Having surveyed the history of economic thought on the subject of austerity, Blyth turns to its “natural history,” the actual application of austerity policies in real economies. He finds little evidence that such policies are effective in ending recessions and generating economic growth.
Blyth begins with the observation, “It’s not until the early twentieth century…that we encounter states that are both big enough to cut, and democratic enough to cause problems for austerity policy.” Austerity policies are harder to sustain in a democratic society because they often place a higher priority on protecting the wealth of the haves than promoting economic growth and employment for the have-nots. Adam Smith, for one, endorsed that priority when he said, “In so far as it is instituted for the security of property, [government] is in reality instituted for the defense of the rich against the poor.”
A key issue in the early twentieth-century dispute over austerity was the gold standard. Rich creditors wanted their loans to be repaid in currency with a fixed value in gold. The focus on maintaining the value of the currency limited the government’s options for dealing with recessions, since nothing that weakened the currency and threated a run on gold was acceptable. Measures that risked inflation, such as lower interest rates to facilitate borrowing, or deficit spending to increase consumption and employment, were off limits. In troubled times, austerity policies protected creditors, but high interest rates and unemployment hurt debtors and workers. Such policies became increasingly hard to maintain in democratic societies. Blyth regards the European common currency as the functional equivalent of the gold standard, and he sees austerity measures there benefiting Northern European creditors at the expense of Southern European debtors.
During the Great Depression, countries that abandoned the gold standard and its associated austerity policies fared better than those who tried to maintain them. That experience convinced many economists that austerity was indeed a dangerous idea. The sad thing about that historical era is that so many countries relied on war spending to get their economies growing again. Keynes observed in 1940, “It is, it seems politically impossible for a capitalist democracy to organize expenditure on the scale necessary to make the grand experiment which would prove my case–except in war conditions.” Blyth argues that the previous failure of austerity policies enabled the aggressive militarists to come to power in both Germany and Japan. (He does not accept the monetarist argument that hyper-inflation in Germany was to blame, since it had been brought under control well before the Nazis came to power.) Meanwhile, continued austerity in France prevented modernization of the French military to deal with the German threat.
In the more recent economic crisis, Blyth focuses on the debate over austerity in Europe. The new advocates of austerity, such as Alesina and Ardanga, have cited Denmark, Ireland, Australia, and Sweden as examples of countries that have restored confidence and resumed economic growth by cutting government spending. While European leaders were quick to use this argument to support belt-tightening in even more troubled economies, the weight of economic opinion appears to be turning against it. Recent research by the International Monetary Fund has failed to find a positive correlation between deficit reduction and economic growth.
Other cases cited in support of austerity theories are Romania, Estonia, Bulgaria, Latvia, and Lithuania, since they managed to make deep fiscal cuts but achieve relatively high growth rates by 2011. Like many others, they were recovering from unsustainable economic booms characterized by loss of traditional industries, heavy investments in finance and real estate, dependence on foreign capital, and an overabundance of risky loans. Blyth doubts that those recent higher growth rates are sustainable: “The much-lauded catch-up is limited, fragile, and likely to be reversed.” The recovery doesn’t fit the austerity scenario in some important respects, since most of these governments have even more debt now than before, and the economic expectations of citizens (supposedly the key to resumed spending) remain very low.
Blyth makes it abundantly clear that this is an anti-austerity book. Although he says that “sometimes austerity can be the correct policy response,” I never found a clear statement of when that is. Certainly, he believes it isn’t now.
What then is the alternative? One country that seems to have found one is Iceland. When it experienced a huge financial collapse in 2008, it let its banks go bankrupt, letting “institutional creditors shoulder the cost of the collapse rather than the taxpayer.” It also increased taxes on the wealthy and strengthened its social welfare system. The result is that its deficit is falling, unemployment is low, and real wages have been rising. Blyth contrasts Iceland with Ireland, where the government guaranteed all bank assets at a cost of 45% of GDP and also cut spending, but where both public debt and unemployment rose substantially.
In the United States, it’s too late not to bail out the banks, but Blyth does like taxing the rich as a way of reducing debt without cutting useful government spending. The wealthiest 1% of the population amassed large fortunes during the economic boom; the richest 400 Americans alone own more assets than the bottom 150 million, nearly half the population. And the Great Recession has not yet been followed by any reduction in inequality, as occurred after the Great Depression of the 1930s. Blyth seems sure that the country will eventually tap into that enormous pool of private wealth and turn some of it to public good. So a policy of protection for the wealthy, but belt-tightening and insecurity for the rest of us will be replaced by something more democratic and more workable.