When President Obama announced in December 2009 that “We don’t have enough public dollars to fill the hole of private dollars that was created as a consequence of the crisis,” the leader of the largest economy in the world told us that, despite having caused the worst economic crisis in eighty years, neoliberalism was still firmly in charge. The global economic crisis might suggest that the neoliberal promise—that markets can self-regulate and deliver sustained prosperity for all—was a lie. But that doesn’t seem to have registered with governments, which have, without exception, built their responses to the crisis on a series of myths—the same myths that caused the crisis. Despite millions remaining jobless and poverty rates rising, governments have claimed that there is no alternative but to impose austerity by cutting budget deficits. In the United States and among most parties in Europe—whether in government or opposition—the unquestioned dominance of neoliberal ideology has reduced economic debate to questions of nuance. So conservatives eschew tax increases and want larger spending cuts, whereas progressives favor a combination of spending cuts and tax increases. This homogenization of the political debate has not only stifled progressive voices; it is also obscuring the only credible route to recovery.
What began as a problem of unsustainable private debt growth, driven by an out-of-control financial sector aided and abetted by government deregulation, has mysteriously morphed into an alleged sovereign debt crisis. As private spending collapsed in 2007–08, budget deficits (public spending minus taxes) rose to bridge the gap. Now conservatives, some of whom were direct beneficiaries of bailout packages in the early days of the crisis, tell us that our governments are bankrupt, that our grandchildren are being enslaved by rising public debt burdens and that hyperinflation is imminent. Governments are being pressured to cut deficits despite strong evidence that public stimulus has been the major source of economic growth during the crisis and that private spending remains subdued.
Austerity will worsen the crisis, because it is built on a lie. Public deficits do not cause inflation, nor do they impose crippling debt burdens on our children and grandchildren. Deficits do not cause interest rates to rise, choking private spending. Governments cannot run out of money. The greatest lie—endlessly repeated by neoliberal economists and uncritically echoed by the mainstream media—is the claim that if governments cut their spending, the private sector will “crowd in” to fill the gap. British Prime Minister David Cameron’s austerity campaign and President Obama’s foreshadowed budget cuts are built around these lies.
The neoliberal narrative has run into some inconvenient facts. Interest rates remain low, and governments—even those of deeply troubled Greece and Ireland—have not defaulted on their debts. In most of the developed world inflation is falling, and where it is rising, it is due to rising energy and food costs rather than excessive deficits. Further, despite what they might say in public and what they demand of governments, bankers’ private actions show they know better—why else would long-term bond yields remain at historic lows? Yet the public conversation is mired in misinformation, paralyzing policy-makers, while the public interest is being sacrificed and a lost generation of unemployed is emerging.
But isn’t there a sovereign debt crisis in Europe? True, the nations that signed up for the euro did surrender their individual economic sovereignty—they use a currency they do not issue and thus have to borrow to cover deficits, which makes them dependent on bond markets and thus really does put them at risk of insolvency. Events in Greece and Ireland are testimony to that fact. But that problem lies in the flawed design of the euro monetary system, which was a neoliberal ploy to limit the capacity of these governments to borrow and spend. The euro nations are an exception to the rule that modern governments—like the United States and Britain—cannot run out of money and will never default on their public debt.
How Did We Get Here?
The Great Depression taught us that without government intervention, capitalism is inherently unstable and prone to delivering lengthy periods of unemployment. The Hooverian orthodoxy of balanced budgets, tried during the 1930s, failed. Full employment came only with the onset of World War II, as governments used deficit spending to prosecute the war effort. The challenge was how to maintain this full employment during peacetime.
Western governments realized that with deficit spending supplementing private demand, they could ensure that all workers who wanted to work could find jobs. All political persuasions accepted this commitment to full employment as the collective responsibility of society. As a result, very low levels of unemployment in most Western nations persisted until the mid-1970s. While private employment growth was relatively strong during this period, governments maintained a buffer of jobs for the least-skilled workers. These jobs were found in the major utilities, the railways, local public services and major infrastructure functions of government. By absorbing workers who lost jobs when private investment declined, governments acted as an economic safety valve. In addition, welfare systems provided income support and other public services (such as health and education) to citizens in need. While there were significant differences across nations in the scope of these systems, they all shared the view that the state had a role to play in providing economic security to citizens.
However, conservative resistance to the use of budget deficits grew in the late ’60s, particularly in the United States, as inflationary pressures mounted because of spending associated with the Vietnam War. And conservatives believed that trade unions had become too powerful. But the full-employment consensus didn’t collapse until the escalating inflation that followed the OPEC oil-price hikes of the ’70s. This marked the beginning of the neoliberal era, which has dominated the political debate ever since.
Rather than a failure of the system to create enough jobs, an idea that underpinned the New Deal consensus, mass unemployment was now depicted as an individual problem—poor work attitudes leading to a lack of job-seeking—exacerbated by excessively generous welfare payments. Policy-makers also adopted the neoliberal theory of unemployment, which claimed that Keynesian-style spending could no longer deliver lower unemployment without causing inflation. The only way the government could reduce this “naturally occurring rate of unemployment” was to further free up the labor market. So if governments were unhappy about the level of unemployment, their only alternative was to make it harder for workers to get income support payments and to eliminate other “barriers” to hiring and firing (for example, unfair dismissal regulations). Attacks on trade unions and statutory protections for workers began in earnest.
These same ideas had driven the failed policies that led to the Great Depression. But history is easily forgotten, and with support from business and a co-opted media, a paradigm shift in the academy permeated policy circles. As the neoliberal train gathered pace, the debate became focused on so-called “microeconomic reforms”: cutting expenditures on public sector employment and social programs and dismantling what were claimed to be supply impediments (such as labor regulations, minimum wages, Social Security payments and the like). Privatization and outsourcing accompanied these policy shifts.
Fiscal policy (spending tax revenues to achieve social aims) was actively used during the full-employment era, with monetary policy (the government’s power to set interest rates) being considered less effective. The neoliberal assault on the use of fiscal policy began in the ’70s, with the rise of monetarism. Politicians seized on the ideas of Milton Friedman to claim that their sole objective should be to control the money supply in order to manage inflation. Although various experiments at controlling the money supply failed dismally in the ’80s (remember Reaganomics?), the dominance of monetary policy in mainstream economics was complete. Fiscal policy was demonized as being inflationary and its use eschewed, depriving liberally inclined governments of the tools to advance a more progressive agenda.
The public justifications were all about creating more jobs and reducing poverty, but the reality was different. Since 1975 most nations have failed to create enough jobs to match their willing labor supply.
The assault on regulation and the attack on workers’ rights brought about a growing gap between labor productivity and real wage growth. The result has been a dramatic redistribution of national income toward capital in most countries. For example, in the G7 countries between 1982 and 2005 there was aâ¨6 percent drop in the share of national income paid as wages (as opposed to interest or dividends). This was a global trend.
In the past, real wages grew in line with productivity, ensuring that firms could realize their expected profits via sales. With real wages lagging well behind productivity growth, a new way had to be found to keep workers consuming. The trick was found in the rise of “financial engineering,” which pushed ever increasing debt onto the household sector. Capitalists found that they could sustain sales and receive an additional bonus in the form of interest payments—while also suppressing real wage growth. Households, enticed by lower interest rates and the relentless marketing strategies of the financial sector, embarked on a credit binge.
The increasing share of real output (income) pocketed by capital became the gambling chips for a rapidly expanding and deregulated financial sector. Governments claimed this would create wealth for all. And for a while, nominal wealth did grow—though its distribution did not become fairer. However, greed got the better of the bankers, as they pushed increasingly riskier debt onto people who were clearly susceptible to default. This was the origin of the subprime housing crisis of 2007–08.
The Myth of Austerity
The conservative agenda to dismantle workers’ rights was interrupted by the global financial crisis—which also refocused our attention on the importance of government spending in the form of fiscal stimulus or bailout packages. Before the crisis neoliberal economists and policy-makers claimed that the role of government should be limited to freeing up markets via deregulation. With unemployment seen as an individual problem, neoliberals argued that governments should not try to reduce unemployment by increasing public spending and/or reducing taxes. In fact, neoliberals claimed that whenever misguided governments did try to bring down unemployment in this way, they only made things worse—causing inflation and increasing debt burdens on taxpayers (now and later).
As the worst of the recent crisis abated, neoliberals launched a massive propaganda campaign to reinforce their claim that budget deficits are bad and should be avoided. Austerity is now viewed as inevitable. But is any of this true? The short answer is no, but it needs careful explanation, because the neoliberal arguments against deficits—at least some of them—are seductive.
Neoliberals claim that governments, like households, have to live within their means. They say budget deficits have to be repaid and this requires onerous future tax burdens, which force our children and their children to pay for our profligacy. They argue that government borrowing (to “fund” the deficits) competes with the private sector for scarce available funds and thus drives up interest rates, which reduces private investment—the “crowding out” hypothesis. And because governments are not subject to market discipline, neoliberals claim, public use of scarce resources is wasteful. Finally, they assert that deficits require printing money, which is inflationary.
But they go further than this. They claim that quite apart from these alleged negative impacts, deficits are not required to achieve the aims of the Keynesians. It used to be considered noncontroversial that government deficits could stimulate production by increasing overall spending when households and firms were reluctant to spend. In a bizarre reversal of logic, neoliberals talk about an “expansionary fiscal contraction”—that is, by cutting public spending, more private spending will occur. This assertion comes with the fancy name of “Ricardian Equivalence,” but the idea is simple: consumers and firms are allegedly so terrified of higher future tax burdens (needed, the argument goes, to pay off those massive deficits) that they increase saving now so they can meet their future tax obligations. Increased government spending is therefore met by reductions in private spending—stalemate. But, neoliberals argue, if governments announce austerity measures, private spending will increase because of the collective relief that future tax obligations will be lower and economic growth will return.
Economic policy is now clearly being driven by this idea that austerity is good. The only problem is that none of the propositions that support austerity are true.