Abstract
When neoclassical and monetarist ideas were gradually gaining political ground in the late 1970s, this was done by depicting the previous 30–40 years of economic policies inspired by the Keynesian consensus as old-fashioned, ideologically flawed and inconsistent with the real world. After all, it was claimed, unemployment and inflation did coexist in reality. The post-war golden age with full employment, its trend towards greater social equality and intertwined technological and social progress resulted in the collapse of the Bretton Woods system and the stagflation crisis of the 1970s, which deficit spending was hardly able to get under control. Instead it actually made things worse, it was said. And once the anti-inflationistas had become politically firmly established and market liberalism had gained mainstream status throughout the North Atlantic world, neoliberals proclaimed the victory of market efficiency, dismissing Keynesian-style social thinking as zombie economics. Yet the systemic financial crisis and the ensuing Great Recession have seen the bastions of market neoliberalism creed implode. Now market neoliberals have become the zombies of our time and it is in turn their ‘dead ideas that still walk among us’. 1
One of the most popular, but also most dangerous ideas of zombie economics has been austerity in disregard of the real world business cycle. Not just now, but for centuries of economic policy thinking and policy-making, austerity has been a recurring theme of modern capitalist history, though the learning curve has remained stunningly flat over time. This is the central theme of Mark Blyth’s book: he points out three reasons for austerity being a dangerous idea. First, it has never worked in practice; secondly, it has always made the poor pay for the mistakes of the rich, and thirdly, austerians tend largely to ignore the ‘fallacy of composition’ effects of their policy prescriptions or, as Blyth likes to call the latter, their instruction sheet. So why was the Keynesian rebirth in the immediate aftermath of the crisis so short-lived, only lasting a mere 18 months? How come those dead ideas for evidentially failed policies are still alive and kicking?
Put in a nutshell, Blyth’s analysis provides answers that are as much complex as they are comprehensive. Nevertheless, the book is not particularly hard reading, offering accessible political economy at its best even for non-economists. At times it is indeed polemically entertaining, and I highly recommend reading it. Nonetheless it deserves careful study both by those who believe in the morality play of microeconomics and by those who question it from an essentially macroeconomic point of view. Both sides will find Blyth’s answers stimulating them to dig deeper than his 240-page analytical framework can possibly allow.
Taking up the question raised above, why, in the spring of 2010, did ‘you cannot cure debt with more debt, so stop spending’ become the slogan of the year, and why, more than three years on, is the specter still haunting populations in the Western hemisphere? The answer lies in both psychology and politics. The psychology is quickly explained. When spending is regarded as a sin, no politician wants to be caught as a profligate spender allegedly living at the expense of future generations. The author reminds us that ‘debt’ and ‘guilt’ are homonyms in the German language. This is of great importance since Germany has a key crisis resolution role to play in Europe. Alongside this is the confusion between private household debt and public debt. When private households have accumulated debt that they can hardly serve, they need to reduce it to a sustainable level. The confusion climaxes when politicians such as German Chancellor Angela Merkel proclaim public debt sustainability to be equivalent to that of private households, referring to the thrifty and virtuous Swabian housewife as an example for state budgets (‘the Swabian housewife knows perfectly well that she cannot spend more than what she has saved before’). As Blyth consistently argues, the morality play of microeconomics makes people believe that the venom is the cure. At the end of the cure, the patient, a united democratic Europe, might well be dead.
Now to the politics of it. Economic theory has been described by Keynes as the power of ‘ideas of economists and political philosophers, both when they are right and when they are wrong, [that] are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.’ 2 Blyth’s analysis provides indeed not less than an application of Keynes’ famous dictum.
Blyth examines austerity’s twin histories, intellectual and natural, in the middle part of his book, looking first at the power of ideas and their history. The intellectual history of austerity reaches back to its classical origins in Locke’s Second Treatise of Government (1690) and goes up to modern day academic papers by austerians from the Milanese Bocconi University or the IMF. Readers less familiar with economic theory will get the gist of the thoughts of classical liberal theoreticians and their inability clearly to see the role of the state in the economy (Hume, Smith, Ricardo), of the new and neo liberalisms of the earlier 20th century in Britain (famously, Keynes vs. the Treasury View), of the infamous response of the ‘liquidationist’ Hoover administration 3 to the crisis of the late 1920s and early 1930s that quickly transformed the crisis into the Great Depression, and of the Austrian (Schumpeter, Hayek, Mises) and German (Eucken and the Freiburg school of ordo-liberal economics) schools of thinking. The originality of Blyth’s intellectual history of austerity lies in the fact that he manages to relate the cornerstones of historical market-liberal economic ideas to current neoclassical academic policy advice that, as Blyth demonstrates, has had an enormous influence on current policy decisions in Europe and the US to embark on austerity. In that sense, Blyth is an archaeologist of prevailing economic ideas, without being a Marxist. Blyth is far from bluntly saying that the ruling ideas of each age have ever been the ideas of its ruling class. Nevertheless, he asserts that these are bad ideas and always have been, so there must be more to it than meets the eye.
This leads us to the second part, austerity’s natural history. From the crises of the gold standard in the 19th century to Hoover’s and Brüning’s responses 4 to the aftermath of Black Friday, Blyth’s fascinating analysis of recurring austerity policies and the politics that led to them relates to the most recent three to four years. The book was written and published before Pollin, Ash and Herndon provided the world with empirical proof 5 that the research results of Carmen Reinhardt and Kenneth Rogoff 6 concerning the relationship between public debt and GDP growth were based on coding errors, selective exclusion of available data, and unconventional weighting of summary statistics. This led to serious errors that inaccurately represented the relationship between public debt and GDP growth among 20 advanced economies in the post-war period, in that they claimed that economies could hardly ever recover from debt-to-GDP ratios exceeding 90 per cent. Their paper had an immediate influence on top policy deciders, ranging from Manuel Barroso and Olli Rehn, President and Vice-President of the European Commission, German Chancellor Angela Merkel and her Finance Minister Wolfgang Schäuble to the Labour and Tory governments in the UK and of course to large parts of the political elite in Washington DC. The purported 90 per cent trigger for doom and gloom provided a bazooka to austerians against anybody suggesting that the great balance sheet recession needed a more sustained fiscal stimulus precisely to avoid the doom and gloom. Blyth has all the essence of the debate, even before the empirical rebuttal, in that he shows the dangerous consequences of economic thinking based on stylized models rather than the empirical facts of the real world.
But even more so, Blyth shows that – in contrast to widespread belief – we have not seen any government profligacy at all in the aftermath of the financial meltdown. What the North Atlantic world experienced was governments taking over private debt by rescuing the troubled banking sector. For Blyth, rechristening a private debt crisis that was enabled and driven by an allegedly efficient (since deregulated) financial sector gone mad as the ‘sovereign debt crisis’ of profligate southern European governments is a case in point for the ‘greatest bait and switch in modern history’ (page 73). The Greek sovereign debt crisis in 2010 quickly turned into a European tragedy. Greece in fact was the sole European economy with profligate government spending and an ingenious finance ministry assisted by Goldman Sachs to cover up the over-stretching of European fiscal rules. Yet it gave weight to the view that the European crisis was due to peripheral countries’ governments living beyond their means and served as a pretext to prescribe spending and wage cuts throughout Europe. However, slashing government spending in a downturn reduces aggregate demand, in turn leading to reduced output and employment. As Keynes put it famously in 1937, ‘the boom, not the slump, is the right time for austerity at the Treasury.’ In 2010, European economies were light years away from a boom, instead still struggling to narrow output gaps and trying to return to previous growth rates. Yet, Blyth describes how the U-turn was made and austerity unnecessarily self-imposed across the continent. More so, Blyth correctly points to the conditions of the single currency as an additional burden – comparable to the gold standard – necessitating EMU member states to adjust in the most painful way. According to the neoclassical instruction sheet, the absence of nominal devaluations implies that real effective exchange rates need to become downwardly flexible by means of internal devaluation, or in other words, deflation. The Greek crisis came as a welcome surprise guest to the table of European finance ministers. Instead of focusing on repairing the damage inflicted by the financial sector and reducing the overhang of private debt by means of easing the painful deleveraging process of private households and enterprises, EU and G20 finance ministers decided to shift into reverse gear and reverse the fiscal stimulus. Public not private debt became the number one problem for them.
Applying basic arithmetic could have taught them otherwise. The simple truth that the debt-to-GDP ratio had a denominator could happily be ignored since another case in point of highly influential academic research was at hand to fudge the austerian narrative. Blyth describes in detail how the ‘tales of fiscal adjustment’ by Alberto Alesina and Silvia Ardagna 7 from the Bocconi school of economic thinking found their way into the meeting of EU finance ministers in Madrid in April 2010, where Alesina reported on his findings. Their idea of ‘expansionary fiscal contraction’ quickly found its way into the economic policy speeches and official documents of all European institutions, serving the purpose well of defending expenditure cuts by allegedly improving business confidence and consumer expectations. Ever since then, rational expectations and ‘confidence fairies’ have built the cornerstones of European economic policy, of which Blyth reaches the following verdict: ‘They are the final nail in Keynes’s coffin because they make the most contractionary of circumstances expansionary. In such a world, the slump is the perfect place to cut while spending is always and everywhere the wrong policy.’ (page 174) Yet, the bearing-no-relation to the real world, quasi-religious beliefs of austerians in Ricardian equivalence, and the belief that investment and growth from confidence, all miss the essential point that we cannot all be austere at once. Unfortunately, this is precisely what has been attempted in Europe, at a huge social cost and accompanied by a steep fall in European citizens’ confidence in European political elites. In countries where, willingly or not, private sector deleveraging is taking place, austerity has led to high deficits and failure to reduce debt levels: ‘Austerity doesn’t work. Period…. [In the absence of] currency devaluations and accommodative pacts with trade unions … it has never once ‘done what it says on the tin.’ (page 229)
Of course, Blyth does not hide the fact that there have been austerity winners, the wealthy who have been able to watch their wealth grow practically in line with the application of the neoclassical instruction sheet and the increasing financialization of the economy. What now? The war of ideas is set to continue until the current crisis, the deepest and longest since the Great Depression, is resolved. For that, financialization must be abandoned. Full employment, a stable system of finance serving society and the real economy, and a new global monetary system of stable currency exchange must be established 8 . To equip oneself with knowledge of the war’s historical roots and the ideological sources of current dangerous ideas constitutes a necessary precondition to take up the challenge. Mark Blyth’s book does nothing less than that.