The counter-revolution in economics is almost complete. A flirtation with alternative thinking lasted for the six months between the near collapse of the banking system in late 2008 and the London G20 summit in April 2009.
Since then, the forces of economic orthodoxy have regrouped and fought back. There was always going to be a backlash because those who fervently believe that markets never lie, that budgets should always balance and that the government is always bad were well dug in on university campuses, in finance ministries and in some central banks. Even so, the world has returned to the pre-crisis mind-set with remarkable speed.
In 2008 policymakers prescribed a strong dose of John Maynard Keynes to stave off a full-scale slump. Today the solution for Greece, burdened with debts it has not a hope of paying, is belt-tightening and privatisation. The way to bring down global unemployment, which stands at more than 200-million, is wage flexibility. The blueprint for reform of the financial sector is to do as little as possible lest it deter the money-changers from returning to the temple.
In some places resistance continues. President Barack Obama persists in his heretical view that the United States should restore its economy to health before cutting the deficit. The US Federal Reserve and the Bank of England are holding out against the clamour for higher interest rates to tackle inflation. But prospects for a fundamental shift in economic policy, which looked promising two years ago, have dimmed.
Why did this happen? It is a complex story, but the explanation perhaps lies in the fact that it took the born-again Keynesians of 2008-2009 an awful long time to admit the error of their ways.
Having bought fully into the free-market consensus, they received precious little credit for abandoning the old dogma when the collapse of Lehman Brothers threatened a return to the 1930s.
In Britain there is a precedent for this. Between 1990 and 1992, then prime minister John Major insisted the pound had to stay in the European exchange rate mechanism (ERM), even though pegging it to the German mark was making the recession deeper and longer. When sterling was eventually forced out of the ERM in September 1992 interest rates were slashed, the pound depreciated by 15% and economic recovery began almost immediately. But because the U-turn had been forced on him, Major received brickbats rather than bouquets.
The same, I suspect, applies to former prime minister Gordon Brown and the Labour Party, which rediscovered the virtues of government activism only after 10 years of sucking up to the financial sector in the City of London.
Also, the forces of orthodoxy have played a blinder. They have constructed a narrative that blames former US president Bill Clinton for the sub-prime mortgage crisis (he forced the banks to lend money to spread home ownership to the poor) and profligate governments rather than unchecked global finance for the worst recession since World War II. They have been helped in the construction of this storyline by the feebleness of progressive parties.
In one sense, the arguments of the orthodox school are right on the money. The crisis of 2007-2008 was caused by an excess of debt, so why, they argue, should the solution to that crisis be still more debt? Voters seem to buy the idea that there is no easy way out of this predicament and in overleveraged countries such as the US and the United Kingdom they are right about that.
But it was interesting last week to find the Organisation for Economic Cooperation and Development (OECD) starting to get cold feet about the pace of budget cuts in Britain. The OECD has cut its forecasts for growth this year and next. If the think-tank is right, the country will have its weakest recovery from recession since the 1920s.
In this context it is worth mentioning an article written for the Times by Keynes in May 1933 expressing concerns about the economy despite a pick up in activity after Britain’s departure from the Gold Standard in 1931. Keynes wrote: “Confidence has been restored and cheap money established both on long and on short term [the equivalent of zero interest rates and quantitative easing from the Bank of England today].
Yet unemployment has not declined. Where are we to look for the explanation? Not in the international sphere; for our net foreign trade position, though still bad, is much improved [the equivalent of the increase in net exports caused by the 25% depreciation of sterling since 2007].
“We can find it nowhere, I suggest, except in the decline in our loan expenditure, as the result of our no longer borrowing for the dole and of our restraining the capital expenditure of all public authorities.”
A more contemporary critique emerged last week from one of Keynes’s modern disciples, Joseph Stiglitz. In the foreword to a book produced by the European Trade Union Institute (Exiting from the Crisis: Towards a Model of More Equitable and Sustainable Growth), Stiglitz argues that austerity leads to even higher unemployment, putting further pressure on wages and therefore overall demand in the economy.
The position seen from this perspective is as follows. For the first half of the post-war period, the strength of trade unions ensured that income gains were shared across all sections of the population and income inequality declined.
Since the 1970s real wages for those in the middle and at the bottom of the income distribution have been squeezed hard. Equity withdrawal from rising property prices and much higher levels of debt filled the gap left by the stagnation of real wages until the summer of 2007 but the pressures on the so-called “squeezed middle” are now intense.
These pressures will not be eased without pro-growth macroeconomic policies, activist industrial strategies, stronger unions, higher real incomes across the board and tougher action against inequality. A return to the Anglo-Saxon model will lead to stagnation, higher unemployment and even bigger public-sector deficits. —