The response of neoliberal governments to the financial crisis of 2007/8 was first to bail out the banks and then to introduce dramatic public spending cuts which it was claimed would revive economic growth. Yet the promised growth has barely materialised and budget deficits have only increased. Despite these evident failures though, austerity remains the dominant political paradigm of our time. In the first of an in-depth two part interview, NLP’s Tom Mills discusses the contemporary folly and the deep historical roots of austerity with Mark Blyth, Professor of International Political Economy at Brown University in the United States and the author of Austerity: The History of a Dangerous Idea.
Let’s start with two simple questions: What is austerity? And why is it dangerous?
Well they’re simple questions, but there aren’t simple answers. First of all, what is it? Well it’s interesting that even the IMF can’t agree on a definition. What’s usually meant is ‘fiscal consolidation’, a term that basically means reducing the budget deficit in order to create the conditions for stable growth, so that growth over time reduces the net debt of the state. Austerity is when you try and do this in conditions where you don’t have growth. It is based on a particular story about ‘business confidence’ and the idea that the real problem in terms of generating growth is excessive debt and that therefore regardless of macroeconomic conditions what you need to do is cut the debt. That means radical budget reductions to stabilise the budgetary position and begin to actively reduce debt, even in conditions where the economy is already in recession.
So basically austerity is the belief that an appropriate policy response to recession is to cut the government budget and to do so dramatically and rapidly. Now there are two versions of this; there’s the work of Alberto Alesina and his collaborators and then there’s Reinhart and Rogoff. These interventions were both causal and constitutional, in the sense that the decision to do austerity had already been made and they became a handy thing for people to hang their hat on. Both basically make the claim that if you have too much debt it impacts on growth. The Reinhart and Rogoff stuff is the ‘we all die at the 90% debt to GDP’ argument. The Alesina school – basically the Bocconi school coming out of Milan and their Harvard collaborators – make the case for what’s called ‘expansionary fiscal consolidation’, which is really the biggest oxymoron in the world. What they basically say is that ordinary consumers and investors lie awake at night worrying about nothing more than the national debt and are so afraid of this that they are just waiting for the government to slash the welfare budget by 50%. Then they can be confident that ten years down the line there will be a smaller tax bill as a result of this, which means that in the present actual consumptive power increases because of that expectation. Therefore we all go out to Ikea and buy a couch, thus ending the recession.
Now if I’m making that sounds slightly silly, that’s because it is. That really is the argument and it is actually unbelievably silly. I have a general view that when things are hopelessly counterintuitive they are usually wrong. And that’s the argument which underpins austerity, as opposed to fiscal consolidation. Fiscal consolidation is a perfectly sensible thing to do from the point of view of budget management. If you are growing, pay back some debt, then you can accumulate more debt if you need to in the future. That’s a sensible policy. When you’re all in recession and you’re all each other’s trading partners, such as in Europe where you’re everyone else’s trading partner and share a currency none of you control, and you all try and do this once, the result is an economic disaster. And that’s exactly what happened. This is why every country in the Eurozone that has undergone an austerity programme actually has more debt now than when they started.
Okay. Well let’s come back to the Eurozone. Your book is about the history of austerity. So what are the historical roots of the idea? Where do you see it as emerging from and in what historical circumstances?
It goes back to the beginnings of capitalism, which for me is pretty much around the time of the English Revolution. The notion that capitalism has always been with us because there have always been markets kind of founders on the rocks of empiricism. The Romans had mortgage markets. Does that make them capitalists? Well no, because 95% of their output was created by slaves. It was a tribute-taking empire based on the power of slaves. So the fact that you have markets doesn’t tell you anything about the social formations within which they are embedded.
There is a neoliberal and liberal myth that markets and capitalism come fully formed out of the ground like Athena out of the head of Zeus, and its utter nonsense. Most capitalist institutions are less than 200 years old globally. Most of them are a product of imperialism and the late development of capitalism around the world. I’m very much with Karl Polanyi on this. In order to create market, in order to commodify social institutions and social relationships, you need to control the state. So think about what the English Revolution was. It was an attempt by a nascent capitalist class to get hold of the state so that they could make labour markets and create product markets, and create property markets. None of that is given by God.
Now John Locke, chief propogandist for this mob right from the start, knows in his heart that he’s got a problem. The problem is you need the state to make markets. Markets are brilliant because they create astonishing inequalities so you and your mates all get rich. But if you create inequalities you have all these people who are left here going: ‘Hang on a minute, I used to have some degree of social stability and security and you’ve torn all this up and given me nothing more than the possibility of a labour market. You’ve got all the money and I’ve got all the crap. I going to go and burn your house down.’ So you need a state that is strong enough to create markets, but also to protect your property. Cue the second amendment to the American Constitution. Any state that is strong enough to protect your property is also strong enough to take your property. So right at the beginning you have this dilemma. You need the state, but you don’t trust the state. You can’t live with it and you can’t live without it. Now move forward 100 years and capitalism is more developed. This is the beginning of the Scottish Enlightenment. Two figures are brilliant here; David Hume and Adam Smith. Hume on public debt and Smith on taxes and paying for debts. Smith has an observation in the Wealth of Nations where he says:
For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security.
So Smith admits the inequalities that capitalism generates. Indeed, he says this is marvellous, but we’ve still got this problem – we need the state. But we don’t want to pay for it. Smith on taxation is fascinating. He starts off talking about proportional taxation. He says that those with the most skin in the game, to use the contemporary term, should pay the most taxes, because they get the most protection. But then he immediately realises that that’s a tiny part of the population: him and his mates. So he jumps to a budget proposal which is exactly the same as House Republicans in 2013: the elimination of all taxes except consumption taxes, which of course hits the bottom end of distribution far more than the top. But Smith is smart enough to realise that that’s never going to raise enough revenue. So what’s he going to do? In the end he decides that we’re going to have to find some other way of funding the state. Cue his conversations with David Hume about debt.
Now public debt is a wonderful thing because if you think about it it’s a great scam. You are the state and I am the capitalist. And I want my property protected. But I also want to be able to control you in some way. So I’ve got this thing called a debt instrument. I will give you money and you will use to protect me. But the privilege of doing so means that I’ve got you on a leash and you also have to make interest payments to me. And at the end of the term you give me all the money back! I mean could there be a better deal than this in the world? But Hume figures out that there’s a problem here. In order to make that work you’re going to have to pay a rate of interest on the bill which is as good, if not higher, than you would get in the private market.
Otherwise no one would invest anymore?
Right. If everyone invests in public debt, what happens is the economy? It shrinks. So the debt gets bigger, the economy gets smaller, and you end up, as Hume puts it, in hock to foreigners. You end up indebted, the whole nation goes bankrupt, the capitalists flee and the whole thing is screwed. So both Smith and Hume were incredibly pessimistic about the state of British public finances and they actually thought by the 1790s that the whole thing would be finished.
Now here’s the thing: they were right. There was a huge accumulation of debt between 1776 and 1815. At the end of the Napoleonic Wars British debt to GDP was 246%. It was massive! By 1867 though it was in single figures. What happened? Did they go on a huge austerity binge? Quite the contrary. What happened instead was you had had a period of unbelievable growth. Growth financed by imperial expansion, gunboats and all the rest of it absolutely. But also endogenous growth, the growth in consumptive markets, growth in GDP. The British economy by the 1870s – when it was the largest industrial economy in the world and constituted over 30% of GDP – was so much bigger in comparison to what it was at the time that Hume was writing that that same bit of debt became tiny. Because the GDP got bigger, the debt got smaller. And by 1867 it was down to single figures.
So imperial expansion wiped out the Napoleonic debt?
Yes, but wasn’t just imperial expansion. It was also selling stuff to the Americans, the Canadians, the Argentines. So yes there’s the imperialistic side of capitalism to be sure. But there’s also the developmental side which as Marx said compels capitalists to expand across the globe. That’s what happened, and the national debt shrunk as the economy exploded. So what you have there is a cautionary tale of austerity. This idea that government spending crowds out private spending, shrinks the economy, hits investment; its 200 years old and we have empirical example after empirical example showing that this is not true.
And were there people at that time who are arguing that Britain should be cutting spending?
Absolutely, they had exactly the same debates. Pitt the Younger wanted to introduce child allowances and you can look at Hansard and you’ll find people talking about how this is going to harm the private markets and all this bollocks. So you had exactly the same story. There’s a fabulous book from 1994 by Albert Hirschman, I would highly recommend, The Rhetoric of Reaction: Perversity, Futility, Jeopardy. It basically says that regardless of the policy area, conservative arguments only have three forms. The first one is perversity, which is a classic anti-welfare state argument. You try to give people a leg up and what it does is it creates dependency. Then there’s the futility argument, which is that you can try policy X, but it will never work and you will end up back where you started. And the last one is jeopardy and that’s the most powerful of all. The argument is that you can do policy X and you think it will be good in the short term, but in the long run you will throw the economy off a cliff. And austerity is a jeopardy argument. You might want to compensate through spending, but you’re just adding to the debt and you’ll just make it worse. You bring the whole system into jeopardy. Plus there’s a bit of perversity and futility in there as well. Which is why it’s such a powerful rhetorical argument.
So if austerity is so counter-productive why is it still being pursued? And if it’s not working why do they not change direction?
Well part of it is that too many people’s careers, incomes, and prestige are at stake, people who have built their entire careers during 30 years of neoliberal growth. What we had prior to 2008 was basically a global asset bubble in equities, real estate, and commodities, which finally popped in 2008. The resulting bust was bailed out, which is basically reinsuring the global investor class with the taxpayer’s money. They privatised the profits and socialised the losses. Given this, it’s very difficult for these folks to admit that all the stuff they were talking about, you know, the great moderation, inflation targeting, all those growth models, were basically all crap. The folks in charge are not going to turn around and say, ‘Gee guys, I guess everything we thought since about 1970 turned out to be really dodgy, let’s put the brakes on and dust off a copy of Keynes’s General Theory and implement that.’ It’s just not going to happen. So there’s a lots of bureaucratic political reasons for austerity to continue because no one has any interest in explaining what actually happened: the greatest bait and switch in human history.
The second reason is that the post-war consensus ideas were so thoroughly attacked in the 1970s and into the ‘80s that you have a generation of policymakers who just don’t know the old stories. They were literally never taught them. If you did your university training in the late 1980s and early 1990s you’d still hear this kind of echo of something called Keynesianism in a macroeconomics class, but it’s a footnote. Instead you are taught that the economy is on a long run positive growth trajectory and monetary policy and inflationary targeting allows you to manage that, but otherwise there is no role for fiscal policy. It’s complete nonsense, but if you buy that framework things like expansionary austerity seem reasonable because you’ve never been forced to think about notions of inequality, aggregate demand or any of those structural factors, which actually really matter in the macro economy.
What’s the relationship between neoliberalism and austerity? My understanding is that there was quite a lot of public debt in the Reagan period in the United States.
If you look at the work of Wolfgang Streeck on this, he’s got some great stuff on this topic. He’s got a book that’s just come out in German, so if anyone can read German I thoroughly recommend it. He’s also got an edited volume that’s just came out as well, which is called Politics in the Age of Austerity. Really worth a read, it’s got some great essays. And what he points out is that right across the OECD there’s two things going on. One is that debts have been going up. Public debt is a tiny part of it, but private debt is becoming huge. This is Colin Crouch’s ‘privatised Keynesianism’ thesis. You stop budgetary deficits and end up with credit card and household debts. The other thing is that if you take a five-year moving average of the compounded growth rates across the OECD countries, growth rates have just collapsed. Now does this point to a notion I used to give short thrift to but am really having to rethink this now – the old Marxist notion of the long run crises of overaccumulation and overproduction? If you accept that growth over the last thirty years were really drawn from a giant asset bubble, and then you see growth rates going down and debts going up, what you’re looking at is the replacement of real growth with more and more debt. And part of that story is that what wealth that was being generated was being siphoned off to a very small part of the population. So there’s something deep and structural going on here.
Now to go back to the question: what is the relationship between the two? Neoliberalism talked a good line on debt but always liked certain categories of debt. So US military spending is never regarded as debt even though economically it’s a deadweight loss. You can talk about local stimulus effects or whatever, but at the end of the day the military doesn’t make you any money, it just costs you money. Of course you could say the same thing about health care, but that’s an entirely different conversation.
So neoliberals are very much interested in reducing budget deficits, stabilising debt and all the rest of it, but only in certain programmes. That’s standard left-right politics. What changed in 2008 was that as a result of the bail outs you have this massive explosion of public debt. So in the US debt to GDP went from 61% to 89% in three years and in the UK it went up by a similar margin. Ireland and Spain are classic examples. They were 13% and 26% of GDP respectively; tiny public debts that are now both over 100% because they absorbed the cost of saving their financial sectors. It was neoliberalism that caused this bust through deregulation, privatisation, the belief that banks can manage their own risks, derivatives will make the world more stable and so on. Add all that stuff together and you end up with a set of ideas that allows the construction of a system that is inherently fragile and super over-levered. So when this goes bang and lands on the public balance sheet, public sector debt explodes.
And the neoliberal trick, which I call in the book the greatest bait-and-switch in human history, is to then turn around and say, ‘Look at all that debt! We’ve been spending like drunken sailors, we need to start cutting!’ This completely forgets that the debt is basically the transferred costs of bailing out the assets and income of all the people who have all the assets and incomes when their banks blew up. So it is a creditor and debtor stand-off, where the creditors have been bailed and now want the debtors to pay. So I think the politics of neoliberalism is different in different moments. It’s very Janus faced. When they are in charge they don’t really practice austerity, but when everything goes to hell in a hand basket they totally embrace it.
It’s very cynical.
It’s very cynical. But it’s very practical. Imagine you’re a German policymaker. You wake up one morning and there’s been this huge financial crisis and you say to yourself, ‘Well our bankers don’t do this dodgy Anglo-Saxon thing with derivatives.’ Then your policy adviser tells you that in fact Deutsche Bank is the world’s largest derivatives trader.
When you talk to market-makers they will tell you that Deutsche Bank is run entirely by Britons, Americans, Israelis and South Africans. The Germans basically make the coffee, sign the compliance forms, and have no idea what’s going on. But they were in hock for a couple of trillion dollars, constituting 86% of German GDP with an operational leverage of 44 to 1. That means that a 3% return against their assets renders them illiquid, if not insolvent.
Meanwhile, across the rest of Europe you had all these countries whose bonds are denominated in Euros. So they’re treated exactly the same as German bonds, which is why you have this yield compression in 2000 when all the interest rates on all the different bonds converge. So European banks bought as many of them as possible. They stuffed their boots full to make as much profit off of this declining yield. Basically, they became too big to fail as a business model. Because by becoming so big their cost of capital went down and they knew that if they got into trouble they could turn round to the national regulator and say, ‘If you allow us to fail you’ll wreck the whole economy.’ Then the regulator says, ‘Well we’d love to help you but we don’t have a printing press anymore, you need to go to the European Central Bank.’ And the ECB is run by the Germans who turn around and say, ‘Sorry, you want us to bail what!?’ Because the basic problem is that Germany is not big enough to bail the system that the Euro allowed the banks to build. The total assets and liabilities of the European banking system is about three times the size and twice the leverage of the American system.
So go back to that German policymaker. It wouldn’t be cynical at all for him to turn round and say, ‘Hang on a second, never mind Deutsche Bank, what’s the total assets and liabilities position of the collateralised European banking system? Holy crap! That big? Right, there’s no way we can bail this. If we try to take on all that debt what would happen? We would end up killing ourselves. Right, so what are we going to do then? We going to blame it on lazy southerners, we’re going to allow the ECB to add as much liquidity as possible, and we’re going to squeeze the crap out of these Southern economies until bond yields stabilise and in the pray that the whole thing goes away.’
Okay. But that doesn’t seem very feasible. If Germany can’t pay for the banking crisis, then how could Greece and Spain pay for it?
They can’t. That’s the dirty little secret. In Austerity at the end of chapter three I have written a kind of speech that will never be given from a Eurozone leader to the population of a country telling them what’s actually behind the Euro crisis. It has nothing to do with states spending too much, because for states to spend too much you have to have someone who is willing to lend them too much. So let’s look at the lending side. Well the lending side is the north European economies who were exporting like demons and earning all this money but not spending. So they take those savings and they buy southern debt. And what do the southern economies do with this credit (the reciprocal of the debt)? They go off and they buy German and Dutch products. The whole thing works as long as the credit cycle is going. But once it pops, the whole thing falls apart and that’s where we are.
Now you’ve got these banks filled with all this debt and the yields spike. Now think about it this way. A typical bank has got a whole portfolio of assets including government bonds on its book. If you’re a banker and you’re going to lose money on Greece, you need to make it up somewhere else; otherwise you lose your job. So you sell Portugal to make up the loss. But so does every other bank. So the value of Portuguese bonds goes down to zero. And what do you do? You try and get ahead of the bank run. You try to sell Irish debt. And once you’ve gone to Greece, Portugal and Ireland, the only place left is Spain. But Spain is too big to sell on and it’s heavily contaminated into the French banking system. And if you blow up the French banking system, you blow up the German banking system. So as soon as the Germans figured this out they put their foot on the neck of Greece and Ireland and Portugal and said, ‘You guys are going nowhere, because your contagion leads back to us.’
Okay, so it sounds like they don’t have any option but to pursue austerity without fundamentally undermining the financial system right?
Well the problem is in Europe they had completely the wrong interpretation of all this. The markets didn’t actually want austerity. They weren’t worried about debt, they were worried about break-up risk; because a bank holding Irish, Portuguese or Greek debt when the Eurozone breaks up is holding shit. The real problem is that you have a central bank that’s not a real central bank. So you look at the ECB it’s essentially a currency board with a liquidity pump and an inflation target. It’s constitutionally not allowed to mutualise debt. It is institutionally not a proper lender of last resort. So what they were doing was basically cutting off the leg of the patient because they had a problem with their arm but they are not allowed to work on arms. It’s very important that people understand this. Even if there was no alternative to stemming the haemorrhaging of the banking system, austerity was not the proper response. Making the ECB into a proper central bank was and they totally got that backwards.
But why didn’t they do that if that was the obvious solution?
Because at the end of the day somebody has to back the central bank and who is big enough to credibly back the central bank?
This is the first of a two part interview. The second part is available here.
Tom Mills is a researcher and PhD candidate at the University of Bath and a co-editor of New Left Project.