Question Austerity

Via Stellaa, this is a video of Mark Blyth, professor of International Political Economy at Brown University and faculty fellow at its Watson Institute for International Studies, explaining why austerity doesn't work as an economic policy, why it is not common sense, but nonsense, and dangerous nonsense at that: "Austerity confuses virtue with vice."


[Transcript below.]

Transcript as made available by the Watson Institute: Austerity: It's big in Europe, and it's getting big here. Everybody and their prime minister has been talking about it. But what is it? Its' the "common sense" on how to pay for the massive increase in public debt caused by the financial crisis, mostly through the slashing of government services. First you take on debt, then you pay it off. Sounds simple right? Unfortunately, it's never that simple because Austerity confuses virtue with vice. Let me explain why.

Now that, supposedly, the worst of the crisis is over, there's debt everywhere – credit cards, mortgages, government debt. This is the part you know. But we need to remember how we got here. Two years ago the world's financial system exploded. The crisis blew a two trillion dollar hole in financial space-time. And collectively, the rich governments of the world spent, lent or guaranteed between five and fifty percent of their countries' annual product saving the banks. Given this, you might think that a period of Austerity is a good idea. But to see why it's not, you have to think about the world as a series of balance sheets – I know – stay with me. Whether you are a person, a household, a firm, or a state, you have assets and liabilities – a balance sheet.

Before the crisis in 2008, everyone took on a lot of debt. Back then it made sense for many of us to take on debt. For example, the bottom 40 percent of the US income distribution hasn't had a real wage increase since 1979. Really – that's true. Corporates, especially banks, did the same, but they did so to make money rather than to pay the bills. It's called leverage – which is pretty much debt seen from a different perspective. "Levering up" is a little like going "double or nothing" in blackjack. If you've taken on debt from a mortgage, you hope your house will increase in value. If you think there's a high chance the value will increase, you might go double or nothing and take on a bigger mortgage. But like black jack, there is always the risk of losing. So the banks created mountains of debt. They levered up — twenty, thirty times. It was like they had pushed in all their black jack chips, but each chip was just an IOU. So when it all went wrong governments felt they had to step in and bail them out because they had become 'too big to fail.'

This is where the balance sheet problem comes in and why the common sense of Austerity is not so simple. If you are levered-up – in debt – and your assets lose value - your house or your housing derivatives portfolio, if you're a bank - your balance sheet, as a whole, is now 'underwater.' When this happens, whether you are a corporate treasurer or a single mom, if you've got cash coming in you'll want to pay down the debt to bring your balance sheet 'above water' rather than spend money, which means no one is spending. And that's when the government comes in.

If the whole private sector is 'deleveraging'—paying back debt — then government automatically 'levers up' to compensate. Tax revenue falls so the deficit increases, unemployment benefits kick in, and public consumption takes the place of private consumption. Now make no mistake - the problem is debt – there is too much of it across the board – and we need to clean those public and those private balance sheets. But all these pieces are connected – if the public sector cleans its balance sheet at the same time as the private sector, then the whole economy craters.

It's called a fallacy of composition - what's good for any one household or firm or even state is a disaster if all try it at once. So why then have most of the governments of the world decided to do exactly this, and all at the same time?

Remember that two trillion dollar hole in space-time? The answer is that someone has to pay for it and no one, especially the banks, wants to. So governments either have to increase taxes – difficult – or slash services – easier – especially when the policy has the common sense ring of virtue about it - 'Austerity' – the pain after the party.

But here's the kicker – "the hangover" of Austerity is not going to be felt same across the income distribution. Earlier this year, the forum for the governments of the world's most economically developed states, the Group of 20, called for "growth friendly fiscal consolidation" – which, like a unicorn with bag of magic salt, is a nice idea but is pretty much bullshit, precisely because this 'consolidation' doesn't hit everyone in the same way.

Remember those folks in the bottom 40 percent of the income distribution that didn't really benefit from the financial boom – all they got was debt and the illusion of prosperity? They're the ones that actually use government services, those services that about to be so 'virtuously' consolidated. Those at the top end of the income distribution, those who made the mess in the first place, don't.

So where does this "common sense virtue" of Austerity leave us? It leaves us in a cycle where those at the bottom end of the income distribution pay for those at the top with the same stagnant and skewed incomes that now buy less, in a more unequal and unstable economy. There's a term for this – class politics – and it usually ends badly. This 'common sense' of Austerity - of reducing public debt all at once through slashing services—involves a question of equity — of who pays and who doesn't. Those who made this mess won't, while those who already paid for it through the bailout will pay again through Austerity. This is why Austerity is not common sense, it's a nonsense – and a dangerous one at that.