There seem to be two issues that are occupying the minds of mainstream economics at the moment. The first is partly theory, partly evidence and partly policy. It is the question of whether the dominant economic policy solution to the crisis should be austerity, namely cutting government spending and raising taxes to reduce government borrowing and get public sector debt levels down – or not. This issue is partly driven by what was the cause of the Great Recession and from that what needs to be done. Mainstream economics is divided on this. But it is agreed on one thing: that the aim is to put the capitalist mode of production back on its feet.
The second issue is related to this. It is the debate that has broken out between mainstream Keynesian Paul Krugman and left ‘Minsky’ Keynesian Steve Keen. Krugman reckons the cause of the capitalist slump is to be found in Keynes’ traditional idea of liquidity preference and a loss of ‘animal spirits’, leading to an increase in the hoarding of money rather than lending it to boost investment and consumption. Keen says that this is not the cause. Instead, it lies in the build up of ‘excessive’ debt in the private sector, particularly the banks, that eventually led to a financial crisis, a Minsky moment. I’ll analyse this debate in my next post. But let’s look at the first issue now.
Everywhere, governments are trying to reduce budget deficits and stop public sector debt (relative to GDP) from rising any more. Apparently, this is crucial to getting the economies of Europe, the US, Japan and others back on their feet. In Europe, the ‘profligate’ weaker capitalist economies of Greece, Ireland, Spain, Portugal and Italy are being told that they must impose huge austerity measures to achieve this. And indeed, such measures are also being applied in the stronger capitalist economies of Northern Europe and the UK. In the US, once the presidential election is over, whoever wins will impose a major programme of government spending cuts and tax rises for the rest of the decade. And in Japan, with a public sector debt well over 230% of GDP, the government is looking to introduce a battery of new taxes to reduce the budget deficit and debt level.
The question is whether this is the right policy for capitalism. The Austerians say that it is necessary in order to reduce the cost of capital – in other words, raise profitability. If the public sector goes on borrowing more and more, the bulk of savings appropriated in an economy will be eaten up by government. Government will ‘crowd out’ the private sector and stop it getting funds; or the extra demand for savings from the government will drive up interest rates. And as the public sector is inherently ‘unproductive’ – only the capitalist sector is productive – this will lower economic growth and make things worse. This is the mantra of the US Republicans, the British Conservatives, most central banks and big business leaders.
The Keynesians disagree. If public spending is cut and taxes are raised, that will contract domestic demand in the economy and thus lower economic growth. Indeed, more austerity could mean too much contraction and even cause a rise in debt ratios as a result. It is better to keep austerity to a minimum in a period of depression until the demand picks up and then try to get debt levels down later. “Not so deep and not so fast” – is the mantra of Paul Krugman, Martin Wolf, George Soros and the US Democrats and British Labour Party.
Before answering who is right, the first question is to look at why the issue is there at all. It’s there because the capitalist mode of production failed. The Great Recession came about because of falling profitability in the capitalist sector from 1997 (in the US and elsewhere) and the eventual failure in 2007 of the huge expansion of private credit (what Marx called fictitious capital) needed to keep the whole thing going. Then the state had to intervene in aid of capitalism to avoid a banking meltdown and ameliorate the effects of the slump.
The IMF has shown that average public sector debt in the OECD rose 30% pts of GDP from 2007 to 2011. Of that rise, 9% points were due to falling tax revenues and rising expenditure on unemploymnent and welfare benefits during the Great Recession. Another 7% of extra borrowing went on fiscal programmes to stimulate the private sector or to carry out public sector investment programmes. The bailout of the banks cost another 7% pts of GDP and then there were higher interest costs incurred from the extra debt that had to paid to bond holders, which cost another 6% pts. So only one-quarter of the rise in public debt since the Great Recession began was due to a conscious Keynesian-type policy of fiscal stimulus by governments in the mature capitalist ec0nomies. Three-quarters of the rise was due to the capitalist slump and banking collapse.
But this is the crux of the matter: are austerity policies to get a reduction in public debt levels necessary to put capitalism on its feet or will they make it worse? The Austerians say yes and the Keynesians say no. What do Marxists say? It all depends on what is happening to the profitability of capitalist sector. The expansion of public sector spending and borrowing can stimulate the capitalist economy for a while, but just as with private debt, not forever. At some point, government consumption becomes a deduction from the profits of the productive capitalist sector (and here we mean the Marxist meaning of productive, namely generating profit and accumulating capital, not making things).
It is this difference between productive and unproductive labour under capitalism that the Keynesians do not recognise. And that is because Keynes did not have a law of value or any role for profit in economic growth. For him, the production of things and services creates incomes and profit is not an issue.
The Austerians want the process of “creative destruction” (as Joseph Schumpeter characterised it) of unprofitable capital to play out. They do not want the public sector to crowd out the restoration of profitability when capitalism is being weighed down by excessive dead capital in the private sector, which needs ‘deleveraging’. The temporary boost to incomes created by state sector spending is no overall solution to economic recovery under capitalism. Indeed, the rise in public sector debt necessary to fund this state spending in an environment of slump or low growth just adds to the already existing burden of private sector debt weighing down profitability, even if there is interest to be made by the financial sector from buying government bonds.
The mantra from the Austerians is that you cannot overcome excessive debt by more debt. Moreover, if the public sector keeps expanding, it calls into question the capitalist mode of production itself – an issue that the Keynesians themselves start to worry about. So, unless profitability returns through creative destruction, increased state spending and debt will start to aggravate the crisis or at least mean that any recovery based on capitalist production will be muted and insufficient.
That is the why the Austerians have a point. On the other hand, the Keynesians have a point. Too drastic a cut in public spending, in an attempt to reduce debt or stop it rising any further, will also kill the ability of those sectors that benefit from government activity. Thus the debate goes round and round.
As one mainstream economist put it: “we cannot know the answers definitively”, (G. Corsetti, Has austerity gone too far?, Voxeu.org). Both sides of the mainstream agree that government deficits must be reduced and debt eventually ‘stabilised’. Corsetti again: “The debate is not about the desirability of restoring a safer fiscal position after the large increase in gross and net public debt in the last few years. This can safely be taken for granted”. That’s all right then.
But the Austerians want it done quicker and they want cuts targeted towards government spending rather than raise taxes. They present the evidence of 40 years of such ‘adjustments’ recently compiled by the IMF for the mature capitalist economies. This database concludes (rather cautiously) that adjustments through spending cuts are less ‘recessionary’ than those achieved through tax increases (see Devries, Gaujardo, Leigh and Pescatori, A new action-based dataset of fiscal consolidation, IMF working paper 11.128.)
That’s not really surprising under capitalism. Tax increases directly hit the profitability of the capitalist sector (even if taxes are directed at workers incomes or sales rather than corporate tax) and thus will deter investment. Reductions in competing government investment and consumption, although hitting those capitalist sectors that governments buy services from, is more beneficial to capitalists as a whole. Of course, this has nothing to do with what would benefit society.
‘Confidence’ among capitalists also falls when taxes are hiked and do not fall when government spending is reduced. Reducing public sector services and employment will also involve measures to reduce employment protection, pension conditions and other rights of public sector employees. All that will help capitalist accumulation by raising the rate of surplus value.
But if severe austerity leads to a fall in employment and thus demand for capitalist production, it could well lower growth and even drive the economy back into recession. Such is the argument of the Keynesians. Paul Krugman has correctly pointed out that the best way to get the debt ratio down is through faster economic growth, as happened after the second world war. Net public debt to GDP in the US stood at 80% in 1950 and fell to 46% by the end of the decade and yet public spending to GDP rose! Why was that possible? Because average real growth was 4.3% a year (with inflation at 2.3% a year – as it is more or less now). Real GDP growth was decisive in driving down the debt ratio.
But Krugman and other Keynesians do not put their fingers on why economic growth was so high. The 1950s was also a period of high profitability in the US capitalist sector. That was the real key to investment and growth. Such profitability made it possible for the capitalist sector to bear a high public debt level and accept much higher tax rates than now, as well as strong government spending. Profitability was high because of the ‘creative destruction’ of capital that had taken place during the Great Depression of the 1930s and physical destruction that had taken place during the war (at least in Europe). Government spending was thus beneficial to post-war capitalism – for as long as profitability was high. But these conditions do not apply in 2012.
The Keynesians are concerned that “accelerated austerity” risks weakening capitalism because it could lead to the “premature scrapping of fixed capital and human capital” (see JV Reehan, From Plan A to Plan B, 7 March 2011, Vox op cit). But that is precisely the purpose of a capitalist slump. The slump eventually restores the profitability of the remaining capital. Once again, the Keynesians see everything in the terms of output and physical assets and not in terms of profit. Thus they cannot understand the nature of the crisis and offer effective policies to end it.
So instead, we have the attempts of the Keynesians to find a ‘middle path’ between austerity and stimulus. Olivier Blanchard, chief economist of the IMF (see my previous post, Olivier Blanchard and TINA, 28 March 2012), puts it: “substantial fiscal consolidation is needed and debt levels must decrease. But it should be a marathon rather than a sprint. It will take two decades to return to prudent levels of debt (!). There is a proverb that actually applies here: slow and steady wins the race”. (O. Blanchard, 2011’s four hard truths, 22 December 2011, Vox op cit)
More recently, two of the biggest gurus in mainstream economics, Bradford de Long, the Keynesian professor at Berkeley University of California and Larry Summers, the former US treasury secretary under Clinton and well-known denier of any crisis before it happened, have produced a paper that examines whether fiscal austerity is a good idea or not for capitalism (B de Long and L Summers, Fiscal policy in a depression economy, March 201).
One of the big issues in this debate is the size of the fiscal multiplier, as it is called. This measures the change in national income that corresponds to a change in net government spending and tax reductions. The Keynesians says that this is high: namely that a 1% rise in spending leads a equally large rise in economic growth. The Austerians say it is low, or zero or even negative, because any increase in public spending leads to a fall in private spending as investment is ‘crowded out’; or consumers reduce spending and save more to cover increased taxes or because they fear the government will get into difficulty. Thus any government stimulus would be counteracted by an equivalent fall in private spending. This Austerian theory is called the Ricardian equivalence, after the classical economist David Ricardo who first argued it, as against helping the poor with government aid.
What do de Long and Summers conclude? They reckon that when interest rates are near or at zero and central banks have done all they can to stimulate the capitalist economy with injections of credit (quantitative easing or printing money), as is the situation now, and there is still no growth, then fiscal measures will help the recovery of the capitalist economy not hinder it. But this is only true “for only as much fiscal stimulus as can be delivered in a timely and temporary way” . That’s helpful! How large any stimulus should be “remains for future research”. That means they just don’t know.