is unfortunately not an Anglo-American delusion. Both Spain and Italy, aside from demand-choking austerity, are changing their labour laws to bring about more “flexibility”, a classic supply-side measure.

In Spain, labour market “reform” is taking place amidst some of the lowest wages in Europe and a 23 per cent unemployment rate (almost the same as the US during the Great Depression). “There's little doubt that in the context of a downturn, more flexibility means more lay-offs, more short-term contracts and lower wages,” writes one Spanish commentator, Miguel-Anxo Murado. “This will have the immediate effect of increasing earnings for employers, but this will come back to haunt them as households will have less disposable income. The employer's "wish-list" may turn into an employer's last wish.” A perfect example of supply-side reforms strangling demand - in economic terms, eating your own tail.

If a historical case-study was required, the same newspaper, The Guardian, provided one. The economist Ha-Joon Chang wrote of what happened in his home country, South Korea, in the aftermath of the Asian financial crisis of the late ‘90s. Economic deregulation was combined with a relaxation of labour laws. Employers, writes Chang, gained “a decisive upper hand over their workers. Many employees were sacked and re-hired as "agency" workers, doing the same jobs at lower wages.” Economic growth slowed from 6-7 per cent a year to under 4 per cent.

If another supply-side revolution makes no economic sense, then why do it? Murado believes that Spain’s newly elected right-wing government has to be seen to be doing something, even if that something is completely counter-productive. The familiar is a refuge from the unknown. The UK Conservative government has embraced again the prized policy of the 1980s, the “Right to Buy” council houses. The fact that now only 20 per cent of council house tenants are in full-time employment and it has been only five years since the sub-prime mortgage disaster hasn’t acted as a deterrent. It speaks, to put it politely, of an unwillingness to get to grips with reality.

But from the point of view of the controllers of this society, the senseless is also dangerous. If capitalism ceases to deliver rising living standards, its intrinsic features – a slave-like work discipline and exploitation (you work, they get) – will appear less and less tolerable. The management consultant Peter Drucker said in 1939 that “depression shows man as a senseless cog in a senselessly whirling machine which is beyond human understanding and has ceased to serve any purpose but its own”.

A system that has ceased to serve any purpose but its own, is an apt description of contemporary capitalism.

"When she went there, the cupboard was bare" the exhaustion of policy

“No policy of any kind – whether imposed by a dictator, produced by democratic consensus, or anything in between – can ‘fix the problem’” said economist Richard Wolff in 2008.  “No policy ever did”.

The world is now realising this. “Policy” is exhausted. The only company with good prospects at the moment is the one that makes the t-shirt of Karl Marx saying, “I warned you this would happen”.

According to broker Louise Cooper, “the horrible reality is that those leaders in charge of our economy have no answers”.

 If policy can’t solve anything, then it’s time to look again at economists who never believed it could, like Richard Wolff and Harry Shutt, whose books have been reviewed in this blog.

There were only three policy tricks. The first was supply-side economics. This was the right-wing idea that the reason why companies don’t expand, or individuals create businesses, is that they are taxed too much. In the UK in 1973, the corporate tax rate was 53 per cent. It will be 23 per cent in 2014. The Con-Dems’ enterprise zones, with zero business rates for five years, spring from the same contorted and remorseless logic – tax cuts will conjure up economic growth.

The problem is reality. Economic growth was much higher in the ‘60s and ‘70s before supply-side economics took hold. Attempting to answer the paradox that to open a factory in South Korea in the early ‘90s required 299 permits, while the country had grown at over six per cent for three decades, the South Korean economist, Ha-Joon Chang, said: “Strange as it may seem to most people without business experience, business people will get 299 permits, if there is enough money to be made at the end of the process … in contrast, if there is little money to be made at the end  of the process, even twenty-nine permits may look too onerous.”

For permits, read taxation. If there is money to be made, taxation, won’t deter expansion. The trouble is, there isn’t.

Trick number two, was interest rates. They are lower, in Britain, than they have been for 400 years. The United States Federal Reserve has tried to halt huge stock market falls by promising to keep interest rates at near to zero until 2013  At that miniscule level, they are meant to bring about spending and borrowing and make saving an unattractive option. But with personal borrowing at historically unprecedented levels, £1.46 billion in Britain, this doesn’t work either. And if consumer spending doesn’t rise, you can reduce corporate taxation to zero (which might well happen given the mentality of “policy-makers” in the UK and US ) and it won’t magically revive economic growth.

The last trick was the cruellest of all. Take trillions of pounds of private sector debt and transfer them to the public. In Britain, the government has a debt of £2.3 trillion and, £1.5 trillion of that stems from the banking bail-out. Gordon Brown was lauded as the saviour of the global economy. But the economy wasn’t saved from depression. Banks prospered temporarily, but the recovery didn't apply to jobs or spending. And nothing, as we are now seeing, was solved. According to the UN, $18 trillion was added to public sector debt. And just what, it will increasingly be asked, did that unprecedented spending achieve? To delay the inevitable by three years?

The reality of the exhaustion of policy is not pleasant or easy to face. In one way it is an admission of impotence. “The world is now embarked on a supposed recovery strategy that is both self-contradictory and doomed to failure,” said Harry Shutt in 2010. The only comparable experience, he says, was the Great Depression, which lasted a decade and was only ended by the Second World War.

Richard Wolff also likens what is happening now to the Great Depression. Then the reaction was far more creative. The US government employed directly 11 million people, some as singers, poets, painters to take culture around the US. But that far more interventionist policy didn’t solve the Great Depression.

“Policy” solutions are like closing the stable door after the horse has bolted. We can reject the self-imposed policy strait-jacket of western governments, and call for new ones. We can all become Keynesians again, re-regulate finance, ban derivatives or hedge funds. Corporations can be taxed properly and tax havens closed. That might conceivably help with the next downturn but we are still in the middle of this one.

“The whole idea of policy is bizarre,” wrote Richard Wolff in 2008. “The ‘right policy’ represents an absurd claim that that this or not that law or regulation can somehow undo the many different factors that cumulatively produced this crisis. Policies are ‘magic potions’ offered to populations urgently demanding solutions to real problems.”

Wolff attributes the 2007 economic crisis to the fact that US wages had stagnated for thirty years. Huge amounts of borrowing to compensate for this change enabled debt-based financial instruments to become so dominant. And when defaults began as interest rates rose, the contagion spread, causing the “credit crunch”. No government policy could “somehow undo” these trends.

Which is why Wolff’s answer doesn’t involve policy, but rather a shift out of capitalism. Only that can really “solve” the crisis. He wants workers to become their own board of directors. That post-capitalist settlement can change the factors that made the economic crisis happen in the first place.

For Harry Shutt, the problem is related but larger. Capitalist economies like ours are subject to the business cycle. The incessant recycling of profit to make more profit eventually produces more than can be absorbed by consumers.

But the downside of the business cycle – recession - has been evaded for years by government and business.  Now it is happening and will be more severe for having been eluded for so long. One consequence of the business cycle not being allowed to take its natural course, is that people, and governments, are overloaded with debt, and can’t bolster spending even if they wanted to.

Financial speculation is now more profitable than actual production. The upswings of future business cycles will be brief. So, he too, wants a transition out of capitalism, and end to the requirement that for an enterprise to exist it must make a profit, and the severing of the link between a liveable income and paid employment.

These solutions are now out of sight. But if governments have no answers to what will happen, then inevitably attention will shift to those who have some kind of explanation, and a solution, however radical it appears at the moment.

Milton Friedman, who was one of the gurus of neoliberalism, said in 1976 that “brute experience proved far more potent than the strongest of political or ideological preferences” in ending Keynesian economic policies and ushering in free market policies.

In other words, brute experience has a way of altering minds in a way that argument and debate can’t on their own. We shall see.