JUNE 22, 2012
-
Read Later
READ LATERAvailable only to subscribers. SUBSCRIBE TODAY
-
Listen
ARTICLE AUDIO
- Font Size
THE LAST FOUR YEARS have created what economists call a “natural experiment” in economic policy. As a consequence of deregulation and globalization, Britain and the United States experienced the financial crisis of 2008 in much the same way. Large parts of the banking system collapsed and had to be rescued; the real economy went into a nosedive and had to be stimulated. But after 2010, the United States continued to stimulate its economy, while Britain chose the stonier path of austerity.
The British are no more wedded to the idea of fiscal austerity than are the Americans. The Victorian aim of an annual budgetary surplus (in order to allow for the repayment of debt) has long since vanished. Both countries experienced only occasional surpluses in the postwar years associated with exceptional booms. The divergence of the two countries lies not in underlying attitudes but in political and institutional circumstances.
First, the British entered the crisis with a largely discredited Labour government; the Americans with a largely discredited Republican administration. The political swing gave power to the traditional spenders in the United States and the traditional budget-cutters in Britain. Second, despite their small-government rhetoric, Republicans have actually always accepted, and indeed promoted, large deficits in the name of national security. Third, whereas the U.S. Treasury is simply an agency of government, the British Treasury has always assumed that it should control, not facilitate, government spending. Finally, Britain, with European examples in mind, was concerned that foreign bondholders would take fright at the growth of the national debt—at least, this became the grand rationalization of austerity policy after the Greek crisis flared up in 2010.
These factors help explain the differing fortunes of John Maynard Keynes in the two countries. Homegrown in Britain, Keynesian policy was enthusiastically embraced by British governments immediately after the war. In the United States, full-blooded Keynesianism started only with John F. Kennedy and Lyndon Johnson in the 1960s. The United States under Ronald Reagan and Britain under Margaret Thatcher abandoned official Keynesianism in the 1980s, but the taxcutting, defense-boosting commitments of the Republican Party kept unofficial Keynesianism alive in the United States long after it had been relinquished in Keynes’s own country. When George W. Bush, in announcing his stimulus measures of 2001, declared that budget deficits were justified by war, a recession, or a national emergency, Milton Friedman deplored the fact that “crude Keynesianism has risen from the dead.” Paradoxically, Keynesianism, unacknowledged and often reviled, chimed in with some constants in U.S. political life better than it did in Britain, where it is still customary to pay homage to the master while ignoring his teaching.
SO WHAT DOES the experiment in economic policy tell us? At the start of the crisis, leading economic indicators in the United States and Britain were broadly similar: a government deficit of around 2.7 percent of gross domestic
product (GDP), inflation of around 2.5 percent, and unemployment around 5 percent. The greatest differences were in GDP growth, with Britain growing at 3.5 percent in 2007 and the United States at 1.9 percent, and in the debt-to-GDP ratio, with Britain at 38 percent and the United States at 48 percent. In the autumn of 2008, both countries saw their financial and real economies rapidly contract. By the third quarter 2009, GDP had fallen by 5 percent in the United States and 5.9 percent in Britain, with unemployment rising sharply.
Both the Bush and Obama administrations and the British Labour Government subscribed to a Keynesian “savings-glut” interpretation of the crisis. According to this view, excessive saving in East Asia led to current account surpluses and created global deflationary pressure. Cheap money and expansionary fiscal policy in the West in the runup to the crisis were necessary responses. The resulting asset bubbles were not the fault of expansionary policy, but due to the fact that the money was channeled into speculation rather than investment. Once the bubble burst, savings rose and aggregate demand collapsed.
It followed that recovery required a boost to demand. As President Barack Obama put it: “It is expected that we are going to lose about a trillion dollars worth of [private] demand this year [and] a trillion dollars of demand next year because of the contraction in the economy. So the reason that this [stimulus package] has to be big is to try to fill some of that lost demand.” Britain’s Labour government agreed. In 2008–2009, Prime Minister Gordon Brown pumped an extra $41 billion into the British economy; in February of 2009, Obama signed into law a $787 billion fiscal stimulus package. Insolvent banks were bailed out and the central banks of both countries started “quantitative easing”—effectively, printing money—in an effort to expand the supply of credit by forcing down bank lending rates.
The activist policies had an immediate impact in both countries. A year after the onset of the crisis, GDP growth started to pick up. However, while stimulus measures prevented another Great Depression, they helped expand government debt. In 2007, both the British and U.S. government deficits were 2.7 percent of GDP; in 2010, the figures were 9.9 percent and 10.5 percent, respectively.
Chicago economist Robert Lucas has ruefully remarked that “everyone is a Keynesian in a foxhole.” But once stimulus policies removed the danger of prolonged depression, ideological conservatism reasserted itself. The fact that the bond markets started betting against highly indebted governments gave fiscal hawks an excuse to cut state spending under the guise of restoring “credibility” and “sustainability”; in Britain, these ostensible virtues became the basis of official policy after the general election of 2010. Britain’s Conservative spin doctors fueled the debt aversion with images from the streets of Athens and analogies between the private and public purse. Unless the state learned to live within its means, Britain would become “another Greece.” Austerity, not stimulus, was the road to recovery.
AS AUSTERITY POLICIES took hold in most of Europe, a Hayekian “money-glut” analysis of the origins of the slump replaced the Keynesian “savings-glut” one. According to Friedrich Hayek, slumps result from overly loose monetary policy. Excessive money-creation by the central bank makes it possible for banks to lend more than the public wants to save. Hayek called the creditfinanced investment that results from this “mal-investment.” Malinvestment manifested itself mainly in rapidly rising housing and asset prices. These prices were unsustainable, because they were based on debt, not genuine saving. Once the default rates on mortgages went up, the banks found that their AAArated assets had become junk. So they stopped lending.
The collapse of the financial economy led to a sharp contraction of the real economy. In this view of things, the main requirement for recovery was to increase saving and liquidate the malinvestments. Fiscal stimulus would only delay a genuine recovery.
While the Obama administration continued to stimulate the U.S. economy—through the Recovery and Reinvestment Act of 2009—George Osborne, the new British Conservative chancellor, pursued a modified Hayekian experiment. The government set out to slash public expenditure by £99 billion—or 7 percent of GDP—per year by the 2015–2016 fiscal year and increase taxes by another £29 billion per year.
Two years later, the score card is in. Since May 2010, when U.S. and British fiscal policy diverged, the U.S. economy has grown—albeit slowly. The British economy is currently contracting. Unemployment in the United States has gone down by 1.4 percentage points; in Britain, it has gone up by 0.2 percentage points. And despite keeping up stimulus measures, the Obama administration has been more successful in reducing the government deficit—by 2.5 percentage points compared with Osborne’s 1.9 percentage points.
Earlier this year, Paul Krugman wrote that “Britain . . . was supposed to be a showcase for ‘expansionary austerity,’ the notion that instead of increasing government spending to fight recessions, you should slash spending instead—and that this would lead to faster economic growth.” But, as Krugman wrote, “it turns out that . . . Britain is doing worse this time than it did during the Great Depression.”
For Keynesians, this is not surprising: By cutting its spending, the government is also cutting its income. Austerity policies have plunged most European economies (including Britain’s) into double-dip recessions. At last, opinion is starting to shift—but too slowly and too late to save the world from years of stagnation.
Robert Skidelsky is John Maynard Keynes’s biographer and a member of the British House of Lords. His latest book, co-authored with his son Edward, is How Much Is Enough? Money and the Good Life.
This article appeared in the July 12, 2012 issue of the magazine.
12 comments
Superficial. But that's okay. How does the government apply Keynesian stimulus when the government has an enormouss build-up of debt that must be rolled over, when the former increases the cost of the latter, and when the real makers of policy hold trillions in debt instruments that would lose value if expansionary fiscal and monetary policy were actually implemented. Aside from that small dilemma, everything is fine.
- rayward
July 5, 2012 at 9:00pm
Rayward, your comments are superficial, but that's okay too. They also happen to be trite, shallow, and besides the point. All national debts need to be "rolled over" but that occurs with maturity, 10 year notes roll over every 10 years. There is no real world evidence that industrial countries in a depression with their own central banks have any trouble whatsoever funding their national debt. The reason is precisely because of a glut in savings with no useful outlet. The asset base of the United States is over 70 trillion dollars, so another 1-2 trillion dollars of US national debt doesn't change that total materially. Interest rates on government debt are at record lows in Britain, Japan, and the US. The policy response is obvious, spend another 1-2 trillion in the next 3 years and get back to full employment, then raise taxes and cut spending to get deficits under 2% of GDP and keep them there for a decade. That will drive debt to GDP ratio back down steadily.
- nayyer_ali
July 6, 2012 at 9:33am
If it's so obvious we should adopt expansionary monetary and fiscal policy, then why don't we? Could it be that policy makers are trite, shallow, and beside the point. Just like me. Or could it be that "the real makers of policy hold trillions in debt instruments that would lose value if expansionary fiscal and monetary policy were actually implemented". Convincing an investor to buy trillions in debt instruments while simultaneously implementing expansionary (i.e., inflationary) monetary and fiscal policy, if done in the private sector, would be called fraud. In the public sector it's just not done. Not out of a sense of moral responsibility. But because the holders of all those debt instruments actually make the policy.
- rayward
July 6, 2012 at 10:52am
There is absolutely no reason for government spending to lead to inflation. Depends on how it is financed. If it is financed by printing money, then you get inflation. We should do this because an inflation of 4-5% would solve a lot of problems. The other financing alternatives are to borrow or to tax. If we impose high-end taxes to fund government spending, then there is little adverse impact on consumption. The reason why we do not do the obvious? The single biggest reason is that Republicans are actually trying affirmatively to ruin the economy because they see that as the path to power. The second reason is that monied interests (whether they are principally concerned about their debt holdings or not) are much more interested in cheap labor and the loss of labor power than in anything else. They don't care about how many people are unemployed. The like high unemployment because it results in labor discipline and high profits, exactly the situation we are now in despite the overall slackness of the economy. So. it rayward's point is that the people who wield power have no interest in solving the general economic problem, whether out of financial interest or in order to obtain more political power at the expense of working Americans, that is surely correct. If rayward's point is that we don't have their are any insurmountable economic obstacles to substantially increasing government spending, that is incorrect. There is no reason at all why government spending cannot be any arbitrary percentage of the economy. There is no fundamental difference between government spending and private spending. It is merely a choice about what to consume. Whether we sail aircraft carriers around or by air conditioners, it is all the same from a macroeconomic standpoint. Indeed, as Keynes said, it would have the same macroeconomic effect if we paid people to dig holes and fill them in again. Surely, the WWII spending, that consisted of paying people to blast holes in Europe and the Pacific and not even bother to fill them up again was of no productive value. The obstacles, then, are purely political. The bond vigilantes want to claim otherwise only so that they true political decision-making in the interests of the powerful can be concealed from the public.
- roidubouloi
July 6, 2012 at 12:23pm
A little garbled, sorry. I think the point is clear.
- roidubouloi
July 6, 2012 at 12:24pm
Indeed. The point is clear. I live in woods on an island with chickens and a large garden. The chickens scratch holes in their yard, and lay eggs. I feed the chickens grain, fill their holes in, protect them from coyotes, hawks, and raccoons, and eat their eggs. We keep the economy going. I read the article. It was okay. I read Ray Ward's comments, read nayyer's comment, and of course roid's comment. I appreciated all of your comments and the modesty and discretion with which you expressed your view. You are all OK, and perhaps I am OK also. I'm OK, You're OK was a book by psychiatrist David Harris, who is not OK, because he is late.
- skahn
July 6, 2012 at 2:08pm
Roi is right. The biggest obstacle by far to a rapid (12-18 month) economic recovery to 6% or less unemployment and GNP growth of 3% or more is Repub deliberate destroying of the economy and monied interest desire for VERY low interest rates-- which have the side effect of keeping labor costs down. These factors are superimposed of 30+ years of propaganda to promote the ideology that businessmen know best, the wealthy create jobs so don't tax their incomes, and government can do no good. No Democratic leader (including BHO) has attempted to counteract such BS-- in fact BHO has often validated it. The brutal fact is that re-electing BHO and a fair number of Senators will not be of much help in solving our present economic and ideological problems (the House is a different matter). You all are not yet willing to face the brutal reality-- only a re-organization of the Dems toward progressive principals advocated by effective leaders will really solve anything. Anything else is at best temporizing that is more likely to produce disasterous than beneficial outcomes for the US. Whoever is the next President will face economic problems solvable only by applying effective Keynesian solutions. Neither candidate is making such proposals. Both of them are about equal in their Keynesian effects (Mittens will increase military spending-- a good Keynesian stimulus, even if you and I might opt for air conditioners for the poor rather than a Great White Fleet of aircraft carriers). And BHO's inadequate stimulus proposals have next to zero chances of passing in 2013 and beyond, given that he is NOT going to have a House majority and no Senate majority that he would need to pass much of anything -- including I would bet any SCOTUS replacements that some of you keep using to justify why it's important to re-elect BHO. [If any of you think BHO will win in a landslide and have a Senate supermajority then you are more seriously deluded than you think I am as a Dem for not openly backing BHO.] The US is highly likely to do poorly under Mittens for four years-- but better than under Barack. And whichever part is in power for the next four years is likely to suffer for a generation. Does any true Dem seriously wish that Al Smith had won in 1929??For the sake of all, Dems need to start playing hard-nosed politics as chess or bridge or poker with a longer-term stategy than if they were playing roulette in which every round of play is independent of any other round. Repubs certainly play poker-- from Rove to Roberts. I dislike their tactics and goals-i appreciate their strategy. I could make similar observations on the Wehrmacht in France in 1940.
- drofnats1
July 6, 2012 at 4:41pm
The structure of late-stage capitalism (high capitalization, theoretically-low rates of return on investment) means that it is in the best interest of those at the top to stymie growth -- this moves the economy further to the left on the production curve and makes returns on investment higher. This does not benefit anyone save those at the very top. The rest of us just see a less-wealthy society. The Republicans favor the sorts of policies that move the economy backwards, making it more easy to turn a profit: Spending vast sums of money on inefficient military programs (no-bid contracts being a prime example of this on a smaller level), locking huge numbers of young men in prison during their most productive years (that the drug war fuels the private prison market certainly helps, too), slashing education budgets (thus reducing growth of human capital), etc. The Right in America sees the value of Keynesian policies towards a select few industries: namely the military-industrial complex and federal guarantees on banking institutions. Federal spending on those sectors help out the ultra-rich (huge subsidies on agribusiness should not be ignored, either). But otherwise they are the worst sorts of Hayekian sociopaths, and they seek to destroy any program that makes it harder for the wealthy to turn a large profit. I do not know how much of America's right-wing ruling class is cognizant of this reality. But, in any case, it is in their economic interest to wreck as much of America's _real_ growth (that is, the actual wealth the ordinary person has) as possible. This will not change until the people in America -- the people who have an interest in a truly wealthy society -- take control of their government.
- zuludown
July 6, 2012 at 5:26pm
zulu. You correctly continue roi's thread of arguments. The problem is that current Dem leaders, including BHO, directly or indirectly-- wittingly or unwittingly--assist the the Repubs in those efforts. It is a near-certainty that neither Party will change until it suffers a massive defeat at the polls. That will NOT happen to the Repubs in 2012. The Dems suffered a large defeat in 2010. It is truly a complete rebuke if BHO loses in 2012, almost-certainly because of an economic decline between now and November (in which case the Senate is almost certainly lost). The Repubs are wise to keep their focus on the economy-- it really is their best chance of winning in 2012. But if they do win, they are like the dog that chased and caught the semi-- now what does the Repub dog do with it to avoid being crushed. Good luck with that. Most on this tnr site want the Dem dog to catch the semi. Good luck with that, too.
- drofnats1
July 6, 2012 at 6:58pm
We do know how to fix it, malahat, and the reasons why Canada is in better shape are not difficult to discern. First, "stimulus" is a terrible misnomer because it suggests that an initial shock will stimulate a much larger response and then you are done. In fact, Keynes called for "demand replacement," government spending sufficient to replace the missing private demand continued until private demand recovers. That is not "stimulus." The Obama stimulus was first of all way too small. When you excluded the inefficient tax cuts, much of which don't get spent, it was clearly too small to replace missing private demand. The "hope," courtesy of Lawrence Summers, was that the plainly inadequate demand replacement would induce such private euphoria that private demand would quickly recover. In other words, the hope, and that is all it was, was that we could get by with "stimulus" rather than Keynesian demand replacement. Second, the stimulus was a one-shot deal, coming to an end well before the recovery was complete. If even the inadequate stimulus were ongoing, we would likely have returned to normal levels of unemployment. Third, and this is where Canada comes in, we have been faced with the deflationary effect of the debt overhang that came with the bursting of the asset bubble. That depresses consumption. The answer is a modest inflation, to reduce the size of the real debt to manageable proportions. This means printing money, the Fed buying enough Treasuries to induce a 4% inflation. Due to the right-wing mania, the Fed, which, unlike the ECB, is responsible for both controlling inflation AND sustaining employment, has behaved like the ECB, making low inflation its priority. Thus, we remain weighed down with old debt. Canada did not abandon bank regulation, did not have the asset bubble, does not have the debt hangover. Hence, Canada had no need to do what we must but won't. The incidental benefit of printing money would be that we would have a lower public debt. In effect, we would be financing the increased government spending we need by printing money rather than borrowing it. The problem is not lack of knowledge, it is lack of will. The lack of will is due to the Republican strategy of damaging the economy, Republican hatred of Keynes who is justly regarded as part of the left, and the financial interests of the wealthy that are well-served by low inflation and high unemployment. We know what to do, but the right remains dominant in this country because Obama did not take the occasion of its colossal failure in the Bush years to kill it. He dreamt of being a Christ-like figure who would succeed in creating bi-partisan consensus and ending the war of the wealthy against everyone else. Such folly and hubris, self-induced political blindness, may not even rise to the level of naïveté.
- roidubouloi
July 7, 2012 at 7:48am
Hi malahat. Pleasure indeed to talk to you. I quite agree that they have made conversation much more difficult. I have wondered whether that is intended or unintended. Krugman and Kenyes' point, if phrased differently, is that there is a point at which monetary policy is ineffective -- now referred to as a liquidity trap -- and you cannot get out of the slump without strong government spending. We are there. Hence, there has been absolutely no reason to expect that low rates and large deficits would get us out of the slump. Not collecting taxes is not the same as spending money. The question whether and how it could be politically possible to "do the right thing" is an urgent one, and I wouldn't disagree with your analysis as to the present. I am not convinced that the right unrelenting political offensive against treasonous Republicans would not shift the ground such that it became possible, but I have no doubt that Obama did not seek to do that job, indeed appeared to recoil from it. In either case, I think it is very important to keep clear in one's head the difference between the technical issue, which I think has definite solutions, and the political issue that is much more fraught. Canada, being a small economy with a great deal of dependence and connection to the US, can certainly get sick because of what we do despite its best efforts. A very difficult situation for them. I think the best they could do, along with formal low interest rates to avoid destroying their exports due to currency appreciation, would be also to use the opportunity to buy up lots and lots of the public debt and generate some inflation. This would mitigate the rise in housing prices, offset the increase in personal debt, and give them much more freedom of maneuver if they have to run deficits and apply fiscal stimulus later. They could also lift reserve requirements to reduce bank lending, but that would tend to make rates rise. Still, I do think there is a monetary policy, somewhat unorthodox, that could help prevent them from developing asset and debt bubbles in reaction to events here.
- roidubouloi
July 7, 2012 at 11:57am
Good to hear that the Canadian authorities are on it. At least THEY recognize that markets require regulation. It doesn't really matter whether actors are rational or not. They still act in a more or less coherent manner much of the time whether the motivations would properly be described as rational or not. But that does not always lead to economic equilibrium in which resources are fully and efficiently employed. The material about the imperfection of markets is useful to the extent that it makes clear that markets are not always in equilibrium and sometimes can remain away from equilibrium for a long time (although the economic right is constantly dismissive of this reality because they are market fanatics). But, otherwise, I don't think it is important. The empirical evidence that markets can be in a state of disequilibrium is by now overwhelming. The evidence that this can include a state of insufficient demand is by now overwhelming. The evidence that government spending can redress this condition of insufficient demand so that markets return to equilibrium much faster is by now overwhelming. It is a macroeconomic issue, not a microeconomic issue. The right rejects the overwhelming evidence because it does not comport with rightwing ideology and because it is not in the interests of the wealthy to accept the evidence and act upon it. From a technical point of view, the problem is really pretty straightforward. It is the politics that is all screwed up because the masses have the votes, but the wealthy have the power including, increasingly, the power to control both the outcome of elections and the actions of elected officials. We are a Potemkin democracy.
- roidubouloi
July 7, 2012 at 3:56pm