There is major policy battle going on between the economic advisors of the major capitalist governments meeting at the G20 summit this week. Most advisors want action to cut government spending because of the humongous rise in public sector debt in nearly all the G20 economies.
This debt (owed to the banks who bought it with government handouts!) will have to be financed by sucking up all the available savings of the private sector, namely the savings that working households have in their banks or pension funds. The banks and pension funds will demand higher interest rates in return for buying government debt. That will eventually drive up the cost of borrowing and make households less willing to spend and corporation less willing to invest. Or so that argument goes.
Against that view, there is the Keynesian view, expressed in the columns of the New York Times by the Keynesian guru, Paul Krugman and in the pages of the Financial Times by the UK’s new banking advisor, Martin Wolf, that tightening fiscal policy by cutting spending and raising taxes puts the economic recovery in jeopardy. Fiscal austerity is the wrong policy for economic growth, say the Keynesians. Wolf says that what the German government is insisting that the governments of Greece, Spain and Portugal must do will lead to new economic recession in Europe. Krugman says the US government must continue with its policy of spending and borrowing and not adopt the German way – or is it the Austrian (Austerian) way?
The Austerians reply, that without cutting back the huge overhang of debt, business profitability will not recover sufficiently and growth will suffer anyway (see my blog, The overhang of debt, 1 March 2010 ).
The word ‘Austerian’ is a sardonic pun made by the Keynesians on the ideas of the Austrian school of economists. The Austrian school argues economic crises would not happen if it were not for interference by central banks and governments. The boom phase in the business cycle takes place because the central bank supplies more money than the public wishes to hold at the current rate of interest and thus the latter starts to fall. Loanable funds exceed demand and then start to be used in non-productive areas, as in the case of the boom 2002-07 in the housing market. These mistakes during the boom are only revealed by the market in the bust.
From an Austrian perspective, the eventual collapse of the house of cards built on excessive credit represents not a failure of capitalism, but a largely predictable failure of central banking and other forms of government intervention. So the Great Recession was a product of the excessive money creation and artificially low interest rates caused by central banks that on this occasion went into housing.
The recession was necessary to correct the mistakes and malinvestment caused by interference with the market pricing of interest rates. As one Austrian economist correctly points out, “the recession is the economy attempting to shed capital and labour from where it is no longer profitable”. And no amount of government spending and interference will help to avoid that correction – this is in direct contradiction to the Keynesian view. Putting more credit into the economy to solve the recession is like giving more alcohol to a drunken man. As Krugman says about the Austrian school, they reckon that a recession is like a hangover after a heavy night of boozing.
The Austrian school has some useful insights in highlighting the role of excessive credit (or what Marx called fictitious capital) in an economic crisis. But it lacks the overall picture of capitalism. Is the rate of interest really the driving force of capitalist investment and the price signal that capitalists look for to make investment decisions? As Marx explained, interest is just one part of surplus value and it is the latter that is key to investment. Value and surplus-value are created in the production process, in particular, in the exchange of money for labour and through the productivity of labour using capital goods.
What the Austrian school does not explain is why ‘excess credit’ eventually does not work. Apparently, there is a point when credit loses its traction on economic growth and asset prices and then, for no apparent cause, growth collapses. In Marxist terms, the Austrians are really referring to fictitious capital being dramatically expanded to compensate for a slowing of the accumulation in real capital. The result is that ‘excess capital’ is even greater at the height of the boom and, in the subsequent bust, the reduction in excess capital must be even greater. This produces a Great Recession as opposed to any recession.
But for the Austrians, as for the mainstream economic schools, there is no problem with capitalist production for profit. As a result, the policy prescription for the Austrians to deal with slumps and recessions is just accept them and recognise them as the judgement on the sin of not saving enough and letting credit rip. Ultimately, until government interference in the money supply is removed, bubbles and bursts will keep recurring.
Now it seems that this rather wacky view of capitalism has gained credence among many economic advisors, people who cherry pick their arguments according to circumstances. Before the crisis, deregulation and ‘free markets’ along with credit expansion was fine. During the crisis and the subsequent Great Recession, bank bailouts and Keynesian-style public spending was the way out. Now, for most governments (not the US yet it seems), it is fiscal austerity, Austrian-style.
As I write, the new Chancellor (finance minister) of the UK government, George Osborne, is telling parliament and the people of Britain that there is no other way but austerity through slashing public services and raising taxes for the average family(but lowering taxes for corporations to ‘encourage’ them to invest). It was the banks and the private sector that brought capitalism to its knees in 2008-9, but it is the public sector and working households that must now pay. We cannot go on borrowing Keynesian-style. The Austerians now call the shots.