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.