Living in the Age of Magical Austerity Thinking

In Economic Planning, Economics, Financial Crisis, Full Employment, Political Ideology, Politics, Politics of Policy, Public Policy on August 27, 2011 at 2:52 pm

Introduction:

Franklin Delano Roosevelt’s First Inaugural Address diagnosed the essential weirdness of recessions: “our distress comes from no failure of substance,” he noted. “Plenty is at our doorstop, but a generous use of it languishes in the very sight of the supply.” The reason for this? “Primarily this is because the rulers of the exchange of mankind’s goods have failed…they have tried, but their efforts have been cast in the pattern of an outworn tradition.”

This last factor, that in the grip of a massive decline in production, employment, and consumption, the world’s leaders decided to maintain the gold standard and free exchange of currency by balancing budgets, cutting spending, and raising taxes and then to do it over and over again, despite the failure of that policy to show any positive result, is to my mind an absolutely critical one. For all that the critiques of John Maynard Keynes and other dissident economists were eloquent and correct, the reality was that they had been making their arguments for over a decade to no avail.

Today, we seem to be stuck in a similar pattern, where the conventional wisdom on economic policy fails to produce results, but retrenches even more strongly despite this.

Why is this?

A Common Madness:

Here in the U.S, we have seen a sudden lapse into irrational political behavior. Despite the manifest reality that:

Not only have we turned away from any further stimulus well before the 2010 midterms and adopted a national obsession with debts and deficits. We’ve had deficit commissions, ratings agencies, and now a Super Congress pushing and pushing the same line that we must choose austerity or the bond market will retaliate against us. And yet, at no point has the economy responded in the way they have predicted: interest rates on government debt have fallen into the negative for 5 and 7 year Treasuries, and 10 year Treasuries are virtually zero-interest. To the extent that the markets have reacted at all to almost two years of Chicken Littleism on public debts, they have acted out of fear that austerity will lower economic growth.

Normally, when reality does not merely fail to match with theory but runs completely contrary to it, one adjusts theory. Instead, we seem to hold in our minds at the same time that austerity will depress economic growth but that it is necessary for growth to continue.

The same is true across the Atlantic. Despite an increase in unemployment to 2.5 million and a slump in growth to a negligible .2% a quarter, the U.K’s Chancellor George Osborne continues to insist that there is no “Plan B.” In the face of zero growth or near-zero growth in both France and Germany, the two pillars of the Eurozone have called for cuts at home and a balanced budget amendment for the E.U while the European Central Bank still persists in its course of refusing further monetary stimulus.

At every turn, economic downturn has brought calls for austerity for Ireland, Spain, Portugal, Greece, and Italy, austerity depresses expectations for growth, which makes the bond markets demand higher interest rates and lower ratings, which brings renewed calls for austerity. Never has the definition of insanity as “doing the same thing over and over again and expecting a different result” seemed more apt.

The Etiology of Magical Austerity Thinking and “Demand Denialism”

Describing the current wave of “magical austerity thinking” is not hard – and the way is made even more smooth by the yeoman work being done by Paul Krugman, Brad DeLong, Dean Baker, and other public intellectuals in documenting the rise in irrational economic logic. Their work is especially useful in pointing to another key feature of “magical austerity thinking” – not only does it include a belief that austerity must be right no matter what actually happens, but it also includes a flat rejection of the position that deficient demand is the reason for economic stagnation.

The more difficult thing is to explain why this is the case without taking the easy way out of simply asserting stupidity or simple corruption. I think the condition is more complex than that; my own attempt at a diagnosis suggests instead a confluence of four factors: solicitude of the have-muches, distaste for redistribution, fear of state capacity, and fear for the rights of the managing classes, which I’ll discuss in pairs.

Solicitude of the Haves/Distaste for Redistribution:

Part of the problem with a “vulgar Marxist” interpretation of magical austerity thinking is its vulnerability to the counter-argument that, while austerity protects the short-term interests of bond-holders, by depressing economic growth, it damages the interests of stock-holders, corporations, and ultimately bond-holders themselves. If pundits, economists, elected officials and civil servants, and other members of the conventional-wisdom-forming classes are driven by their allegiance to the wealthy, why are they acting in a way that will cause long-term harm to the fortunes of the well-to-do?

I think the explanation is that wealth is not merely material, but contains its own ideology as well – a belief in property rights as well as property itself, even when the defense of the right might hurt the property itself. Part of this ideology includes a distaste for redistribution to the non-wealthy, even when redistribution is in the long-term interest of the wealthy, because the wealthy see their wealth as making them morally or personally superior to the poor – who they see as unworthy, lazy, and dangerous.

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World of Class Warfare – The Poor’s Free Ride Is Over
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In the Great Depression, enlightened businessmen like Edward Filene, who supported the minimum wage, Social Security, and other New Deal programs because he wanted to ensure that consumers had money to spend in his stores, were few and far between. Far more common was the attitude of Andrew Mellon, who called for the liquidation of farmers and workers along with stocks, bonds, and real estate in order to “restore business confidence.”

Today, we see the same dog in the manger attitude – wealthy people bitterly opposed to economic stimulus, foreclosure reform, the extension of unemployment insurance, and so forth, not because it wouldn’t benefit them, but because they are both afraid and outraged that it would benefit the poor.  This has to be understood not merely as class sadism, but as emerging from a world view that combines the Calvinist obsession on the parable of the talents and economic success as a market of the Elect (or the modern fundamentalist “prosperity gospel”) with a Social Darwinist conception of the marketplace. The result of this concoction – as you can see in the video clip above – is an inversion of the classic labor republican ideology of producerism, whereby the wealthy become the producing classes and workers and consumers are turned into parasites.

Fear of State Capacity/Defense of the Rights of the Managing Classes

While distaste for redistribution stems more from an individual distaste for taxes and government benefits, there is also a systemic component. Just as above, part of “magical austerity thinking” comes from an unspoken fear that Keynesian demand management might work – which would greatly expand state capacity for states that have been on the retreat on economic matters for thirty or more years. In this view, socialism follows the Keynesian flag – if people come to expect that governments can and should provide steady economic growth and low unemployment, they might demand state provision of health care, housing, or employment itself.

This anti-statist attitude also has to be understood as more than just abstract theory. Behind the rhetoric of the wealthy as the “producing classes” lies some unspoken approval of the Schumpeterian centering of the entrepreur as the “world-historical individual” of modern capitalism. If the market is self-regulating and the acme of efficiency, then the businessman is elevated as the savior of the world, the font of prosperity, both a rugged striver and a paternalist provider of work and civilization to the passive masses. What the “demand denialists” want, therefore, isn’t just profits, but the unfettered power to determine prices, wages, working conditions, economic development, and public policy – to direct the course of the world’s development.

If the government is needed and capable of providing economic prosperity, if business is ultimately dependent on the power of the exchequer and the purse, then the wealthy aren’t the heroic Atlases they want to be. And when one’s self-image is threatened, one will believe anything that wards off that threat.

Conclusion: the “Respectability Complex”

Theoretically, the “magical austerity thinking” of the center-right shouldn’t matter – the left should be able to win victory on a straightforward agenda of Keynesian stimulus, regulation of the financial sector, direct job creation, and an expansion of social protections more generally. The problem is that, following the right-ward retrenchment of “Third Way” movements in center-left parties in the 1990s, a significant fraction of center-left political parties believe in “magical austerity thinking.”

An even larger chunk don’t, but act as if they do because of an inherited belief that in order to win elections, they must pander rightward to be accepted as a “respectable” political party. This is the larger victory of the “Third Way” – because even outside of the ranks of the DLC in the United States or the arch-Blairites in the Labour Party in the U.K and their continental counterparts, there is a quiet conviction that the electorate is hostile to a forthrightly social-democratic economic program.

This might have been true in the 1990s, so close to the fall of the Soviet Union and a bubble-fueled economic boom. In the era of the Great Recession, it no longer describes reality. The problem is now that the center-left has nothing to differentiate itself from the right; neoliberalism with a human face requires economic growth to spread around, and that isn’t available now. The rising far right in Europe isn’t economically conservative; voters in the U.S approve enthusiastically of taxing the rich and direct job creation.

What’s needed is a center-left party willing to gamble on dis-reputability.

– Steven Attewell

  1. It is pretty strange. I’ve been trying to sort out how this relates to the odd “hyperinflation is just around the corner” crowd, which seems to tie in with some of the deficit-hawk crowd, pushing questionable claims about how the U.S. will necessarily incur huge inflation if it doesn’t enact austerity. What motivates them, especially since they’ve been pushing that line for decades now while being clearly wrong each of those decades?

    The easy portion are that some subset are just survivalist cranks, latching on to the latest reason to stock up on guns and canned beans.

    But for the rest, it’s a bit more puzzling. Is it ideological, that this should be the case in some simplified model of economics, so therefore the blinkered believer holds that it must be the case? Or is it more calculating and strategic, that the purpose of pumping up hyperinflation fears is to force austerity and a contractionary monetary policy? I haven’t quite figured out which of those factors is pushing things.

  2. Hey Steve:

    It is always a pleasure to read the thoughts of a thoughtful person. I disagree with you often but you are unfailingly thoughtful and coherent. Sorry this is so long. I think it is probably unmannerly of me to post this much but the ideas behind what you express in this blog are very interesting. If you would permit me I would like to ask a couple of questions. If I my posts are too long, just let me know and I will reduce them substantially.
    1. “This last factor, that in the grip of a massive decline in production, employment, and consumption, the world’s leaders decided to maintain the gold standard and free exchange of currency by balancing budgets, cutting spending, and raising taxes and then to do it over and over again, despite the failure of that policy to show any positive result . . . .”
    Wasn’t this precisely the policy undertaken in relation to the 1920 deflationary recession under Harding/Coolidge and didn’t it work then? Does reliance on this precedent really make your intellectual opponents sadists?
    2. “. . . It [magical austerity thinking] also includes a flat rejection of the position that deficient demand is the reason for economic stagnation.”
    I have always wondered how demand can be “deficient.” Aren’t we humans always wanting and desiring newer and better things? If we ever slow down, aren’t we assisted by Madison Ave. in thinking that we must have not just the next cool thing but everything? Isn’t the real question why, since we desire everything as we humans always do, do we stop spending our money but find it more desirous to save it? Isn’t the real question why we all of a sudden feel like saving? And isn’t the real answer to this demand problem actually fixing the problem of why we humans, wanting things as we undeniably do, prefer to save than spend? And how does putting the government into more and more debt not create more of the fear which pushes people to save for more and more for a prospective rainy day?
    3. Do you believe that there are unlimited amounts of capital out there so that saving is actually unnecessary in order to create capital for investment and creating production?
    4. “What the “demand denialists” want, therefore, isn’t just profits, but the unfettered power to determine prices, wages, working conditions, economic development, and public policy – to direct the course of the world’s development.”
    If supply/demand do not set profits, prices, wages and working conditions — is there really a conspiracy of the well off setting them? How do they meet to arrive at their conspiratorial aims? Do they actually assign prices, wages and working conditions like the old USSR politburo and lower level bureaucracies did? If this is true wouldn’t there be some among these rich conspirators who would opt out in order to make yet more money by charging less per item? On the other hand you will not find me disagreeing with your idea that rich (particularly Jeff Immelt, Warren Buffet, Bill Gates-rich people) have a disproportionate effect in setting public policy. We agree that this is a big problem!!!!!!!!
    5. I couldn’t get the video to run but I’m sure that John S. was very amusing as always. Your conclusion that, “[t]he result of this concoction – as you can see in the video clip above – is an inversion of the classic labor republican ideology of producerism, whereby the wealthy become the producing classes and workers and consumers are turned into parasites.” Why do you believe that that producing classes does not include workers? Everyone who works and sells produces wealth and has the right to claim his part of the value of his production.

    Thanks for your time and tolerance.
    Mike

    • 1. It didn’t really work that well. The recession of 1920-21, which started during the Wilson administration and continued into the Harding administration, was longer than average and showed quite substantial increases in unemployment and losses of production and things didn’t get back to full employment until 1923. There was economic growth in the 1920s, but there were also recessions in ’23-4 and 26′-7, and as historians have noted, a growing problem of concentrations of wealth and income that made the economy very credit-reliant and helped to pave the way for the Great Depression. Moreover, it’s important to recognize the difference between recessions that happen because of a sudden shock to credit and demand and recessions that are artificially induced in order to reduce inflation, as the 1920 recession was. The latter tend to be a lot more easy to deal with than the former – it’s like lifting your foot off a hose you were stepping on – the water comes through faster if there was water there to begin with.
      2. Demand can be deficient because people lack the money to express it in the market place (either because they’re unemployed or because their bank collapsed, etc.), or when a sudden psychological shift makes people choke back their spending (i.e, their “propensity to consume” reduces and their “liquidity preference” increases).
      2. “. . . It [magical austerity thinking] also includes a flat rejection of the position that deficient demand is the reason for economic stagnation.” The problem with everyone preferring to save, as Keynes demonstrated, is that it sucks so much money out of the economy that businesses can’t make profits any more and begin to fail, which spooks people into pulling their money, which causes a self-reinforcing cycle. In those circumstances, governments must act because they’re the only ones who can – private firms and individuals face a “first actor” problem, but since the government has enormous resources and doesn’t require profits to continue, it can act anyway.
      3. Not as a general proposition, no. The issue with savings is that they don’t always equal investment, depending on the overall liquidity preference. It’s also the case that investment requires a consumer base out there to create profit – if savings are too high, you can wind up with a situation in which too much money is chasing around too few profitable investments, which causes speculative bubbles.
      4. There’s a voluminous academic literature on the subject of corporate consolidation and the extent to which ologopolistic industries become price-makers instead of price-takers. It’s not about the “well-off” as much as it’s about how managers manage and what they want to manage and how. The key thing is unfettered – in many economies at different times, management decides on things like wages or working conditions or prices through consultation with unions and the government; American industry especially for a long time has been much more hostile to the idea that they should talk to anyone about what they’re doing.
      5. I don’t. I was a little unclear. The classic labor republican idea of producerism is that the producing classes (farmers and workers, but also in some formulations proprietors of “productive” industry (as long as they’re actively involved in production) have a superior moral claim to speculators and capitalists, because the producers earn their living through labor. What I’m arguing is that conservatives have inverted this logic, such that in their minds, people with capital become the “producing classes” and workers are considered parasites on them. I believe in the labor republican version.

      • Thanks Steve, very enlightening. I have two additional questions and then I won’t pester you again on this one. I will, however, if you find my comments and questions interesting to deal with, comment on future blogs. Let me know if you want me to bug off.

        2. I assume that you consider the current economic spasm as result of “. . . a sudden psychological shift [which] makes people choke back their spending . . . .” Do you have an opinion as to the cause of the underlying psychological shift(s) which have caused the present mess? Is it possible that the true genesis of the problem was the 9-11 attacks and the 2004-8 oil price shocks? I’ll explain a bit more, I think that it is possible that the 9-11 attacks and the oil price advances were the genesis of the psychological problem and that the issuance of vast numbers of mortgages, second mortgages, and other credit used to furnish the new homes, most with extremely low interest rates, was the (a joint Fed and US Gov’t effort) governmental “cure” for the problem which kept us chugging, via indirect but nevertheless Keynesian style stimulus, until 2007-8. And then, when that cure petered out because housing appreciation had run it’s course, the result was the financial debacle which caused the need for TARP. At that point all three factors, 9-11 (and it’s military aftermath), the oil price peaks and the financial meltdown, working together caused the underlying psychological shift to come to the surface with the result of a recession/depression. When Bush asked us to continue on with business as usual after 9-11 wasn’t he exactly right just like FDR when he said ‘that the only thing we have to fear is fear itself’? Now the prescription is yet more Keynesian borrowing and spending and my problem with this is that I don’t see a logical end point to the stimulus. We’ve been at this for ten years next month.

        And, finally, is it not possible that the large budget deficits themselves can have a psychological impact which may outlast our ability to borrow more money from China, Japan, or the Fed. What do you think? Probably not much I’m guessing, but I am interested in your thoughts.

        4. I certainly agree that “how managers manage and what they want to manage and how” is a very big problem. Have you read “The Suicidal Corporation” by Paul Weaver? It talks in some detail about this problem although from a libertarian point of view. I think that you and Weaver might find some interesting agreements. Do you think that it is the presence of economies of scale in some industries which tend to create oligopolistic producers which can then be resistant, in combination, to price reductions and wage increases? Is that why a free market model does not create better outcomes in these industries which are dominated by large producers?

        Thanks again for your time and your thoughts.

        Mike

      • 2. I don’t think the cause of the most recent recession had anything to do with 9/11 – 9/11 certainly had an influence on the 2001 recession, but its effects had worked through the economy before 2007. Oil spikes didn’t help, but weren’t the major cause. The major cause of the recession was the collapse of the housing bubble, followed by a panic in the financial industry which choked off credit and widened the recession, and which continues to retard recovery to this day.

        We haven’t really been doing Keynesian stimulus for 10 years; for most of that period, we’ve been doing monetary expansion instead. In terms of a logical end point, my preference is to set an unemployment target, size the stimulus to hit that target (a key mistake – the 2009 stimulus was sized to only 20% of the decrease in demand), and then begin reducing stimulus in proportion to new employment. To use my direct job creation example from my job insurance series: we’ve got about 14 million officially unemployed (there’s more unofficially, but let’s jut use this number for the sake of argument) or 9.1%. Let’s say we set 4% unemployment as the goal – that means we need to create 6 million jobs. I would appropriate $210 billion to employ all 6 million of them, but as private employment picks up in response to lower unemployment and more wages pouring into the economy, I would cut the number of jobs I’m creating at a gradual rate (you don’t want to cut a number that’s equal to the private sector, because then you’re blunting any decrease in unemployment, so you want to aim at a percentage that means the combined rate of job creation is keeping you on target) until you get to 4% and zero directly created jobs. You’ll probably come under $210 billion in the final summing up, so that’s all to the better.

        Large budget deficits matter less than people think. To begin with, our borrowing from the Fed is basically us borrowing from ourselves, so it doesn’t really matter. Nor does the rest of the 43% of U.S debt that’s “intragovernmental debt.” It might make a difference to the 30% of U.S debt held by U.S citizens, or the 27% owned abroad (mostly from the E.U actually, China and Japan together only own 40% of foreign debt), except that the Eurozone bonds are in crisis and the global economy isn’t doing too well – so right now we actually have a negative interest rate on U.S debt. Basically, large deficits matter when there are attractive alternative sources of investment – but, keep in mind, debt matters only in relation to GDP, so the presence of alternatives would suggest the return of growth, which makes it easier to pay off deficits.

        4. Classically, economies of scope and scale are a major source of oligopoly, but you really need to look back historically to see the whole picture. It really starts with the emergence of industries with high fixed costs – the railroad corporations were the first classic case. When you have high fixed costs, it becomes to your advantage to hold prices and cut production rather than vice versa. At the turn of the 20th century, there was the “great merger movement” that was actually directed by the financial industry as a way to deal with what they saw as “ruinous competition” that drove prices below the profit rate and (according to this “overproduction” theory) caused the periodic crashes of the 19th century. This was followed by a wave of vertical mergers about 15-20 years later, as more companies followed the early model of U.S Steel and Standard Oil in consolidating their supply and distribution chains. These would be the classic scope and scale cases – buy out your competitors or buy out your supply chain, spread out your fixed costs over larger volume. There have been four subsequent waves since then, which have been oriented on other goals.

  3. I wasn’t talking about the economic effects of 9/11, I was talking about the underlying psychological effects. I understand that you do not see any lingering economic effects but what of lingering psychological effects of being abruptly attacked, thrown into the so-called “war on terror” and then experiencing being bogged down for seven years, with the attendant loss of treasure, lives and prestige and with no end in sight as of 2007-8. And then the housing bubble burst so we were dealing with it and the war all at once. I respectfully suggest that you carefully consider whether this might have been a significant part of cause of the psychological shift which caused the current recessionary mess.

    I would also propose that you look carefully at the outcome after the implosion of the housing bubble before tossing out altogether my thesis concerning these being the functional equivalent of Keynesian policies. First, we agree that the money was not appropriated and spent prior to 2008, there is no dispute about that, but . . .
    The money which was used to fuel the housing bubble, however, appears in retrospect to have been money directly or indirectly available because of government policies, implicit guarantees and wink and nod understandings. The creation of the sub-prime market segment was caused significantly by incentivizing mortgage originators and lenders to lend with little reference to creditworthiness and this policy was in turn at least partially caused by government policies. The ultimate evidence for my thesis is that when it all came tumbling down the government paid most of the bills because the US entities involved were too big to fail and others were big foreign players with political connections which could demand the cash from us. Taken together with the roles of Fannie Mae and Freddie Mac it seems plain now that the fuel which fed the fire was implicitly backed by the government and that is, in fact, where the bill was paid when it came due. That the funds were not appropriated before the bubble burst really doesn’t, to me anyway, change the nature of the government’s involvement. The effect was substantially the same, it was money paid out into the economy during a difficult economic period, it kept our head above water for awhile, and in part, at least, this money ended up as debt on the books of the U.S. government. And, to look at it this way, it also puts Bush legitimately on the hook for all of what was paid out to cover the financial crisis, not just the $4 T which was run up during his own eight years. Maybe not, but it sure looks to me that in principle and practice it is the same thing.

    Thanks again, Steve, for the stimulating conversation.

    Mike

  4. […] recently wrote a blog post, ‘Living in the Age of Magical Austerity Thinking.’ He argues that those who believe that austerity is the answer to our current economic problems are […]

  5. […] first thing we need to establish is that this current wave of magical austerity thinking isn’t purely the fault of bond traders or ratings agencies or financial journalists. It’s true […]

  6. […] a progressive movement and a Democratic Party that has to fight itself all the time on education, economic policy, unions, and other […]

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