Friday, 1 May 2015

Austerity: The Almost Myth

So Labour "bankrupted" the economy by spending too much on welfare dependents? Let's look again at that claim, made by one very angry man  - along with the national media and the Tory party, repeatedly for five years - on TV this week. As is so often the case, Ed Miliband "stumbled" in response. Here's what he might have said in a more rational world.

Public debt fell in the early years of the Labour government and then increased as growth slowed in the late 2000s. See the proof here:

In fact, welfare spending rose in absolute terms throughout Labour's time in power - though as a percentage of GDP it actually fell slightly. Channel 4 reports this here:  

This is important: spending as a proportion of GDP, in the context of an ageing and increasingly sick population, fell during Labour's tenure.

Why did the debt increase so precipitously after 2008? For one, growth collapsed and tax revenues declined. Expenditure on things like out-of-work benefits increased automatically  as a necessary result of a collapse of economic activity and a fall in total employment. This is inevitable in a downturn. 

But the crisis went deeper: over leveraged banks had to be bailed out and deposits secured in order to prevent financial meltdown. In 2010 the National Audit Office reported: 

"The scale of the support currently provided to UK banks has fallen from a peak of £955bn to £512bn, but the amount of cash currently borrowed by the government to support banks has risen by £7bn [to a total of £124bn] since December 2009."

That report is quoted here: 

The Guardian, in the same report, found that the government had initially offered £1.2 trillion to the banks, presumably to secure confidence. The amount actually spent was £123.93 billion. How much of this gets paid back doesn't concern us here, since all I want to show is that it was this borrowing - as opposed long-term welfare expenditure and a culture of dependency - that increased the national debt. Here's Keynes biographer Robert Skidelsky in the Newstatesman:

"In short, the big holes in the public finances inherited by the coalition when it took office were the result not of misguided splurging, but of the sudden emergence of deep craters in the British and world economy. This is confirmed by a 2011 IMF report, which calculated that of the 37 per cent increase in UK public debt from 2007-2011, 25 per cent was due to loss of revenues, 7 per cent to support of the financial sector and only about 2 per cent to fiscal stimulus. Furthermore, it’s true that the rise in the deficit was somewhat higher than the OECD average, but this was because British governments were more dependent on revenues from the financial services sector."

Financial "exuberance" - and the accompanying waves of Minskyian fraud - stemmed from unsustainable profit expectations, themselves based on past profits made at higher rates of growth. Financial institutions took greater and greater risks across the world as profitability decreased in the real economy (due to the end of the IT consumer boom in the early 00s and spiralling oil prices). Essentially a "choke-chain effect" (James Galbraith) on growth was curtailing profitable investment, which led financial institutions to greater - and more fraudulent - lengths to secure higher returns. All it took was a downturn in US house prices to send mortgage securities prices downward and to presage a global banking collapse (it was very often European banks that were most exposed to these CDOs).

Have the Tories "sorted out Labour's mess" by cutting spending? Though they've decreased the spending deficit, the public debt has doubled relative to GDP because growth is sluggish and erratic and there is little to no renewed consumer demand built into the recovery. Moreover, the rest of the West is suffering from an absence of demand in the midst of continuing volatility. The government is withdrawing from the market, but private investors have no demand on which to base investment.

This is the harsh reality that refutes the neoclassical belief that government "crowds out" private entrepreneurs. What really happens is - in good times and bad - the state secures and expands markets. The state guarantees growing output by providing a safety net and a healthcare system. This makes private investment and growing demand by households possible. There is in fact no reason for the state to withdraw from this role. A strike by the holders of sovereign debt remains highly unlikely as long as the central bank (the Bank of England) controls interest rates. Moreover, there is no real reason for interest rates to rise. Inflation - which is broadly very low - doesn't need to be stamped out any time soon. Britain is not Greece. It has autonomy in its fiscal and monetary policy and can use both. The government can - and evidently does - live with high debts. The path to future growth - led not by speculative fraud in the financial sector and "asset-price Keynesianism" in homes and mortgages, but by worthwhile investment - lies in the public, not the private sphere.

The reality of Tory austerity, according Simon Wren-Lewis, is that the bulk of it has been postponed. The rate of cutting slowed significantly after 2012. This allowed the UK economy to grow - a bit. But growth has now halved. And the Tories are planning to cut a lot more next parliament. As Mark Blythe shows in his book about austerity, "expansionary contractions" (ie cutting to growth) don't work, ever. The so called "rational expectations" of creditors are a fantasy. If you command a printing press and a currency people want to hold in reserve, then you can always afford more debt. States are not like households. If public debt leads eventually to private wealth, eventually the scale of the public debt will decline relative to the size of the economy. That said, I don't think a bit of monetary stimulus (like quantitative easing) will finally end the crisis, because investment will remain cautious while volatile resource prices and financial risk prevail. A major New Deal conducted by the state is necessary. It ultimately takes the state to guarantee sustainable growth, not markets. The state doesn't "crowd out" markets but secures and sustains them. This is what happened in the US before WW2 and Europe after. Capital was essentially disciplined. This, incidentally, is what Varoufakis would like Europe to do when he talks about the ECB issuing bonds and giving the cash to the EIF. The alternative is drudgery as real wages decline, the state shrivels, and growth remains erratic, all in the name of an imaginary "return to normal" (to quote James Galbraith).

The risk of austerity is that it is a little more than a myth. Confidence may, as Krugman says, be a fictional driver of growth. But if austerity appears successful it will shape the future of politics for a long time. The mauling of Labour - and their own self-destructive commitment to austerity - is evidence of this. 

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