Amid the wreckage of the 2008-09 Wall Street collapse and Great Recession, orthodox economists and political elites in both the United States and Western Europe have been strongly and consistently pushing the idea that the only way out of the mess is to deliberately make life worse for almost everybody. Details aside, this is the basic idea behind the austerity agenda that has become the conventional wisdom in both the U.S. and Europe, regardless of which political parties happen to hold office. It is the underlying premise for both the Democratic and Republican sides of the current debate over sequestration—i.e., imposing across-the-board cuts on social spending and defense, starting this coming Friday.
Thus, despite Barack Obama’s reelection in November, the inside-the-beltway Democrats, including Obama, continue to appear committed to reaching common ground with Republicans over a bipartisan austerity agenda that would entail significant cuts in Medicare, Social Security and public spending on education and public services. To be sure, the Obama austerity agenda is softer than the hard-right approach favored by Republicans. But the Republicans continue to frame the D.C. debate around proposals to gut Medicare, Social Security, and public schools.
The situation is still worse throughout Europe, where the dominant elite view is that the European welfare state is no longer affordable. Public employment, health care budgets, and pensions are being slashed, while poverty is rising dramatically. For example, The New York Times reported that 22 percent of Spanish households are living in poverty and that 600,000 have no income whatsoever. As the Times noted, “For a growing number, the food in garbage bins helps make ends meet.”
But such human suffering aside, could the austerity hawks be correct that there is simply no alternative to forcing this bitter medicine down people’s throats now? The basis for the austerity hawks’ claim is that both the U.S. and European economies are being consumed by out-of-control levels of public indebtedness. Public spending must therefore be slashed before total economic collapse becomes a real possibility.
In fact, however, austerity hawks’ claims are wrong across the board: the public debt burden in the U.S. is actually at a near-historical low level, not a high; in Europe, where government debt burdens are severe, there are still clear alternatives for managing the problem that do not entail a crushing austerity agenda; and finally, the austerity agenda actually solves nothing. Making life worse now for most people now also makes it more difficult to pull the economy out of the ditch into which Wall Street has shoved it. What then is behind the austerity agenda?
The U.S. Case: There is No Government Debt Crisis
Both U.S. government deficits—how much the government is borrowing each year—and government debt—how much the government owes overall—did rise sharply as a result of the Great Recession. This occurred because economic policymakers enacted extraordinary measures to counteract the crisis created by Wall Street. These included financial bailouts; monetary policies that pushed central-bank-controlled interest rates close to zero; and large-scale fiscal stimulus programs, financed by major expansion in central government fiscal deficits.
In the U.S., Barack Obama signed into law the American Recovery and Reinvestment Act (ARRA) in February 2009, which included $787 billion in new government spending and tax cuts for households and businesses. Adding still further to the government’s deficit was the fact that the recession by itself produced declining tax revenues, as a consequence of falling household incomes and business profits. Total federal tax revenues fell from $2.5 trillion in 2008 to $2.1 trillion in 2009, a 16 percent decline in one year. As of 2011, federal revenues are at $2.3 trillion, $200 billion below the pre-recession level. Overall, the U.S. fiscal deficit reached 10 percent of GDP in 2009, and was still at about 8.3 percent of GDP in 2012. Prior to that, the government deficit averaged 2 percent of GDP under George W. Bush, and 0.8 percent of GDP under Clinton.
But does this pattern constitute a debt crisis that can only be brought under control through austerity? The austerity hawks focus, with some small variations, on three major hazards. They begin with the claim that high levels of government borrowing would drive up interest rates, since government borrowing increases the economy’s overall demand for credit dramatically, without correspondingly increasing the national savings that are the basis for the supply of credit. These high interest rates then produce two more problems: a heavy burden of government debt and strong inflationary pressures. According to the austerity hawk argument, rapid inflation is supposed to occur because large-scale spending injections are pushing excess money into the economy much faster than the economy is producing new goods and services.
But what does the evidence show? Two facts in particular are crucial: the interest rates of U.S. government bonds, including long-term bonds, have been at historically low levels since the Obama stimulus program was introduced; and, similarly, the inflation rate has been close to zero throughout this full period.
Why have interest rates on government bonds and inflation remained low despite the large deficits? Two factors are at play. The first is that financial market investors globally have been focused on reducing their risks since the financial collapse, in a dramatic reversal of their mindset during the hyper-speculative years. Investors have been voting strongly in support of U.S. government bonds as the single safest store of their wealth.
The second factor has been the Federal Reserve’s aggressive policies to hold down interest rates. This includes the Fed’s near-zero interest rate policy for the rate at which banks can borrow in financial markets, called the “federal funds” rate. In addition, under its “quantitative easing” program, the Fed has also successfully lowered the longer-term rates on U.S. Treasuries by buying these long-term Treasuries directly in the open market. As for lack of inflationary pressure, this is a direct result of the high rate of unemployment which applies little upward pressure on wages and prices.
The reality of low interest rates also means low debt burdens. In fact, despite historically large fiscal deficits, the U.S. government was making annual interest payments on this debt, as of the most recent September 2012 data, at a near historically low rate of 7.7 percent of total federal spending. As I showed in a previous blog post, under the Republican presidents Ronald Reagan and George Bush-1 from 1981-1992, the average ratio of federal interest payments to federal spending was more than double the current level, at 16.8 percent.
It is true that over the longer term the government will need cut both the military budget and the exorbitant share of overall U.S. healthcare spending captured by the private insurance and pharmaceutical companies (see this post on military spending).We also need further taxes on the wealthy beyond the mild increases enacted last January. The place to start here is to tax all Wall Street trading, just like consumers now pay taxes when we buy things (see this post on the Robin Hood tax). But while recognizing the need for these measures as a way to stabilize the government finances over the long run, the fact is that at the moment, there is no short-term crisis whatsoever in terms of the government’s ability to pay off debt obligations it faces now or over the next few years.
An Anti-Austerity Plan for Europe
The fiscal deficits and debts of the European countries did also rise sharply as part of the effort to counteract the 2008-09 Wall Street collapse and Great Recession. But unlike the U.S. case, interest rates for the most distressed European governments did increase rapidly afterwards. As of September 2012, long-term bond rates were, respectively, 5.9 percent for Spain, 5.1 percent for Italy, 5.3 percent for Ireland, 8.1 percent for Portugal, and an astronomical 21.1 percent for Greece, even while those for Germany and the U.K. were, like the U.S., less than 2 percent. These high rates are why Spain, Italy, Portugal, Ireland and Greece now face such difficulties repaying the debts they incurred as a result of the recession. However, the private European banks who bought the bonds want to be repaid at exactly the rates at which they lent. If that means squeezing the public dry to get their money, then so be it.
The short-term solution here is that the European Central Bank simply needs to follow the approach of the U.S. Fed’s quantitative easing program. That is, the European Central Bank needs to buy from the private banks the outstanding “toxic debts” of the heavily distressed countries at some reasonable discount—like say, 50 cents on a dollar of debt. That way, the banks will get some return on their bonds, which they may not receive at all as long as austerity conditions worsen. Meanwhile, Europe could begin moving out of its austerity death spiral.
In fact, to varying degrees, the European Central Bank President Mario Draghi did pursue this strategy for most of 2012. The problem is that Germany, which carries the most clout at the European Central Bank, opposed such measures, arguing that it could encourage irresponsible government spending levels in the future and could also create a destructive inflationary spiral. However, more recently Germany seems to be softening its position slightly, mainly because it now also seems to be facing a period of zero growth or even recession through 2013. The vicious cycle of austerity policies thus seems to be coming back to bite Germany, which, as Europe’s export powerhouse, now sees its export markets shrinking due to the very austerity policies it has imposed.
The Class Struggle at Hand
If austerity policies aren’t even benefitting Germany at this point, then it is reasonable to ask why the majority of elites in both the U.S. and Europe continue to push this agenda on everyone else. No doubt, there are sincere austerity hawks who think—however erroneously—that there are no alternatives in the face of historically high government debt levels. There are also scheming Republicans who support austerity now because they calculate that it could well drag the economy down, which in turn will damage Obama and the Democrats just in time for the 2014 elections. But there is certainly a deeper factor at play: that elites in both the U.S. and Europe are eager to push down wages dramatically and eviscerate the welfare state in their respective countries. Their purpose is to permanently lower their labor costs and taxes, which in turn means fatter profits.
Regardless of the actual motives of the all varieties of austerity hawks, they are correct about one thing: assuming we can finally push our way out of the Great Recession and onto a reasonable growth trajectory, neither the U.S. nor Europe can simply return to the policy framework that created the economic crisis in the first place. But what we need now is to advance a coherent alternative policy agenda that places human welfare above corporate profits. Step one would be to establish tight regulations on financial speculation—something like an austerity agenda for Wall Street. Step two, related, would be to advance policies in both the U.S. and Europe that focus the economy’s financial resources on investing in productive activities that also can generate an abundance of decent jobs. Restoring the public education system and green economy investments would be two good places to start here. The main point for now is clear: austerity is not a solution, either for the U.S. or Europe.
This post is a slightly revised version of my Winter 2013 “Economic Prospects” column for New Labor Forum. The column in its original form can be found here: http://nlf.sagepub.com/content/22/1/86.full.pdf+html