Austerity

Introduction

In the wake of the 2007/2008 global financial crisis, many countries found themselves facing severe economic challenges. As governments scrambled to find solutions, one word kept coming up: austerity. This economic policy, which involves cutting government spending and raising taxes to reduce budget deficits, was touted as the cure-all for struggling economies. However, in his book "Austerity: The History of a Dangerous Idea," Mark Blyth argues that this approach is not only ineffective but potentially harmful.

Blyth's work takes readers on a journey through the history of austerity, its implementation in various countries, and its consequences. He challenges the common narrative that government overspending caused the crisis and that belt-tightening is the only way out. Instead, he presents a compelling case for why austerity often fails to deliver on its promises and can even exacerbate economic problems.

The Fallacy of Austerity

Austerity's Impact on the Economy

One of the central arguments in Blyth's book is that austerity measures often have the opposite effect of what's intended. While the goal is to boost an economy's competitiveness and inspire confidence in businesses, the reality is quite different.

When a government implements austerity measures, it typically involves:

1. Reducing public spending
2. Cutting social programs and benefits
3. Raising taxes

The logic behind this approach is that by reducing government debt, the economy will become more stable and attractive to investors. However, Blyth argues that this logic falls apart when applied on a national scale, especially when multiple countries implement austerity simultaneously.

Here's why:

• When government spending is cut, it reduces the overall demand in the economy.
• As demand falls, businesses see their revenues decline.
• To cope with reduced income, businesses may lay off workers or reduce wages.
• This leads to higher unemployment and lower consumer spending.
• The cycle continues, with the economy shrinking further.

In essence, austerity can create a vicious cycle that weakens the economy rather than strengthening it.

The Disproportionate Impact on Lower Classes

Another crucial point Blyth makes is that austerity measures don't affect everyone equally. In fact, they tend to hit the lower classes the hardest. When governments cut spending, it's often social programs, welfare benefits, and public services that bear the brunt of these cuts. This means that those who rely on these services – typically the most vulnerable members of society – suffer the most.

Meanwhile, the wealthy and corporations often benefit from tax cuts or other incentives designed to stimulate economic growth. This creates a situation where the burden of economic recovery is placed squarely on the shoulders of those least able to bear it.

Historical Evidence Against Austerity

Blyth doesn't just rely on theoretical arguments to make his case. He delves into history to show that austerity has a long track record of failure when it comes to restoring economic growth.

The Great Depression Era

One of the most striking examples comes from the United States during the Great Depression. In the 1920s, President Warren Harding implemented austerity measures in an attempt to balance the budget. Far from preventing economic crisis, these policies contributed to the onset of the Great Depression.

Later, when President Herbert Hoover tried to increase taxes in 1931 to balance the budget, it only deepened the recession. It wasn't until President Franklin D. Roosevelt abandoned austerity in favor of increased government spending through the New Deal that the economy began to recover.

Post-World War I Germany

Another chilling historical example comes from Germany after World War I. The harsh reparations imposed on Germany by the Treaty of Versailles led to severe austerity measures. These policies impoverished large portions of the population and created social unrest. Blyth argues that this economic hardship played a significant role in setting the stage for Hitler's rise to power.

Other European Examples

Blyth also points to examples from Sweden, France, and Japan in the 1930s. In each case, austerity measures failed to stimulate economic growth. Only when these countries reversed course and increased government spending did their economies begin to recover.

Debunking "Successful" Austerity Cases

Some economists point to countries like Australia, Denmark, and Ireland as examples of successful austerity. However, Blyth carefully examines these cases and finds them wanting:

• Denmark: The budget cuts were made during economic booms, not recessions.
• Ireland: The country was experiencing economic growth in the 1980s, aided by the devaluation of the Irish pound.
• Australia: There's no evidence of cuts to unemployment benefits or capital taxes, as austerity proponents claim.

These examples, Blyth argues, are often misrepresented or taken out of context to support pro-austerity arguments.

The True Causes of the 2007/2008 Financial Crisis

A significant portion of Blyth's book is dedicated to debunking the myth that government overspending caused the recent financial crisis. Instead, he points to the US banking system and the housing market as the primary culprits.

The Role of Banks and Mortgage Securities

Blyth explains how banks became heavily involved in "repo markets," which allowed them to make short-term loans to each other using housing-mortgage securities as collateral. This system worked well as long as homeowners kept paying their mortgages. However, when mortgage defaults began to rise in 2007, the entire house of cards came tumbling down.

The author introduces readers to complex financial instruments like Collateralized Debt Obligations (CDOs) and credit default swaps (CDS). These tools, which were meant to spread risk, actually concentrated it in ways that made the financial system extremely vulnerable.

The Spread of the Crisis

As news of the crisis spread, panic set in. People rushed to withdraw money from banks, which didn't have enough cash on hand to cover these withdrawals. This led to a chain reaction of banks borrowing from each other, spreading the problem throughout the financial system.

Blyth emphasizes that this crisis was not caused by government overspending, but by risky practices in the private banking sector. Yet, when the crisis hit, it was governments – and by extension, taxpayers – who were left to foot the bill.

The European Debt Crisis

The book then shifts focus to Europe, explaining how the global financial crisis morphed into a debt crisis in the eurozone.

The PIIGS Nations

Blyth introduces the concept of the PIIGS nations – Portugal, Italy, Ireland, Greece, and Spain. These countries were already facing economic challenges before the crisis hit:

• Portugal and Italy: Aging populations and low birth rates
• Ireland and Spain: Bursting property bubbles
• All PIIGS: Struggling industries due to competition from core European countries like Germany

The adoption of the euro had given these countries access to more credit, but it also removed their ability to use traditional crisis management tools like currency devaluation.

The Fatal Decision to Bail Out Banks

When the crisis hit, European leaders made the fateful decision to bail out the banks. This decision, Blyth argues, doomed the PIIGS nations to permanent austerity.

The logic behind the bailouts was that the banks were "too big to fail." However, Blyth points out that they were also "too big to bail." The value of many banks had grown to be larger than the GDP of the countries they were based in. For example, in 2008, the combined value of the three largest French banks was over 300% of France's GDP.

By bailing out the banks, the PIIGS nations essentially transferred private debt to public debt. This left them with enormous debts and no money to invest in economic growth or social programs.

Case Studies: Ireland vs. Iceland

To illustrate the effects of different approaches to the crisis, Blyth compares the experiences of Ireland and Iceland.

Ireland: The Austerity Approach

Ireland is often held up as a model of successful austerity. After spending €70 billion to bail out its banks, Ireland implemented severe austerity measures:

• Public sector salaries were cut by nearly 20%
• Welfare and social benefits were drastically reduced
• Taxes were increased

However, Blyth argues that Ireland's "success" is a mirage. By 2012:

• Economic growth was below 1%
• Unemployment had risen from 4.5% in 2007 to almost 15%
• The debt-to-GDP ratio had climbed from 32% in 2007 to 108% in 2013

Most of the limited growth came from foreign companies taking advantage of reduced taxes, with the wealth generated not staying in the country.

Iceland: An Alternative Approach

In contrast, Iceland took a radically different approach. Despite being in an even worse position than Ireland in 2007 (with bank assets nearly 1000% of GDP), Iceland allowed its banks to fail.

Instead of bailing out the banks, Iceland:

• Provided additional support to social benefit programs
• Raised taxes on top earners
• Lowered taxes on low-to-middle income families
• Devalued its currency
• Implemented capital controls

The results were surprisingly positive:

• GDP only dropped 6.5% in 2009 and 3.5% in 2010
• By 2011, Iceland was experiencing 3% growth, which continued into 2012
• Iceland became one of the top-growing economies on the OECD list

Blyth uses this comparison to argue that letting banks fail, while politically difficult, can lead to better outcomes for the majority of citizens than implementing austerity to save the banks.

Alternatives to Austerity

In the final sections of the book, Blyth outlines several alternatives to austerity that could help nations recover from economic crises without placing the burden on the most vulnerable members of society.

Letting Banks Fail

The first step, as demonstrated by Iceland, is to be willing to let troubled banks go bankrupt. While this may seem drastic, Blyth argues that it's less costly than bailing them out and allows the state to preserve resources for protecting its citizens during the recovery period.

He challenges readers to consider what essential service banks provide that justifies their bailout. Unlike food or energy providers, banks primarily serve as intermediaries between borrowers and lenders, often making enormous profits in the process.

Taxing the Wealthy

Another alternative Blyth proposes is raising taxes on the wealthiest members of society. He cites a 2012 study by German economists that showed how a one-time tax on the wealthiest 8% of the population could significantly reduce national debt:

• A 10% tax on net wealth over €250,000 could increase GDP revenue by 9%

Similarly, American economists Peter Diamond and Emmanuel Saez suggested that:

• Raising income tax on the wealthiest 1% from 22.4% to 43.5% could increase US GDP revenue by 3%

These measures would allow countries to reduce their debt without cutting essential services or placing the burden on those least able to bear it.

Rethinking Economic Priorities

Blyth argues that the fundamental problem is not just about economic policy, but about whose interests are being served. He suggests that if nations prioritized the well-being of the majority over the interests of a wealthy few, there would be no shortage of creative solutions to economic crises.

This might involve:

• Investing in public infrastructure to create jobs and stimulate the economy
• Strengthening social safety nets to support those affected by economic downturns
• Implementing policies to reduce income inequality
• Regulating the financial sector more strictly to prevent future crises

Conclusion

Mark Blyth's "Austerity: The History of a Dangerous Idea" presents a compelling case against the use of austerity as a tool for economic recovery. Through historical examples, economic analysis, and case studies, he demonstrates that austerity often fails to achieve its stated goals and can even worsen economic conditions.

The book challenges readers to rethink common assumptions about government spending, debt, and economic policy. Blyth argues that the narrative of government overspending causing economic crises is often misleading, and that the true causes are more complex and often rooted in the private sector.

Perhaps most importantly, Blyth highlights the human cost of austerity measures. By disproportionately affecting the most vulnerable members of society, austerity not only fails as an economic policy but also raises serious ethical questions about how societies should respond to economic crises.

As Blyth points out, another financial crisis is likely to occur in the future. The hope is that by understanding the failures of austerity and considering alternative approaches, we can make better choices when that time comes. Rather than defaulting to policies that protect the interests of banks and the wealthy, we can pursue solutions that benefit the majority of citizens and lead to more sustainable and equitable economic growth.

In the end, "Austerity" is not just a critique of a particular economic policy. It's a call for a fundamental reassessment of our economic priorities and the values that underpin our financial systems. By challenging the conventional wisdom about austerity, Blyth opens up a space for new ideas and approaches that could lead to more resilient economies and fairer societies.

As we face ongoing economic challenges and uncertainties, the lessons from this book remain highly relevant. Whether you're a policymaker, an economist, or simply a concerned citizen, "Austerity: The History of a Dangerous Idea" provides valuable insights into one of the most contentious economic debates of our time. It encourages us to look beyond simplistic solutions and consider the complex realities of modern economies, always keeping in mind the human impact of the policies we choose to implement.