Mark Blyth. Austerity: The History of a Dangerous Idea. Oxford University Press, 2013.
Austerity has emerged as a dominant–if not the dominant–public policy response to the financial crisis and ensuing Great Recession. In Europe, leading politicians and central bankers impose austerity measures on struggling economies as a condition of receiving loans, forcing their governments to curb spending, reduce public payrolls and cut public-employee pensions. In the US, Republican lawmakers have become preoccupied with spending cuts to the exclusion of almost every other public policy besides national defense. Apparently, the economic crisis has encouraged the view that nations are out-of-control spenders who must be reined in for the good of the economy.
Mark Blyth, Professor of International Political Economy at Brown University, joins an increasing number of political scientists and economists who are questioning the rush to austerity. Is it really good economics, or is it a blend of weak economic arguments and strong political opportunism?
Blyth defines austerity as:
…a form of voluntary deflation in which the economy adjusts through the reduction of wages, prices, and public spending to restore competitiveness, which is (supposedly) best achieved by cutting the state’s budget, debts, and deficits. Doing so, its advocates believe, will inspire “business confidence” since the
government will neither be “crowding-out” the market for investment by sucking up all the available capital through the issuance of debt, nor adding to the nation’s already “too big” debt.
Blyth regards austerity as a dangerous idea for several fundamental reasons. First, there is little hard evidence that austerity policies actually work to pull countries out of economic recessions. Second, austerity is unfair to the poor, who end up paying for the financial mistakes committed by the rich in their own self-interest. Third, the argument for austerity rests on fallacious reasoning and misrepresentation of economic facts.
The main fallacy here is the “fallacy of composition,” which assumes that what is true for the parts is also true for the whole. Although an individual household can improve its economic position by cutting spending, that is less true for an entire nation or the global economy. As Keynes explained with his “paradox of thrift,” too much saving by too many people at the same time reduces consumption, discourages investment and perpetuates high unemployment.
The main misrepresentation of economic facts is the characterization of the crisis as primarily a “sovereign debt crisis” brought on by too much government spending. Blyth views it instead as “a banking crisis first and a sovereign debt crisis second.” Austerity is partly a political argument intended to shift responsibility from powerful financial interests to ordinary citizens. It has also become a kind of morality play. “Austerity is the penance–the virtuous pain after the immoral party–except it is not going to be a diet of pain that we all share. Few of us were invited to the party, but we are all being asked to pay the bill.”
In Part One of the book, Blyth sets out to explain how the private sector generated the crisis in both the United States and Europe. With regard to the US, economists have identified many contributing causes, but Blyth focuses on the four he regards as most essential:
- During the US housing boom, banks not only made too many risky mortgage loans, but the large investment banks relied too heavily on mortgage-backed securities as collateral for their own borrowing. When those securities lost value, there was a run on the banks in the “repo” market where businesses lend to one another. Credit dried up, and banks had to start dumping assets to maintain their liquidity and solvency.
- The availability of “credit default swaps,” which in effect insured banks against mortgage defaults, both encouraged banks to be more reckless in issuing mortgages and mortgage-backed securities, and spread mortgage risk to the insurers.
- Financial analysts grossly underestimated the probability that a large number of financial assets could lose value at the same time. They assumed that individuals acting in their own self-interest could manage risk, but what actually happened was that many self-interested actions combined to create a systemic risk too large for the private financial sector as a whole to manage.
- The prevailing neoliberal economic ideas celebrated the rational individual and the efficient markets that result when such individuals are free to make their own economic decisions. They did not anticipate large-scale systemic failure or support market regulations to prevent it.
In Europe too, the crisis “has almost nothing to do with states and everything to do with markets. It is a private-sector crisis that has once again become a state responsibility.” Ireland and Spain did not have excessive debts or deficits before they experienced privately funded housing bubbles. The problem in Portugal and Italy was not primarily public debt either, but low-growth, low-productivity economies. One country that did engage in excessive public borrowing and spending was Greece, where the government was trying “to increase personal income and public consumption, an understandable response to decades of instability, violence, and political polarization.” The advocates of austerity used the case of Greece to brand the entire European crisis as a “sovereign debt crisis,” with government belt-tightening the primary solution.
Leading up to the crisis, the European banks engaged in some of the same reckless borrowing and lending that brought down the US economy. But in this case, they were aided and abetted by the European Monetary Union. The replacement of local currencies by the supposedly stronger euro made lending to weak economies like Greece and Italy seem safer. Interest rates fell dramatically in the peripheral countries, indicating that debts owed in euros were considered less risky. Yet the yields remained high enough to motivate European bankers to flood the periphery with cheap money. “While the Northern lenders lent to local banks, property developers, and the like, periphery consumers used this tsunami of cheap cash to buy German products, hence the current account imbalances….” The stronger core and the weaker periphery seemed to be getting rich together, the core by exporting capital and goods, and the periphery by importing them. Relative to the GDPs of European countries, European banks held financial assets far greater than those of US banks, and those assets included many of the same shaky securities that brought down US banks. Once the banks started to fail, the credit crunch hurt all the weak economies, whether they already had heavily indebted governments or not. Now many governments faced higher borrowing costs, the expense of bailing out troubled banks, and the declining tax revenues and higher social expenses resulting from a contracting economy. So what began primarily as a private banking crisis quickly became a sovereign debt crisis.
One could argue that even if the financial crisis originated in the private sector, public austerity is still required to resolve it. In Part Two of his book, Blyth examines the historical record for evidence that austerity is good economic theory or good policy.