A few weeks ago on New Left Project, Kevin Blowe wrote on the need for a clearly articulated opposition to massive cuts: an Alternative Plan for the Economic Crisis. From contributions on this site and elsewhere, we can start to see what such a plan might look like: a preference for taxing the rich over cuts for the poor; a preference for investment in what’s socially useful and for cuts to waste like Trident. Lots of good ideas. But perhaps we’re skirting around the main issue: How can we promote economic recovery? How can we create jobs? How can we manage the massive private debt hangover from the last decades? And how can we hope, eventually, to get the public borrowing back to a sustainable level?
Mainstream economics only seems to be offering four unpalatable ways forward:
Try to balance the budget through cuts and/or tax rises, and hope, risking the creation of a downward, recessionary, deflationary spiral (neo-classical/Thatcherite).
Keep borrowing and hope that growth (that is not dependent on continued stimulus) somehow returns before the bond markets pull the plug (orthodox Keynesian).
Devalue the currency and inflate the debts away (actually a regressive tax on currency users, particularly ordinary savers), and hope.
Partial or complete sovereign default (risking blow back if the financial system collapses), and hope.
The great hope seems to be export-led growth, but as has been noted, its not clear who will do all the importing. What we need is not so much an alternative, as a solution.
The key to recovery is to maintain and stimulate aggregate demand, as Keynesians advocate. The problem is that the mainstream Keynesian remedy of deficit spending is only sustainable if there is a prompt economic rebound. As described below, this doesn’t appear to be the context we are in. Many countries in Europe are already at the buffers.
This is why the left needs to turn to a largely over-looked observation of Keynes (though hinted at on this site by Susan Pashkoff), that tax-based public expenditure in itself stimulates demand, and that “If fiscal policy is used as a deliberate instrument for the more equal distribution of incomes, its effect in increasing the propensity to consume is, of course, all the greater.” (General Theory, Chapter 8, II). In other words: redistribution can be used to create a stimulus effect, promoting job creation and recovery, without a necessary need for fiscal expansion, merely by allocating existing resources in a different way.
We need to understand why this is the case. The explanation also sheds a revealing light on the origins of the current crisis.
The explanation of persistent unemployment
Keynes’ starting point was the behaviour of individuals regarding consumption and saving. How much of our income we save is determined by how much income we have (obviously), and our underlying desire for savings relative to consumption. The latter is influenced by a whole host of factors, including interest rates, expectations of future need, expectation of the utility of further consumption, and cultural values.
Keynes observed that as people become richer, they tend to save a greater proportion of their incomes. This is largely because, with increasing wealth, the utility of further consumption falls. The same is true on a national scale: falling unemployment means increasing average household income, creating a tendency for the overall rate of saving to rise.
This seemingly innocuous fact has far-reaching implications. A rise in employment means, on the one hand, an increase in the production of goods and services. On the other, it means a rise in income and consumer demand, but because of the tendency for the savings rate to rise at the same time, consumer demand doesn’t rise so fast as production. It starts to lag behind supply. The market can respond to such an imbalance in several ways:
• Increased exports could absorb the increased production (if you’re lucky).
• Increased domestic investment by firms could absorb the increased production and savings. Unfortunately, investment beyond the rate needed to sustain consumption is unsustainable (unprofitable) over the long run. Such over-investment will lead to a compensatory period of under-investment. This is the classic business cycle.
• Speculation on asset prices (houses, shares) could absorb increased savings and return them to circulation, maintaining consumption. Obviously, this is also unsustainable (a bubble), effectively borrowing demand from the future.
• Increased consumer credit could absorb savings and maintain consumption. This is linked to asset price speculation (houses) and is similarly unsustainable. Demand is effectively borrowed from the future.
• Firms will react to increasing inventories of unsold goods by cutting back production and employment, reducing income and causing the rate of saving to return to its previous level.
In other words, over the longer term, the hidden hand of the market will balance aggregate supply and demand by maintaining enough unemployment to ensure that people don’t save too much of their incomes. In the shorter-term, however, various types of bubble may trick us into thinking that sustainable employment growth has taken place.
Keynesianism and capitalism’s “Golden-Age”
The 1950s and ‘60s are seen as the “Golden Age” of capitalism. A conjunction of factors sustained low desire for savings compatible with a sustainable rate of saving at a high level of employment. These factors included a build-up of private savings after the war years and the Depression, pent-up demand for goods like suburban housing, cars and domestic appliances, and welfare state policies and organised labour that enhanced financial security and reduced inequalities (see The Great Financial Crisis).
In this favourable context, it was not difficult to achieve something like full-employment, and the problem of the day was seen as countering the business cycle, making sure that any down-turn was shallow and none turned into a depression. Orthodox Keynesianism thus used public deficits and surpluses to counter fluctuations in private investment spending and to maintain aggregate demand. For a while, it worked.
The limits of Keynesianism
Since the war, industrialised economies have become richer, and also older, increasingly concerned with saving for old age. Latterly, neo-liberalism has made the situation worse, increasing inequality and dismantling the safety nets of the welfare state, again encouraging saving. The level of employment compatible with sustainable saving, borrowing and investment behaviour has fallen. This process began in the late ‘60s.
Orthodox Keynesianism was fine as anti-cyclical policy, but it couldn’t sustain employment in the face of such a long-term trend. As the ‘60s came to an end, maintaining previous levels of employment started to require ever greater fiscal and monetary stimulus, with ever less opportunity to re-balance the books. It was unsustainable.
Privatised Keynesianism – 1979–2008
Led by the “Anglo-Saxon” economies, the ‘80s and ‘90s saw a turn to what Colin Crouch has labelled “privatised Keynesianism”. In other words: more of the same, only with public borrowing replaced by private borrowing and speculation as the engine of unsustainable demand management. In the US, total outstanding debt rose from 154% of GDP in 1970, to 373% ($53 trillion) in Q1 2009 (see here, table L1, and here, table B-1). This trend has been accompanied by the rise of the FIRE sector (Finance, Insurance and Real Estate). In the 1960s, it accounted for 15% of US domestic corporate profits; the 2000-2008 average was 35%, peaking at 43.8% (see here, table B-91). It is common to blame the growth of ponzi finance on de-regulation, as if without de-regulation everything would have been just fine. But there was an underlying problem of stagnation and the growth and “innovation” of finance, helped along by neoliberal de-regulation, seemed to offer a solution.
Indeed, these trends succeeded in propping-up consumer demand and employment, even creating consumer(-debt)-led booms in the US, UK and elsewhere, absorbing the savings and exports of the more saving-prone Japan and Germany. But these trends were never sustainable, prompting a series of worsening crises from “Savings and Loans” to “Dot.com” and “Subprime”. In each case governments and central banks have rescued the financial system, acting as the lender of last resort, but their capacity for further bail-outs is reaching its limit.
The alternative to austerity
Since 2007, governments have returned to “public Keynesianism”. Deficit spending has been the right thing to do, but in the absence of a strong growth rebound, its rapidly becoming unsustainable. With bond markets threatening to veto the refinancing of debt, governments are now turning from stimulus to the depressant of fiscal tightening.
Yet this short history points to the alternative approach described at the beginning of this article. The redistribution of income puts more money in the hands of those who tend to consume a high proportion of their incomes (the poor), and less in the hands of the wealthy who tend to save more of what they get. Technically speaking, it raises the level of employment compatible with a sustainable rate of saving. In more familiar language, it provides an economic stimulus, increasing demand, in a way that does not rely on borrowing or printing more money, but merely reallocates existing resources in a different way.
All this should be obvious. For years, demand, and thus growth, has been propped-up by huge transfers of income from the well-off to the less well-off in the form of loans. Now the problem is that the less well-off are “maxed-out”; this particular form of stimulus cannot be continued, and even threatens to be put into reverse as the well-off demand their money back. The putative solution of the austerity agenda is effectively to force the less-well off to pay their bills: taxpayers’ money is used to bail-out predominantly wealthy savers, whilst the less well-off foot the bill through public service cuts. Obviously this is no solution at all to the core economic problem. The alternative to austerity is a similar redistribution of wealth, providing a similar economic stimulus. The difference is that the money wouldn’t have to be paid back.
Elements of an alternative plan
An alternative plan will need to cover three areas: we need a plan for crisis management to protect savings, pensions and banking services for the real economy; we need a plan for the radical reform of the financial system, both nationally an as part of an international effort, with the aim of freeing democratic states from the consequences of the irrational group behaviour of speculators, and we need a plan for reducing economic inequality.
What the latter may mean in practical terms is not difficult to surmise. The overall fiscal stance should be to maintain or increase public spending as a % of GDP, to use deficit spending as a positive stimulus tool, as far as is possible, and to reduce the deficit, if needed, principally through taxation, cutting only in the areas with least stimulus effect such as defence. Taxation needs to be made more progressive, including effective action against loopholes and evasion. New public investment (Green New Deal?) should focus on areas that create many jobs, such as home energy efficiency improvements. Finally, we need an industrial policy that aims to reduce pay inequality, through minimum, and perhaps maximum, earnings legislation, and a more conducive environment for workplace organisation and collective bargaining.