by This post has been brewing for a long time. It reflects my attempt to make sense of the growing political confusion and chaos in the world today. William Butler Yeats's poem The Second Coming well expresses what I see: Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world, The blood-dimmed tide is loosed, and everywhere The ceremony of innocence is drowned; The best lack all conviction, while the worst Are full of passionate intensity. But how have we come to this pass - and where are we heading?Post-crisis panicIn the deep recession that afflicted the Western world after the 2008 financial crisis, government debt built up as financial and other corporations were bailed out, tax revenues fell and unemployment benefits rose. Government debt is usually quoted in relation to GDP: the recession knocked a huge hole in the GDP of many Western countries, inflating the debt/GDP ratio.Suddenly, countries that had previously looked like paragons of fiscal rectitude found themselves with rising government debt/GDP and stubbornly high fiscal deficits. Others, more fragile before the crisis (though not necessarily worse managed), needed the help of the IMF. Advanced economies suddenly looked at least as risky as emerging markets. Investors took flight, forcing Western governments to support asset prices with extraordinary measures such as QE.
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This post has been brewing for a long time. It reflects my attempt to make sense of the growing political confusion and chaos in the world today. William Butler Yeats's poem The Second Coming well expresses what I see:
Things fall apart; the centre cannot hold;But how have we come to this pass - and where are we heading?
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
Post-crisis panic
In the deep recession that afflicted the Western world after the 2008 financial crisis, government debt built up as financial and other corporations were bailed out, tax revenues fell and unemployment benefits rose. Government debt is usually quoted in relation to GDP: the recession knocked a huge hole in the GDP of many Western countries, inflating the debt/GDP ratio.
Suddenly, countries that had previously looked like paragons of fiscal rectitude found themselves with rising government debt/GDP and stubbornly high fiscal deficits. Others, more fragile before the crisis (though not necessarily worse managed), needed the help of the IMF. Advanced economies suddenly looked at least as risky as emerging markets. Investors took flight, forcing Western governments to support asset prices with extraordinary measures such as QE.
Into this cauldron, someone lobbed a research paper purporting to show that government debt/GDP ratio above 90% spelled disaster. The paper turned out to be fatally flawed: but that information did not come to light until some years later.
Other research papers were added to the toxic brew. Among them, the clever models of Alesina and Ardagna supposedly proved that fiscal consolidation could restore growth. The empirical evidence presented in support of this claim was later shown to be seriously inadequate, relying on inaccurate data and omitting important factors. But in the chaos and panic of the post-crisis world, any prescription was better than none. At least they had a treatment plan.
The final ingredient was the Greek debt crisis. It scared the world. Suddenly, high government deficits and debt were terrible things. We had to get them under control. That meant deep cuts to government spending, if necessary including raising taxes and cutting benefits for the most vulnerable in society. Government after government in the developed world, and especially in Europe, accepted this harsh medicine. After all, we were told, Alesina & Ardagna had promised it would restore growth.
A political paradigm shift
To be fair, Alesina himself never claimed there was strong empirical evidence for his theory, and did not push it as a solution to the post-crisis slump. The push appears to have been political. Iyanatul Islam and Anis Chowdhury wondered whether the theory unwittingly played to a small-state political ideology:
One plausible answer lies in collective and wilful ignorance driven by an ideological aversion to counter-cyclical fiscal policy because fiscal interventions are seen as an enlargement and encroachment of the state on the functioning of the private sector. As Simon Wren-Lewis (2011) points out, and as Romer (2011)concurs, one can find eminent economists objecting to counter-cyclical fiscal policy based on ideological proclivities, even though such economists support the idea of using monetary policy to stabilize business cycles.But the question is, why was a small-state political ideology suddenly in the ascendant? It had not been, prior to the crisis. Somehow, the crisis itself had shifted the political paradigm.
It is easy to see how this could happen. In the aftermath of a monetary crisis, people are angry with those they believe caused it and fearful of losing their money and assets. They reject the existing political regime in favour of one which promises safety. They will accept harshness in the short term if they are sufficiently convinced that this will eventually bring back prosperity. Liam Byrne's tongue-in-cheek note to incoming UK chancellor George Osborne captured the political mood: "I'm afraid there is no money", he said.
"There's no money" is the psychological framing of both Reinhart & Rogoff's flawed paper, and Alesina & Ardagna's theory. The model is one of scarcity. No money is available, so we have to manage without. Belt-tightening is in order. Together, these two papers not only supported the small-state ideology of the UK's Conservative chancellor, but justified extreme fiscal tightness in the Eurozone. Reinhart & Rogoff's paper creates the justification for cuts and tax rises: Alesina & Ardagna promise the "sunlit uplands" necessary for people to accept the harsh medicine.
But the prescription turned out to be voodoo. Seven years on, prosperity has not returned: many countries in Europe are still mired in austerity, some are deeply depressed, government debt is higher than ever and unemployment is still painfully high. Failure of austerity measures to deliver the promised prosperity is toxic: popular anger and fear fuel the rise of populist politicians. Rudi Dornbusch, in a wonderful paper about debt crises and populism in Latin America, observed that the roots of populism lie in austerity, often imposed by an external agent such as the IMF. Chancellor Brüning's austerity measures in the German Great Depression, designed to end Germany's debt crisis and restore foreign confidence, led to the rise of Hitler.
The profligacy-austerity cycle
We endlessly cycle from profligacy to austerity and back again. The shift from profligacy ("the money will never run out") to austerity ("there is no money") is triggered by a monetary crisis of some kind: austerity is imposed by technocrats. And the shift from austerity to profligacy is triggered by a political crisis fuelled by popular unrest: profligacy is reintroduced by populist politicians.
In 2008, the monetary crisis that triggered the shift to austerity was the abrupt bursting of a debt bubble, leading to unpopular bank bailouts and a deep and prolonged recession. In the early 1970s, it was the collapse of the Bretton Woods fixed exchange rate system.
After the fall of Bretton Woods, rising oil prices and a global recession fuelled rising inflation. In the UK, successive governments imposed spending cuts and interest rate rises to try to arrest the fall of sterling and get inflation under control. The response to this was popular unrest led by the big unions, with continual strikes causing further economic damage. The UK was dependent on coal for electricity generation, a fact exploited by miners' unions in their claim for large wage rises: strikes caused damaging power cuts. For the UK population, inflation that eroded pay packets, economic stagnation and rising unemployment caused misery - and growing anger.
In 1976, Dennis Healey called in the IMF: the condition for the loan was further fiscal restraint, though the loan was never fully drawn. The fiscal consolidation contributed to the famous "Winter of Discontent", when the country was riven by strike after strike in opposition to government pay caps.
By 1979, the people of the UK had had enough. The Conservative party's famous posters with pictures of dole queues and the slogan "Labour isn't working" touched a nerve. Margaret Thatcher's brand of populist politics ensured that the Conservative party won the 1979 election - and kept Labour out of power until 1997.
Populist politics works by directing popular anger towards an "enemy" who can be blamed for people's woes. The enemy must be capable of catching the public imagination, so usually it is a defined group of people who can be cast in the role of scapegoat. Blaming the "other" is a powerful way of creating a sense of common purpose. Often, the "enemy" is external: there are numerous examples throughout history of populist politicians distracting attention from domestic troubles by starting a war. In Thatcher's case, though, the enemy was internal, at least to start with. She was elected on a mandate to break union power - and in particular, the power of the miners' unions.
Thatcher's government is widely remembered for the harsh anti-inflation measures, deep recession and very high unemployment of the early 1980s. But people will accept austerity in the short-term, if they are promised that it will bring prosperity. The trick is to deliver the prosperity - and that means profligacy, but targeted at those who support the populist regime. And to ensure that the regime is not blamed for the preceding austerity, the "other" must be broken.
So the unions were defeated by heavy-handed policing following extensive anti-union legislation. Breaking the unions also involved dismantling the UK's coal industry and much of its heavy industry: the areas most dependent on these industries have never really recovered. Thatcher is hated to this day in the former industrial areas of the Midlands, the North and South Wales. But we should not forget that in in other areas, especially the South East and London, she was immensely popular. Populist politicians are divisive.
The destructiveness of Thatcher's industrial policy was coupled with the return of profligacy. The Right to Buy scheme for council housing was extraordinarily expensive. So too was the Falklands War. As interest rates fell, the UK economy got a big fiscal boost - and the result was the "Lawson boom", which ultimately ended in the property crash of 1990. Prosperity for "us", destruction for "them"....that is the goal of populism.
Since the financial crisis, "bankers" have been the "other" in the popular mind - but so have "scroungers and shirkers", who are seen as taking much-needed money from "hard-working people". In an interview with the Guardian, the former Deputy Prime Minister Nick Clegg said that George Osborne deliberately targeted the poor and vulnerable for cuts because this would be popular with Tory voters. This is populism at its worst. And like Thatcher before him, Osborne combined harshness towards the "other" with generosity towards supporters, especially the old and the well-off. The UK's recovery in recent years has been primarily driven by profligate support of the housing market.
A new political paradigm
Greece was the archetype for the post-crisis "there is no money" paradigm. This paradigm still holds - but it is beginning to fracture. A new, darker paradigm is beginning to emerge. The new paradigm is nationalism ("take back control"). And the archetype for the new paradigm will be my own country, the UK. I never, ever thought this could happen here.....
The populist paradigm shift started with the EU referendum. This time, the enemy was external. The EU was vilified as the "other" by Leave campaigners. Leave the EU, all your troubles will be over....This is a false promise, of course. Leaving the EU is likely to cause at least as many problems as it solves. I fear for those who have been promised prosperity by the sellers of snake oil. It will be a long time before they see it - and as many are old, they may never see it at all.
But it is not the rejection of the EU that horrifies me: many people voted for Brexit for good reasons. No, it is the emergence of a small-minded, "Britain for the British" mindset, coupled with hate speech and even physical attacks on ethnic and religious minorities that are seen as "foreign". If Brexit does not deliver the closed borders and cherry-picking of immigrants that these people want, what will they do?
We have seen the darker side of nationalism before, of course, though it has been hiding under a rock for a long time. Outright racist views are not widely accepted, but there is plenty of toxic "othering" along the lines of "I'm not racist, but I hate Muslims/Poles/Lithuanians/Syrians/immigrants [choose as many as you like]". Some groups are demonised: refugees, for example, who are often described as rapists and murderers despite the lack of any convincing evidence.
Creating groups of "others" who can be demonised is the essence of toxic nationalism. To their credit, the current UK government is attempting to stamp on this unpleasant behaviour. But they are trying to hold back the tide. I think this is the manifestation of the breaking of a long political and economic cycle - the release of pent-up anger and frustration built up over decades. And it will not be limited to the UK. Nationalist forces are rising all over the world.
The "golden age" of globalisation
Thatcher's generation of populist politicians discarded the big state, "Keynesian" model that had dominated since WWII. They replaced it initially with austerity (to break unions power and defeat inflation). But in any democracy, austerity is short-lived unless you can find a way of convincing your supporters either that they are not really suffering (so you protect people who will vote for you) or that the good times will return "any day now". Thatcher's generation - or perhaps more correctly, Reagan's generation, since this comes from economic thinking in the USA - promised that globalisation would bring prosperity for all. We could say that they replaced a "big state" model with a "big world" one. Free trade, free movement of people, free movement of capital: these were the pillars on which the new golden age would be built.
And golden it was, for many. Branko Milanovic has shown how, along with the top 1% who always benefit from everything, the rising Asian middle class benefited from globalisation. The last three decades have seen more people lifted out of poverty than ever before.
But the Western middle classes saw no benefit. For them, globalisation brought stagnation and decline, as their jobs were offshored and their wages fell to the global mean. Their prosperity turned out to be an illusion, built on an insubstantial debt bubble. The promise made to them in the Reagan years has been exposed as a lie. And they are angry. Globalisation has failed - now it is time to "take back control".
As with all long-cycle paradigm shifts, few saw this coming. We are short-lived creatures, and we see only our own small part of the web of time. And just as in the paradigm shift of the 1980s the economic theories of the past were discarded in favour of something new and untried, so now the mainstream economics of the last 30 years is under attack, not just from those who want to reform it but also from those who want to reject it entirely. "I think people of this country have had enough of "experts", said Michael Gove.
Rejecting existing "experts" is a feature of populist politicics. But unlike the 1980s, when populist politicians could claim the work of Milton Friedman and Friedrich Hayek as an alternative to Keynes, this time there is nothing much to replace them. Few economists, either mainstream or heterodox, would support return of general capital and exchange controls, tariff and non-tariff barriers to trade and significant restrictions on the movement of people, let alone the unfairly skewed versions of these that the new nationalists seem to want ("we expect to export to you tariff free but we will impose tariffs on imports from you"; "we can live and work in your country but you can't live and work in ours": "when we devalue our currency that is monetary policy, but if you do the same you are a currency manipulator"). So although, after six years of painful soul-searching, mainstream and heterodox economists now seem to be singing from the same hymn sheet in many respects, people are no longer listening. Populist politicians deride "experts", and pursue divisive policies designed to appeal to protected groups of voters.
The terrible lesson of history
Historically, resurgent nationalism has always led to war. I see no reason why this time should be different. We scared ourselves silly at the end of World War II: the memory of Hiroshima has kept the world in an uneasy peace (though with numerous local breaches) ever since. But as the memory fades, and old tribal loyalties reassert themselves, the world enters a new and dangerous phase.
There is a fine line between nationalism and imperialism, and at some point, someone will cross that line. I don't know who, or where, that will be. But when they do, there will be war.
Related reading:
When the world turns dark
What have we learned from history?
A Latin American tragedy
Currency wars and the fall of empires - Pieria
Vortex star trails image from www.sgarciarill.com with thanks.