by Marx said that history does not repeat itself. But sometimes, history does. This may be particularly true in the domain of economics and economic knowledge. Economics is a complex subject. It is the study of a series of abstractions (markets, firms, governments) built upon abstractions (money) built upon abstractions (value), a great metaphysical muddle stacked up to the sky like a wobbly Jenga tower. At a simpler level, economics is the study of human behaviour, or as von Mises put it, human action. Business cycles from the boom to the bust are a great cavalcade of individual human action and individual decisions. The sum of individual decisions manifests itself as the market. And the behaviour of the market informs future individual decisions, in a great self-reinforcing spiral of feedback. The question of what the government should do in a bust is one particular realm where little progress has been made since the Great Depression. Indeed, perhaps future historians will refer to the current economic malaise as Great Depression II, given that in various polities including Britain and the eurozone the depth of the slump in gross domestic product has been greater and longer than that in the 1930s. Why? Well, the urge to purge is strong. And I say that as a former austerian — someone who has done a good deal of urging for purging.
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Marx said that history does not repeat itself.
But sometimes, history does. This may be particularly true in the domain of economics and economic knowledge.
Economics is a complex subject. It is the study of a series of abstractions (markets, firms, governments) built upon abstractions (money) built upon abstractions (value), a great metaphysical muddle stacked up to the sky like a wobbly Jenga tower.
At a simpler level, economics is the study of human behaviour, or as von Mises put it, human action. Business cycles from the boom to the bust are a great cavalcade of individual human action and individual decisions. The sum of individual decisions manifests itself as the market. And the behaviour of the market informs future individual decisions, in a great self-reinforcing spiral of feedback.
The question of what the government should do in a bust is one particular realm where little progress has been made since the Great Depression. Indeed, perhaps future historians will refer to the current economic malaise as Great Depression II, given that in various polities including Britain and the eurozone the depth of the slump in gross domestic product has been greater and longer than that in the 1930s.
Why? Well, the urge to purge is strong. And I say that as a former austerian — someone who has done a good deal of urging for purging.
The logic goes that a crashed market is a sick market. A corrupted market. So let the sickness kill off the weakness. Let bad firms fail. Let the bad investments fuelled by false expectations fail. Let resources be reallocated from the unproductive to the productive. Then — through harsh market discipline — market participants will learn lessons that set the stage for abundant new economic growth. As Paul Krugman notes, Friedrich Hayek called for: “the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending.”
It’s a simple call: no bailouts, no stimulus spending. In fact, cut government spending to balance the budget. Stop subsidising the unproductive. Let the voluntary market of savers, investors and spenders sort itself out.
The trouble is that it doesn’t really sort itself out. And we have a good deal of empirical evidence to back up that idea. The more austerity, the deeper the slump.
Lionel Robbins — who went on a similar journey away from austerianism, only eighty years earlier — reached this conclusion:
Whatever the genetic factors of the pre-1929 boom, their sequelae, in the sense of inappropriate investments fostered by wrong expectations, were completely swamped by vast deflationary forces sweeping away all those elements of constancy in the situation which otherwise might have provided a framework for an explanation in my terms. The theory was inadequate to the facts. Nor was this approach any more adequate as a guide to policy. Confronted with the freezing deflation of those days, the idea that the prime essential was the writing down of mistaken investments and the easing of capital markets by fostering the disposition to save and reducing the pressure on consumption was completely inappropriate.
To treat what developed subsequently in the way which I then thought valid was as unsuitable as denying blankets and stimulants to a drunk who has fallen into an icy pond, on the ground that his original trouble was overheating.
This is a powerful debunking of David Cameron’s confidence fairy logic. The idea that the answer to an economic malaise is to slash spending, slash welfare and let the market sort itself out is a bit ridiculous. It is very much denying blankets and stimulants to people who have been thrown into an icy pond. The great irony is that the brunt of the cuts are falling not upon the drunk market speculators who caused the financial crisis, but vast swathes of disabled and poor who had nothing to do with it.
In the face of Cameron’s austerity policy, the UK had the slowest recovery since the South Sea bubble in the 18th century. And the UK’s recovery only really began when Cameron paused the austerity. With more austerity now, we risk another recession.
The trouble, I think, is that government austerity looks very superficially plausible. It looks the responsible thing to do.
For an individual or as a firm, austerity in a slump can be a very sensible choice. For an individual or firm, getting into an unsustainable level of debt risks going bankrupt. And while it is not incoherent to suggest that someone in debt trouble take on more debt as a means to dramatically increasing their income — for instance, through entrepreneurship — it is undoubtedly a major gamble.
But for government, it’s very much the other way round. As Keynes noted, government spending is an awful lot of people’s incomes. Even if some businesses are cheered by the “fiscal responsibility” shown by a government willing to slash spending, many other businesses are going to be less cheered as their revenue falls due to the falling incomes of the individuals and firms who rely on government spending for a portion of their income.
That’s not to say that it is impossible that slashing spending in the middle of a recession may under some theoretical circumstances be consistent with a fast-recovering economy. But in the overwhelming majority of cases, it is a very, very major gamble that does not pay off. It hasn’t paid of in the eurozone since 2008, it didn’t pay off during the Brüning years in Germany, and it didn’t pay off for Cameron and Osborne, who were forced to pause austerity in 2013 with the economy flatlining. And in a very major vindication for Keynesian thinking, not only did that precede a recovery but it was also the turning point on the government deficit as a percentage of GDP. Once the slashing stopped, the deficit began to fall fast. So the responsible thing to do was to rack up government debt, allow the government to channel resources back into the economy, and let the economy recover.
This is all very counterintuitive stuff. It is hard for its discoverers to spread, which is why it has to keep being rediscovered again and again and again. I am sure there will be people in the 22nd Century who have to learn this lesson, too.