The Great Austerity Magic Trick

A Review of Austerity: The History of a Dangerous Idea, by Mark Blyth, part one

If there was an award for the dumbest yet most bizarrely effective political idea of recent years, one candidate would be an absolute shoo-in. The notion that debt racked up by the last Labour government in the UK caused the financial crisis, doesn’t seem to suffer in the least from endless repetition, despite being economically infantile. Expect it to play a possibly decisive role in the General Election campaign early next year.

As Mark Blyth observes in his book, Austerity: The History of a Dangerous Idea, this stems from “a wonderful confusion of cause and effect”. The state gets the blame for a “quintessentially private-sector crisis”. In the UK and US, privately funded housing bubbles imploded, rendering insolvent hugely leveraged (indebted) financial institutions. In Europe even more vastly leveraged banks (in 2008 Deutsche Bank had assets that were 80% of German GDP) were left high and dry by either, as in case of Ireland and Spain, the bursting of a similar house price bubble, or, as with Italy and Portugal, too much lending to governments that suddenly went sour.

In no case, apart from possibly Greece, did wild public spending have anything to do with it. Spain actually ran a budget surplus prior to the financial crisis. In 2007, Ireland had a debt to GDP ratio far better than Germany’s – 12% compared to 50%.

“The fiscal crisis in all these countries,” writes Blyth in a statement of the obvious that shouldn’t be, but evidently is, painfully necessary, “was the consequence of the financial crisis washing up on their shores, not its cause.”

But that is not the way our politics has been able to rationalise what happened. “What were essentially private-sector debt problems were rechristened as ‘the Debt’ generated by ‘out of control’ public spending,” says Blyth. Cue homilies about the penance we all have pay for partying like there was no tomorrow in the boom years. And that penance takes the form of huge public spending cuts – austerity, “a deserved doomsday for the borrowing way of life” 

Here is Mark Blyth (a Scottish professor at an American university) speaking:

But I think Blyth is so concerned to nail the patent deceit and injustice of this subterfuge that he neglects one thing. We don’t actually have austerity. We have public sector austerity in spades, sure. Disabled people in Britain, who clearly spent the years prior to 2007 downing endless bottles of Moёt, are paying a wholly justified penance through the withdrawal of the Independent Living Fund, the Bedroom tax, the work capability scandal, the limiting of contribution-based Employment and Support Allowance to one year and the abolition of the disabled worker element of Working Tax Credit.

But private sector austerity, a penance for the sector of society that actually caused the problems in the first place? I must have missed that one. After the taxpayer funded bail-out that caused the debt to mount initially (£1.5 trillion in Britain and $7.7 trillion in the US), the private sector has been suitably chastised by successive bouts of Quantitative Easing, a subsidy to banks and other financial institutions that has amounted to £357 billion in Britain, all under the watchful eye a government run by the austerity evangelising Conservatives. Banks in the UK have also had to deal with the crushing blow of the £80 billion Funding for Lending programme, and a state guarantee of 15% of the value of mortgage loans made under the Help to Buy Scheme. All this has taken place in the context of near zero interest rates which makes borrowing money incredibly cheap and saving it kind of pointless. And the tough medicine has been topped off with a cut of corporate income tax from 28% to 20% (by 2015). I really don’t know how they cope.

It’s not as if you can say that debt isn’t a problem for the private sector and it is for the public sector. As Blyth says, we are dealing with “weaknesses internal to the private sector” and weaknesses that was transferred to the state’s books. According to a report by the consultants McKinsey in 2011, overall debt in the UK was 507% of GDP, making Britain the second most indebted country in the world, behind Japan. Government debt (and this is post-bailout remember) was the smallest component, at 81%. The debt of financial institutions made up a huge 219%, non-financial institutions 109% and households 98%. Overall debt is now down to 484% of GDP but it’s still enormous.

In November 2013, household debt in the UK reached a record level of £1.43 trillion.

But when confronted with a two decades-long bout of financial incontinence by the private sector, governments in the UK, US and Europe, in contrast to the unbending sternness with which they have imposed public sector austerity, have responded by … prescribing laxatives.

They certainly don’t make austerity like they used to in the old days. One of the attributes of Blyth’s book is that he delves into the intellectual antecedents of austerity, as well as critiquing its contemporary application. And here you get a rather different kind of austerity. Adam Smith, the father of market economics, was against “easy money” and thought merchants, unlike governments, were by nature savers. Early nineteenth century economist David Ricardo was adamant that states shouldn’t “cushion market adjustments.” Into the 20^th century and the ultra-free market Austrian school believed austerity meant “a flight into real values”. “The thing to do” wrote Austrian free marketeer Ludwig von Mises, “is to curtail consumption … the economy must adapt itself to these losses”. Another “austerity enabler”, late twentieth century right-wing economist, Milton Friedman, believed in controlling the money supply.

According to Blyth, Austrians like Von Mises and Friedrich Von Hayek (Margaret Thatcher’s favourite economist) thought that “the very worst thing that can happen is for the government to get involved. By flooding the market with liquidity, keeping the rate of interest low when credit is scarce, or attempting to stimulate the economy to smooth out the cycle, government intervention simply prolongs the recession”.

This is practically an instruction sheet of how our austerity-preaching governments have reacted. First of all they “got involved” from the outset through massive bail-outs of banks in the US, UK and also Europe (the difference with the European Central Bank is that they haven’t taken on toxic bank assets but there have been huge bail outs in Ireland and Spain and the ongoing suffering inflicted on Greece is to ensure that French and German banks never have to face up to their bad debts).

Next we have the mistake of “flooding the market with liquidity” which is the definition of Quantitative Easing, practiced by austerian Conservatives in Britain as well as the austerity-sceptics of the Obama administration. And the unwavering, government-toppling autocrats of the European Central Bank are not averse to a spot of Quantitative Easing, either. The Long-term Refinancing Operation undertaken for still massively indebted banks in 2011 and 2012 was, in Blyth’s words, “an unorthodox policy of quasi-quantitative easing.” Then there is keeping the rate of interest low when credit is scarce (like after a credit crunch). British interest rates are stuck at 0.25% and there is paranoia about what will ensue if they are raised. European, ECB, interest rates are also at a record low of 0.25%. The last thing any government wants to do is “curtail consumption” even if it is rooted, as the value of real wages fall, in borrowing. And as for Milton Friedman and controlling the money supply, as David Coleman once said, “if he were alive today, he’d been turning in his grave.”

In the real-world austerity experiments of the 1920 and ‘30s, we find governments not only slashed what public spending there was but also let busts run their natural course, an eventuality our governments desperately stopped from happening. The ‘liquidationist’ doctrine of the US government of the early ‘30s turned the Wall Street Crash and a series of bank failures from a “relatively minor budget deficit into a full-blown financial crisis and depression,” writes Blyth. Both the US and Britain aggressively raised interest rates, rather than sinking them to below the rate of inflation as current policy dictates. Japan’s civilian government of the early ‘30s, we read, raised interest rates into the teeth of the depression, paving the way for a Fascist military takeover that radically reversed course. In all cases, austerity was applied with the same vigour to the private sector, as the public.

Marxian economist Andrew Kliman has pointed out that the destruction engendered by the laissez-faire approach of the 1930s was far greater than governments had expected and led to momentous changes such as World War Two. “Policymakers have not wanted this to happen again, so now they intervene with monetary and fiscal policies in order to prevent the full-scale destruction of capital value,” he writes in his book, The Failure of Capitalist Production. “This explains why subsequent downturns have not been nearly as severe as the Depression.”

It also explains the special kind of austerity we have, which is only applied to the public sector. The private sector is treated with the utmost permissiveness and government intervention.

In the second part of this review, I want to discuss how Keynesianism, which Blyth says returned for a brief twelve month reunion tour, in fact never went away. And how Blyth’s conclusion – that we should, in retrospect, have let the banks fail – is a version of liquidationism the Left should embrace.

Reality-mongering about inequality will get you nowhere

Oxfam is a “thinly disguised left-wing lobby group” tweeted a Conservative Parliamentary candidate earlier this week after the British branch of the development charity reported that the five richest families in the UK boast more wealth than the poorest fifth of the population put together.

It’s an interesting definition of left-wing where your deep red political stripes are inadvertently displayed by the mere fact of relating what is actually happening in the world.

Charities can now so easily slip into the crime of “reality-mongering”. Last December, Christian food bank charity, the Trussel Trust was damned as “political” by Tory minister, Iain Duncan Smith, for daring to suggest that the government’s benefits sanctioning regime and the soaring price of food might have something to do with the fact half a million people are regularly forced to call on its services.

But there is, despite the brickbats, an unmistakable thirst for more reality, unencumbered by ideological blinkers. Manchester University’s “Post-Crash Economics Society”, for example, was formed by students last October, because they say orthodox economics “cannot explain the world we live in”.

“Neoclassical economics in the era of neoliberal triumph, beginning in the late 1970s,” say two Marxian economists, John Kennedy Foster and Robert McChesney, “promoted versions of economics that eschewed reality for pure market conceptions.” In their obsession with the fantasy battle of state versus market, conservatives simply cannot see inequality or the growing trend towards monopoly in contemporary capitalist society.

 The world won’t listen

Oxfam’s problem does not lie in its ability to discern the existence of huge inequality, but in its plaintive appeal for the British political system to do something about it. For long ago British politics forgot how to listen.

“The only effective design for diminishing the income inequality inherent in capitalism is the progressive income tax,” noted famed 20^th century economist John Kenneth Galbraith, in 1992.

“That taxes should now be used to reduce inequality is, however, clearly outside the realm of comfortable thought,” he went on.

To appeal to conservatives to raise taxes on the wealthy, is rather like imploring Michael Bay to embrace slow cinema. The tragedy of British politics is that the centre-left is almost equally resistant to causing the wealthy even mild discomfort. In this sense, as one economist has noted, Britain has an effective one party state.

The last Labour government, for example, slashed capital gains tax (the tax you pay, if you make money from selling shares) from 40 to 18%, a cut that was, ironically, partially reversed by the coalition. Labour did raise the top rate of income tax (on income above £150,000 affecting 1% of taxpayers) to 50% and has pledged to reverse the coalition’s cut back to 45%. But, in order not to appear “anti-business”, the party says a renewed 50% rate would only be temporary.

 Robin Hood in reverse

Corporate income tax was reduced by the 1997-2010 Labour government from 33% to 28% (it was 53% in the 1970s) and has been scythed down to 20% by the current government (at the same time as raising VAT which affects everyone). Labour has said – exposing an indelible stain of Bolshevism - that they will increase it back up to 21%!

By way of international comparison, Barack Obama, who has raised the top rate of tax in the US slightly, wants to cut the headline rate of American corporate income tax from 35% to 28% (the effective rate, taking into account all the exemptions that can be got, is 19%).

Corporate income tax is a tax on company profits and is frequently presented by politicians, who want to reduce or better abolish it, as a tax on economic growth. But these profits pay for all the dividends to large institutional shareholders, like hedge funds, and astronomical executive salaries and stock options – thus making a massive contribution to inequality.

Moreover, many wealthy people have, for tax purposes, transformed themselves into corporations to take advantage of the fact that the rate of corporation tax is so much lower than the top rate of income tax. Half as much, in fact, in the UK.

“The more corporation taxes are cut,” says the Tax Justice Network, “the more wealthy folk will shift their income out of personal tax category and into corporate forms, so as to pay the lower corporate tax rate. The more they do this, the more governments feel they must cut personal tax on wealthy people to stop it.”

It is worth recalling that when the profits tax (the precursor to corporation tax) stood at 50% in 1960s Britain, economic growth - at 3.27% - was more than double its current rate.

There is no appetite among the political class in Britain, for raising taxes on the wealthy in other ways either. While EU, led by Germany and France, is determined to introduce a financial transactions tax (a tax of 0.1% on the sale of shares and bonds, AKA the Robin Hood tax), a measure highlighted by Oxfam as a way to reduce inequality, the British government is opposed and the Labour opposition deafening in its silence on the issue.

Britain’s one party state on tax is so entrenched, it will survive even its dissolution. Scottish First Minister, Alex Salmond, is pressing for independence from Britain in September’s referendum, but is also in favour, should the yes vote win, of an even lower corporate tax rate than the UK – three percentage points lower, in point of fact.  In addition, Salmond parrots the UK government line that, while a financial transactions tax is eminently desirable, it can only be introduced if the whole world agrees, because unilateral implementation would damage the Scottish financial services sector. Isn’t consensus lovely?

 Don’t redistribute, distribute

But besides the futility of petitioning a deaf political culture, Oxfam’s inequality campaign is doomed for a more integral reason. For it rehashes the time-honoured method of reducing inequality through tax redistribution. At the risk of sounding simple-minded, if you don’t want the outcome of gaping inequality, perhaps you ought to alter how wealth is distributed in the first instance.

“If change is ever to occur,” writes Gar Aperovitz in his book, America Beyond Capitalism, “an assault must ultimately be made on the underlying relationships that have produced the inequality in the first place – especially those involving ownership and control of the nation’s wealth.”

There was acclaim across the political spectrum, including from Conservative MPs, for the 2009 book, The Spirit Level. Authors Richard Wilkinson and Kate Pickett showed how problems such as obesity, mental illness and violence were made worse by greater economic inequality. But what seemed to escape understanding was that Wilkinson and Pickett did not place all their faith in the traditional method of combatting inequality, tax redistribution. They placed greater importance in changing the “underlying relationships” through democratic employee-ownership of companies, as a way of addressing inequality at its root.

Capitalism produces inequality as surely as breathing produces carbon dioxide. And unsuccessful capitalism – the kind we have now – generates extreme inequality. According to French economist Thomas Picketty, if the rate of economic growth is below the after-tax rate of return on capital, inequality will spiral.  Those are precisely the conditions – insipid growth and capitalists demanding a high rate of return - that we have experienced in the West for the past 30 years.

To return to Alperovitz, he argues that the future of efforts to reduce inequality do not reside in tax redistribution but in worker and municipally controlled economic enterprises. “There is no way to achieve movement towards greater equality,” he writes, “without developing new institutions to hold wealth on behalf of small and large publics.”