The daily rhetoric being used to promote fiscal austerity maybe couched in the urgency of the day but we have heard it all before. In this blog I just reflect on history a little to remind the reader that previous attempts to carve public net spending, based on the “expectations” belief government was not going to tax everybody out of existence, failed to deliver. The expected spontaneous upsurge in private activity has never happened in the way the mainstream macroeconomic supply-siders predicted. Further, the chief proponents usually let it out in some way that the chief motivation for their vehement pursuit of budget cuts was to advance their ideological agendas. Of-course, the arguments used to justify the cuts were never presented as political or class-based. The public is easily duped. They have been in the past and they are being conned again now. My role is to keep providing the material and the arguments for the demand-side activists to take into the public debate.
The American Prospect Magazine article – “Strategic Deficit” Redux (published January 27, 2010) concluded:
But apparently Democrats still haven’t learned even in the midst of an economic crisis that prioritizing federal deficit reduction is a game for suckers. Somewhere David Stockman is having yet another laugh.
So for non-Americans and Americans who cannot remember:
President Ronald Reagan’s budget director David Stockman coined the phrase “strategic deficit” to describe the usefulness of creating long-term budgetary shortfalls to undercut political support for governmental spending … Moreover, strategic deficits can enable opponents of public investments to sound compassionate — “We can’t steal from our children to pay for our short-term desires.”
The logic that Stockman adopted and which was all the rage in the early 1980s was the so-called “supply-side” economics (famously represented by the Laffer curve). In a famous interview published in the Atlantic Monthly (December 1981) – The Education of David Stockman – we learn a lot about the conservative hypocrisy of this era:
The supply-side approach … assumed first of all, that dramatic action by the new President, especially the commitment to a three-year reduction of the income tax, coupled with tight monetary control, would signal investors that a new era was dawning, that the growth of government would be displaced by the robust growth of the private sector. If economic behavior in a climate of high inflation is primarily based on expectations about the future value of money, then swift and dramatic action by the President could reverse the gloomy assumptions in the disordered financial markets. As inflation abated, interest rates dropped, and productive employment grew, those marketplace developments would, in turn, help Stockman balance the federal budget.
Stockman admitted in that interview that “”The whole thing is premised on faith … On a belief about how the world works.” He also predicted that “The inflation premium melts away like the morning mist … It could be cut in half in a very short period of time if the policy is credible. That sets off adjustments and changes in perception that cascade through the economy. You have a bull market in ’81, after April, of historic proportions.”
Students of economic history will already recall that none of this happened. The “faith” was misplaced.
In the Atlantic Monthly interview, several salutary admissions were made by Stockman. He admitted that his plan to dramatically cut the federal budget:
… boils down to a political question, not of budget policy or economic policy, but whether we can change the habits of the political system.
He also exposed the agenda of the Reagan tax cuts:
But, I mean, Kemp-Roth was always a Trojan horse to bring down the top rate.” … he was conceding what the liberal Keynesian critics had argued from the outset – the supply-side theory was not a new economic theory at all but only new language and argument to conceal a hoary old Republican doctrine: give the tax cuts to the top brackets, the wealthiest individuals and largest enterprises, and let the good effects “trickle down” through the economy to reach everyone else. Yes, Stockman conceded, when one stripped away the new rhetoric emphasizing across-the-board cuts, the supply-side theory was really new clothes for the unpopular doctrine of the old Republican orthodoxy. “It’s kind of hard to sell ‘trickle down,'” he explained, “so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.”
However, things didn’t turn out the way the ideological pronouncements predicted. History also didn’t obey his ideological presuppositions:
In August, when enactment of the Reagan program was supposed to create a boom, instead, the financial markets sagged. Interest rates went still higher, squeezing the various sectors of the American economy. Real-estate sales were dead, and the housing industry was at a historic low point. The same was true for auto sales. Farmers complained about the exorbitant interest demanded for annual crop loans. Hundreds of savings-and-loan associations were at the edge of insolvency. The treasury secretary, perhaps also losing his original faith in the supply-side formulation, suggested that it was time for the Federal Reserve Board to loosen up on its tight monetary policy.
The US economy went into recession and the budget deficit rose. Stockman resigned from his role at the OMB less than 5 years into Reagan’s presidency. In that time, the gross federal debt level had nearly doubled. Unemployment had risen sharply, growth was slow in returning and all the predictions of the supply-siders were exposed for what they were misplaced faith statements.
As an aside, Stockman left government and went to Wall Street and got involved with the Blackstone Group. This is the company that made Peter G. Peterson rich. The latter is one of the principal deficit terrorists in the US, using his considerable fortune to fill the minds of Americans with propaganda (ably supported by News Limited – Fox).
Stockman admitted that the supply-side view of “expectations” was flawed:
Stockman … was beginning to leave the … (supply-side) … church. The theory of “expectations” wasn’t working. He could see that … Stockman began to disparage the grand theory as a kind of convenient illusion – new rhetoric to cover old Republican doctrine.
In the end, the initial premise that he used to justify the austerity cuts also collapsed:
Now, as the final balance was being struck, he was forced to concede in private that the claim of equity in shrinking the government was significantly compromised if not obliterated.
Fast forward to 2001, and the new President (Bush) inherited a recession made worse by the fiscal drag arising from the Clinton administration that budget surpluses were good policy. Bush enacted large tax cuts mostly of benefit to the very high income earners and eliminated the Clinton budget surpluses within 7 months of taking office. The automatic stabilisers were significant in this regard.
In this New York Times article (August 25, 2001) – President Asserts Shrunken Surplus May Curb Congress – Bush said:
… there was a benefit to the government’s fast-dwindling surplus, declaring that it will create “a fiscal straitjacket for Congress.” He said that was “incredibly positive news” because it would halt the growth of the federal government.
The reality is that it didn’t and now Obama’s lackeys are trying to use the Bush deficit build up to gain political capital as they try to cut net public spending, despite the US economy being mired in stagnant growth after a lengthy and debilitating recession.
But despite not being able to contain the budget outcome, Bush was described in this article – The Inside Scoop – (published January 28, 2003) and written by the conservative journalist Fred Barnes as a “strategic deficit” supporter:
An old notion from the Reagan presidency has come alive again in the Bush White House: the strategic deficit. It was associated with Reagan’s budget director, David Stockman, and posits that a budget deficit is a good thing to have because it holds down spending schemes. In other words, spenders can be told, “Nope, can’t pay for that. We’ve got the deficit, you know.” The most important fan of a strategic deficit in Bushland: Bush.
Now fast track to July 2010 and all the same arguments are being rehearsed in the public debate.
There was an interesting article in the UK Guardian (July 11, 2010) – Deficit cuts: We’re all in this together. But some are more in it than others – by William Keegan.
Keegan says that:
… from the insouciant way they are going about the cuts, and the savagery of their approach to the public sector, the coalition is in danger of reviving an old-fashioned class war. I say “in danger”, but perhaps this is what some of them want … I have known policymakers who have had to take counter-inflationary measures which they knew would result in higher unemployment. But seldom have I witnessed a government announcing, with apparent relish, that it intends to reduce public sector employment by 600,000 at a time when unemployment is already high, and the threat in western economies continues to be deflation rather than inflation.
I have already discussed in this blog – The BIS is part of the problem – that the UK austerity measures will cost about 1.3 million jobs over 5 years.
Keegan notes that even the OECD “which, to my mind, is too keen on premature deficit-cutting, expressed concern last week that Osborne’s budget ends funding for two important government job-creation schemes.”
The point is that austerity cuts always impact on the most disadvantaged. Reprise Stockman’s “discovery” that the supply-side attacks on spending worsened equity and failed to achieve the planned fiscal goals anyway.
The neo-liberals have been attacking the equity basis of economies throughout the world for the last 30 years or so. As I have shown in several blogs – for example, The origins of the economic crisis – these years have seen massive redistributions of real output towards capital away from labour. The way this was engineered was to outlaw key labour protections and allow real wages growth to lag dramatically behind labour productivity growth.
Keegan notes that this change was essential for the financialisation of the global economy to occur and we saw from the 1980s onwards a huge increase in speculative capital flows. The pre-conditions of the current crisis were being sown. The question is posed: “If profits and output rise persistently faster than wages, who will buy the output?”
In this regard, Keegan quotes on informed commentator who said:
… real wages were not growing fast enough to underpin final demand without excessive borrowing by wage earners.
In other words, “the growth of inequality contributed to the borrowing spree and the crisis” and when the:
… crunch came and the private sector cut back, government deficits were the natural counterpart of the private sector’s “de-leveraging”. They still are.
You would think that was obvious and given how history has discredited the “strategic deficit” and supply-side agenda by history.
Now to 2010. In an New York Times article (July 5, 2010) – A Little Economic Realism – by conservative David Brooks (who is actually held out as being a small-L liberal) the full supply-side agenda is once again being argued.
He argues that “demand side theorists” (like me by the way) have no practical experience and who use theoretical models to show that stimulus spending will increase employment. But:
Are you really willing to risk national insolvency on the basis of a model?
So the argument shifts from a distrust of econometric modelling (which has some foundation) to the totally spurious and emotional argument that budget deficits compromise national solvency. There is never a risk of insolvency for the US government in terms of being able to honour all its public debt obligation denominated in US dollars (which is all of it). Any notion to the contrary is a “trojan horse” along the lines of Stockman’s admissions above.
Brooks also says that:
… the Demand Siders write as if everybody who disagrees with them is immoral or a moron. But, in fact, many prize-festooned economists do not support another stimulus. Most European leaders and central bankers think it’s time to begin reducing debt, not increasing it – as do many economists at the international economic institutions. Are you sure your theorists are right and theirs are wrong?
I am definitely sure. All the noted parties were also proponents of the policy regimes that created the crisis. They also have other agendas.
This is a theme taken up in the UK Guardian article (July 9, 2010) – The European right is capitalising on a crisis – by Mark Weisbrot.
One thing should be made clear about the situation in the eurozone economies that is not clear at all if we rely on most of the news reports. This is not a situation where countries face a “dilemma” because they have overspent and piled up too much public debt. They do not face “tough choices” that will force them to cut spending and raise taxes while the economy is weak or in recession, in order to “satisfy financial markets”.
What is really going on is that powerful interests within these countries – including Spain, Greece, Ireland and Portugal – are taking advantage of the situation to make the changes that they want. Perhaps even more importantly, the European authorities – including the European commission, the European central bank and the IMF – who are holding the purse strings of any bailout funds, are even more committed than the national governments to rightwing policy changes. And they are further removed from any accountability to any electorate.
Ironically, the people who want to take advantage of the “crisis” in Spain are actually increasing the risk of more serious debt problems, since the debt burden will rise if the economy lapses into recession or years of stagnation because of their fiscal tightening measures. But they are willing to take these risks in order to accomplish their political objectives.
The neo-liberal attack on welfare and unions and the public sector over the last three decades (variously) was damaging but not emphatic. Public sectors survived and welfare states resisted widespread retrenchment. Now we have the situation that a major economic crisis brought about by the near-collapse of the financial system is being used to finish the agenda off.
If you think about it for any more than a nano second you will wonder why we are all being duped.
You have a period of vigorous promotion of the self-regulating capacities of the “market” and intense lobbying of governments to relax long-standing rules that protected the financial system from excess and meltdown. The lobbying was universally successful and the regulations tumbled.
Then the excesses started appearing and a few economists (including the Modern Monetary Theory (MMT) camp) started to ring the warning bells (like, back in the late-1990s!). But the lobbying continued and the bell-tollers were vilified in various ways by the arrogance of the mainstream economists.
They even coined terms to describe how the business cycle was dead – please read The Great Moderation myth – for further information.
The strutting arrogance of my profession – all these notables that Brooks think should be listened to – was something to behold as the underlying conditions for the crisis were being created by their policies.
Then it crashed and the hands of those who had been the most vociferous opponents of government fiscal initiatives were quickly held out to receive their bailouts. Many of the large banks that are once again highly profitable would have gone under had not the governments provided the fiscal support.
A much deeper crisis that the one the world is already enduring was prevented by fiscal intervention – the type hated by the neo-liberals. Once the financial interests and their support clubs (Peter Peterson Foundation etc) realised they were safe they unleashed a massive and on-going campaign of deficit terrorism.
Virtually nothing has been done to reform the banking sector. We are still essentially operating with the regulative environment that brought us unstuck. There is a massive resistance in all nations to any changes which would stop the free-wheeling bankers from getting as much of the real output as they can.
Returning to Brooks, he claims that:
The Demand Siders don’t have a good explanation for the past two years. There is no way to know for sure how well the last stimulus worked because we don’t know what would have happened without it. But it is certainly true that the fiscal spigots have been wide open. The U.S. and most other countries have run up huge, historic deficits. And while this has helped save public-sector jobs, we certainly haven’t seen much private-sector job growth. It could be that government spending is a weak lever to counter economic cycles. Maybe monetary policy is the only strong tool we have.
Maybe Brooks should read my blog – Fiscal policy worked – evidence – and several I wrote before that as the evidence was starting to mount that the stimulus packages were working.
I am the first to admit that most of the fiscal interventions were poorly considered both in magnitude and targetting. First, the reality is that given the collapse in private spending the fiscal input had to be much larger. The fact that we have “huge, historic deficits” is just a reflection of the size of the private collapse and the disruption to world trade.
China which provided the largest fiscal stimulus showed the way.
Second, the spending should have been evaluated using a better jobs for dollar criterion. Governments everywhere would have been able to spend less for more jobs by announcing an unconditional Job Guarantee. That would have targetted the stimulus directly at jobs and put purchasing power into the hands of the most disadvantaged workers.
Third, MMT has an excellent explanation for the past two years and the thirty that preceded them. The mainstream macroeconomic theory has not explanation for any of this period. Please start with the following blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3. Then proceed to the others within the Debriefing 101 category of my blog.
But then we get to the Brook’s agenda:
The theorists have high I.Q.’s but don’t seem to know much psychology. Lord Keynes, though a lesser mathematician, wrote that the state of confidence “is a matter to which practical men pay the closest and most anxious attention.” These days, debt-fueled government spending doesn’t increase confidence. It destroys it … Consumers are recovering from a debt-fueled bubble and have a moral aversion to more debt.
You can’t read models, but you do talk to entrepreneurs in Racine and Yakima. Higher deficits will make them more insecure and more risk-averse, not less. They’re afraid of a fiscal crisis. They’re afraid of future tax increases. They don’t believe government-stimulated growth is real and lasting. Maybe they are wrong to feel this way, but they do. And they are the ones who invest and hire, not the theorists.
So this is just a restatement of the supply-side, trickle-down whatever driven by a fundamentalist belief that private agents are “Ricardian” and will start saving now to pay for the higher taxes in the future because of the deficits.
There is no historical correlation between tax rates and deficit dynamics. Taxes rise when deficits fall but that is because economic growth drives both through the automatic stabilisers.
What Keynes said was that when private agents become mired in pessimism and the economy gets stuck with high unemployment, there has to be an exogenous aggregate demand intervention from government to get the economy moving again.
The supply-side agenda erroneously assumed that firms would invest even if there was no demand for the product and that consumers, who were deeply pessimistic would immediately start consuming again. Neither proposition has ever had any empirical support.
The fact is that firms are more concerned with their order books than they are about statements from economists about the fiscal disaster. No firm will invest and start producing if their sales books are flat.
Further, consumers facing unemployment or already enduring unemployment will not suddenly start spending in a blissful demonstration that they understand the mainstream macroeconomic models. As their job prospects worsen they always increase their saving (if they can).
Both demonstrations of pessimism ensure that aggregate demand fails to promote growth. The mindless belief in Say’s Law (supply creates its own demand) has never described any economy that humans inhabit.
We have heard all of Brook’s “expectations” arguments before. They were wrong then as they are wrong now.
It is always salutary to go back in history. You will find the same arguments that are being used by the mainstream economists now in past debates. You will also find they were discredited then by empirical developments.
There is nothing new in mainstream macroeconomic thinking. It was always an ideological position dressed up to look “scientific”. It never had any credibility then and it doesn’t now.
That is enough for today!