Well, that went quite well, I thought...
February 18, 2011: "Austerity"
For nearly 200 years economists from John Stuart Mill through Walter Bagehot and John Maynard Keynes and Milton Friedman to Ben Bernanke have known that a depression caused by a financial panic is not properly treated by starving the economy of government purchases and of money. So why does "austerity" have such extraordinary purchase on the minds of North Atlantic politicians right now?
- Chair: J. Bradford DeLong, UCB Economics
- Speaker: Joseph Lough, UCB Political Economy
- Speaker: Rakesh Bhandari, UCB Interdisciplinary Studies
Location: Blum Hall Plaza Level
Time: 2:10-2:40: Panelists. 2:40-3:10: Discussion. 3:10-4:00: Reception.
J. Bradford DeLong:
Let me speak as a card-carrying neoliberal, as a bipartisan technocrat, as a mainstream neoclassical macroeconomist--a student of Larry Summers and Peter Temin and Charlie Kindleberger and Barry Eichengreen and Olivier Blanchard and many others.
We put to one side issues of long-run economic growth and of income and wealth distribution, and narrow our focus to the business cycle--to these grand mal seizures of high unemployment that industrial market economies have been suffering from since at least 1825. Such episodes are bad for everybody--bad for workers who lose their jobs, bad for entrepreneurs and equity holders who lose their profits, bad for governments that lose their tax revenue, and bad for bondholders who see debts owed them go unpaid as a result of bankruptcy. Such episodes are best avoided.
From my perspective, the technocratic economists by 1829 had figured out why these semi-periodic grand mal seizures happened. In 1829 Jean-Baptiste Say published his Course Complet d'Economie Politique..." in which he implicitly admitted that Thomas Robert Malthus had been at least partly right in his assertions that an economy could suffer from at least a temporary and disequliibrium "general glut" of commodities. In 1829 John Stuart Mill wrote that one of what was to appear as his *Essays on Unsettled Questions in Political Economy in which he put his finger on the mechanism of depression.
Semi-periodically in market economies, wealth holders collectively come to the conclusion that their holdings of some kind or kinds of financial assets are too low. These financial assets can be cash money as a means of liquidity, or savings vehicles to carry purchasing power into the future (of which bonds and cash money are important components), or safe assets (of which, again, cash money and bonds of credit-worthy governments are key components)--whatever. Wealth holders collectively come to the conclusion that their holdings of some category of financial assets are too small. They thus cut back on their spending on currently-produced goods and services in an attempt to build up their asset holdings. This cutback creates deficient demand not just for one or a few categories of currently-produced goods and services but for pretty much all of them. Businesses seeing slack demand fire workers. And depression results.
What was not settled back in 1829 was what to do about this. Over the years since, mainstream technocratic economists have arrived at three sets of solutions:
Don't go there in the first place. Avoid whatever it is--whether an external drain under the gold standard or a collapse of long-term wealth as in the end of the dot-com bubble or a panicked flight to safety as in 2007-2008--that creates the shortage of and excess demand for financial assets.
If you fail to avoid the problem, then have the government step in and spend on currently-produced goods and servicesin order to keep employment at its normal levels whenever the private sector cuts back on its spending.
If you fail to avoid the problem, then have the government create and provide the financial assets that the private sector wants to hold in order to get the private sector to resume its spending on currently-produced goods and services.
There are a great many subtleties in how a government should attempt to do (1), (2), and (3), and how attempts to carry out one of the three may interfere with or make impossible attempts to carry out the other branches of policy. But that is not our topic today. Our topic today is that, somehow, all three are now off the table. There is right now in the North Atlantic no likelihood of reforms of Wall Street and Canary Wharf to accomplish (1) and diminish the likelihood and severity of a financial panic. There is right now in the North Atlantic no likelihood at all of (2): no political pressure to expand or even extend the anemic government-spending stimulus measures that have ben undertaken. And there is right now in the North Atlantic little likelihood of (3): the European Central Bank is actively looking for ways to shrink the supply of the financial assets it provides to the private sector, and the Federal Reserve is under pressure to do the same--both because of a claimed fear that further expansionary asset provision policies run the risk of igniting unwarranted inflation.
But there is no likelihood of unwarranted inflation that can be seen either in the tracks of price indexes or in the tracks of financial market readings of forecast expectations.
Nevertheless, you listen to the speeches of North Atlantic policymakers and you read the reports, and you hear things like:
“Obama said that just as people and companies have had to be cautious about spending, ‘government should have to tighten its belt as well...’”
Now there were—and perhaps there still are—people in the White House who took these lines out of speeches as fast as they could But the speechwriters keep putting them in, and President Obama keeps saying them, in all likelihood because he believes them.
And here we reach the limits of my mental horizons as a neoliberal, as a technocrat, as a mainstream neoclassical economist. Right now the global market economy is suffering a grand mal seizure of high unemployment and slack demand. We know the cures--fiscal stimulus via more government spending, monetary stimulus via provision by central banks of the financial assets the private sector wants to hold, institutional reform to try once gain to curb the bankers' tendency to indulge in speculative excess under control. Yet we are not doing any of them. Instead, we are calling for "austerity."
John Maynard Keynes put it better than I can in talking about a similar current of thought back in the 1930s:
It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924-1929] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy.
We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.
I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity...
I do not understand it either. But many people do. And I do not understand why such people think as they do. So let me turn it over to the first of our speakers, Joseph Lough, to try to provide some answers.
I too can think of no better place to begin a discussion such as this than Mr Keynes’ complaint against austere and puritanical souls. The only problem is that from our lips, or in any case from mine, this complaint cannot help but sound a bit hollow.
What, practically or theoretically, do I know about "austerity"?
What do I know about "puritanism"?
We might therefore do well to ask: does Mr Keynes’ complaint amount to anything more than ad homonym. Austerity is foolish; puritanism is silly—less so now perhaps than in Lord Keynes’ day—when none was a Keynesian, but when all, thank God, not excluding Chicago’s own Frank Knight and Jacob Vine, were—how should I put it—godless. The retreat of secularism and humanism—we must admit—has blunted Keynes’ criticism: austerity? foolish? puritanism? silly? Not any more.
Let me see if I can therefore put the discussion on a different footing. Not Lord Keynes’ ad hominem, but, rather, the solid ground of science. Because, unless I am mistaken, there is something indubitably self-evident about economic austerity—something us salt-water types are liable to overlook.
Don’t get me wrong. Although a product of Chicago, I am not myself Chicago. I am as salty as the next guy. But I do feel that, when we ask our audience to embrace one or another variety of profligacy, however packaged, we are, my friends, beating our heads against the storied brick wall. And since a substance metaphysics does not match the experience of any save the most metaphysical among us, we will beat and beat and beat until we bleed and then some more.
Immanuel Kant won this debate over two centuries ago. It went something like this: if you attribute the state of your soul to the material, bodily, conditions of your life, then you must kiss ethics, religion, and, with it, all law and justice down the road. For there can be no condition placed on true freedom.
This, my friends, is the turnkey to fresh water (Chicago) economics. Without it, Chicago economics melts into a pool of mush. And, with it, all talk of austerity and belt-tightening. This was Amartya Sen’s message to us—a message for which he was duly awarded a Nobel Prize. Do we embrace a negative, purely abstract, notion of freedom—freedom as the absence of constraint? Or do we embrace a positive, substantive, notion of freedom—freedom as the conditions of the good life? Aristotle or Plato? Hegel or Kant?
But this really doesn’t solve our problem, does it? For, as Professor DeLong has pointed out, there is a long list of economists quite willing, ready, and able—Deontological Ethics or None—to point out precisely where, empirically, austerity is simply wrong-headed. But, wrong-headed for what? Surely, wrong-headed for long-term economic growth and full employment. Wrong-headed as well for general social welfare.
Ahhh. But, what about freedom? But, you say, we weren’t talking about freedom. Oh, yes, we were. Or, rather, should I say, yes THEY were and are. For, really, it has always been about freedom. Even when Uncle Gary [Becker] and Uncle Milty [Friedman] secreted us away into Graduate Course 301, it was always about freedom—meaning, of course, the absence of constraint.
At which point, we could have—we should have—pulled out our big guns; not Karl Marx or John Maynard Keynes; not Locke and Hobbes. What I mean is Aristotle. Aristotle’s Politics, Book I, Chapter 1, the very first page. The heart and soul of western thought and culture. The very core of the Core Curriculum itself. Surely, even Hutchens could not object to our sources. This is the Great Books Tradition.
So, is the ruler of a republic simply the ruler of a somewhat larger private oikos, private economy, private enterprise? No? Why not? Because, says Aristotle, the ruler over a private enterprise, an oikos, is a despotes, a despot, the ruler over subordinates, dependents, workers, women, children and slaves. Therefore, writes Aristotle, you should never ever, ever allow a businessman to rule over a republic. No. The ruler over a republic is not the ruler over a somewhat larger private enterprise. The ruler over a republic is a ruler over others who like himself (or herself) is a substantive beneficiary of substantive freedoms.
But freedom here—as Amartya Sen points out—is not the absence of constraint. Freedom here is the substantive condition of its own possibility. You know it. You are its beneficiaries. A good education. Freedom from fear. Good health. Leisure—the time to read, to go to the opera, the theater, the ballet, MOMA, the symphony, to help your children with their homework, to go on bike rides, to work in the garden, to conduct research, the freedom to fail and to learn without the fear of losing one’s living.
These freedoms—so different, so nearly opposite the freedoms that govern the private oikos, the private enterprise—are the freedoms that compose the public sphere in a republic.
But, at the very instant that we began to understand these freedoms—was it in 1944 or 45, was it with Karl Polanyi or Franz Neuman, Herbert Marcuse or Hannah Arendt?—at that very moment we began to cede the field of economics to forms of thought and modes of research ill-suited to anything but Kant’s deontological absence of constraint.
At that moment—and this is pure Kant—substantive freedom lost its footing in economics. Not that we didn’t continue to talk about it and recommend it. But absent a coherent and compelling theory of substantive freedom, our talk and research lost out to their theory. We can cry in justice till we are blue in the face. We can yell—and we are right to yell—that families should not have to choose between health, safety, and education. But until we realize that morality for most of us intuitively entails the absence of constraint, we will almost certainly be preaching to the choir.
So. What is the answer? I don’t know. How do we begin to shift the weight of experience, at least where freedom is concerned, from the absence of constraint, to the conditions of freedom? How do we shift our own research perspectives from quantitative documentation and modeling, to qualitative, critical, interrogation?
Which brings us back, I feel, to the question of profligacy. All of you, I am sure, have heard the story about the Prodigal Son who receives and squanders his share of his father’s inheritance. His father—who, in the story, represents God—is bereft and bereaved at his loss. But then his son returns, sick and broke. And what does the father do? The older son, the good son, counsels austerity and puritanical punishment. But what does the father—who, in the story, represents God the father—what does the father do? He slaughters the fattened calf. He throws a party. He welcomes his son with open arms. How utterly irresponsible. Or not.
Will $1.2T (or is it now $2T) of fiscal stimulus via expanded government purchases lead us to full employment? I don’t know. But, is that the right question?
Maybe the right question is instead: do you miss your son?
We should not confuse the description of a general crisis with its explanation. Of course theoretical blinders may make it difficult to observe what is plainly happening. Until the error of the classical economists’ conflation of barter with the money-mediated circulation of commodities was openly recognized, it would prove difficult to countenance the possibility of and thus recognize the actual eventuation of a general crisis, caused by the general attempt to sell without the intention to buy commodities. But the mediation of the circulation of commodities by money only creates the possibility of a general crisis. It does not explain why the course of accumulation is in fact punctuated by such crises. We need to move beyond a phenomenology of crises to a structural explanation thereof.
Today there is much talk of a Minsky crisis; such a crisis is rooted in the financial sector. Marx was skeptical of monetary theories of crisis. Vaguely hinting towards an endogenous theory of credit avant la lettre, he believed that crises would only appear to be caused by a shortage of circulating media (he would thus have been skeptical of quantitative easing as sufficient for the overcoming of general crises, though he certainly agreed that crises often appeared to be the result of insufficient circulating media).
For Marx the shortage of money was however a result of weakness in the real economy. Marxists to this day have no agreement as to what Marx thought the fundamental weakness in the real economy was—underconsumption caused by a maldistribution of income; disproportionalities resulting from the anarchy of production; or an insufficiency of surplus value to finance and motivate further accumulation caused by a falling rate of profit even as the total investment increases.
But I find it highly doubtful that Marx was an unconsumptionist. Hayek’s main frustration with Keynes (though it should have been with the Keynesians) was his putative belief that crises are caused fundamentally by deficient mass purchasing power. Harold Mouton, Robert Reich and Branko Milanovic have all thought this in different ways. But I am skeptical.
Many today find the acceptance of austerity puzzling because they cannot see how investment demand will recover unless and until the prospects of final consumption brighten. But is this social democratic shibboleth true?
Well, then, why do crises often break out just when purchasing power is at its height? If deficient purchasing power is the cause, then it should have been falling before the onset of the crisis, not as a result of it and the contraction of consumer credit associated therewith.
To be sure, Branko Milanovic and others have offered reasonable underconsumptionist arguments (see http://yaleglobal.yale.edu/content/two-views-global-crisis). Pointing to accentuation of inequality in many forms over the last three decades, Milanovic asserts that the highest income earners found little reason to invest in expanded production, given the weakness of mass purchasing power. Flush with funds, they got caught up in a speculative mania that could lift the economy only as long as the speculative run in mortgage backed securities and derivatives generally lasted. Behind the fictitious prosperity and its dissipation Milanovic finds disturbed relations of distribution.
But would the redistribution of income (or deficit financed creation of jobs) and thus the strengthening of the marginal propensity to consume and thus of final demand really bolster private investment, the most volatile component of aggregate demand?
I am not sure. While businesses may not make replacement investments in times of austerity, they may well make innovatory investments just to cut costs faster than prices are sagging, and as James Galbraith (no Hayekian himself!) suggested more than ten years ago, some high valued added capital goods firms may well prefer low product prices for just this reason.
Some firms may decide that it is advantageous to build on the trend and thus take advantage of lower depression prices in materials, wages and possibly interest rates. The more powerful firms may well believe that the damage that a weak economy does to weaker competitors is crucial for their own long-term health.
Lastly firms may well think that they are likely to lose new customers to foreign producers in a global market and thus see not see the benefits of greater final demand in relation to the costs of higher taxes presently, and in the future.
Disturbed by an unacceptable level of unemployment and human suffering, Professor DeLong has raised the question for us of why we are finding the acceptance of a politics of austerity and thus a needless self-imposition of suffering.
After all, Professor DeLong believes Keynesian theory has long shown that a high level of unemployment is not only not necessary for capitalist accumulation but also positively harmful. Government spending can step in and top up when there is a lack of effective demand. After the initial injection of spending, a multiplier process leads to income employment increasing severalfold, and the initial government spending could be recouped in additional tax revenue paid from the extra income. A high level of employment and a high level of profits are reconcilable as long as public investment, which is not motivated by profitability, takes up the slack between saving and private investment when animal spirits are weak (see Lord Meghnad Desai, Marx’s Revenge, pp 180-182 where he reprises arguments made long ago by his teacher Lawrence Klein in The Keynesian Revolution; note also that animal spirits may be weak presently not for fundamentally psychological reasons but due to an objectively depressed marginal efficiency of the capital as Justin Fox has recently argued at http://blogs.hbr.org/fox/2010/11/the-real-story-behind-those-re.html ).
But—and here is the point that I have been driving at—it does not necessarily follow that the way to increase aggregate demand in a depressed economy is raise G and C. That is, if we take the standard macro-economic identity of Y=I+C+G+X (income equals Investment plus Consumption plus Government plus Net Exports), it does not follow that the best response to a drop off in I is a compensatory increase in debt-financed government spending and increased consumption through redistribution.
There has been for thirty years now a conservative method for managing aggregate demand, as Jawaharlal Nehru University Professor of Economics Amit Bhaduri long ago noted.
Drawing more from Michael Kalecki than Keynes, Bhaduri underlines that for monetary profit (the surplus in Marxian terms and savings in Keynes’ framework) can only be realized if there a source of autonomous demand beyond what can be sustained by current income. For example, this autonomous source of demand could be borrowing by a private firm through overdraft facilities from a bank. But according to Kaleckian/Keynesian theory autonomous expenditure will do in situations of deficient private investment demand. It seems to follow government should in such situations undertake the autonomous expenditures required for the surplus to be realized. Even wage increases will not be sufficient because there will be a surplus that needs to be realized over and above current income.
Yet as clear as the case seems to be for such autonomous government expenditures, it has been politically marginalized for thirty years. The reason is simple: governments have sought to reignite private investment not by direct governmental creation of an autonomous source of demand but by making private investment more profitable and net exports more competitive. Investment can be made more profitable by pro-corporate tax cuts and by undermining labor, and firms are motivated to invest in such climate by the fear that their competitors will take advantage of it. Net exports can be made more competitive again by wage repression, subsidies, manipulation of the currency—though the US confronts unique problems with the last given the dollar’s position as a reserve currency as recently explained by Professor Eichengreen.
I am not at all surprised by today’s politics of austerity. President Obama is as beholden by the conservative program for the management of aggregate demand as the neo-liberals before him (Bhaduri quotes Helmut Schmidt announcing his shift from a social democratic to conservative program for the management of effective demand in 1977!) President Obama probably has some sense that autonomous government expenditures would not stabilize private investment more effectively than pro-corporate and anti-labor policy would; moreover there is always that the risk that government expenditures will leak out of the national economy.
Yet the evidence for the conservative program for the management of effective demand is not strong, though the case for it can be made coherently from within the technocratic Keynesian framework. Still it has not greatly stimulated private investment at least not in the short term; and it poses deflationary risks. Moreover, it is simply a fallacy of composition to think that each nation an export its way out of crisis.
Yet at the same time I think there is reason to doubt that a more aggressive government stimulus program would have been or would be effective. There is no simple mechanical effect from autonomous government expenditures to rising private investment. It is certainly however worth a try, especially given that the fears of the bond vigilantes remain unfounded.
And that raises the political question of why the more liberal governmental program of managing effective demand is giving way to private method. Surely part of the answer has to lie in the division and passivity of the American working class. Without mass protest we prove ourselves willing to tolerate great and troubling levels of human suffering. We have not yet seen massive protests for the creation of government jobs. I suspect that one reason remains racial divisions within the working class. The belief that undeserving minorities and even (god forbid!) illegal aliens are disproportionately represented among those now suffering most sharply still tragically weakens the resolve of too many of us to fight against the labor market conditions that harm workers generally. Prejudice can reconcile us to conditions that over time take on the objectivity of the state of the weather.