There
is major policy battle going on between the economic advisors of the
major capitalist governments meeting at the G20 summit this week. Most
advisors want action to cut government spending because of the
humongous rise in public sector debt in nearly all the G20 economies.
This debt (owed to the banks who bought it with government
handouts!) will have to be financed by sucking up all the available
savings of the private sector, namely the savings that working
households have in their banks or pension funds. The banks and pension
funds will demand higher interest rates in return for buying government
debt. That will eventually drive up the cost of borrowing and make
households less willing to spend and corporation less willing to
invest. Or so that argument goes.
Against that view, there is the Keynesian view, expressed in the columns of the New York Times by the Keynesian guru, Paul Krugman and in the pages of the Financial Times
by the UK’s new banking advisor, Martin Wolf, that tightening fiscal
policy by cutting spending and raising taxes puts the economic recovery
in jeopardy. Fiscal austerity is the wrong policy for economic growth,
say the Keynesians. Wolf says that what the German government is
insisting that the governments of Greece, Spain and Portugal must do
will lead to new economic recession in Europe. Krugman says the US
government must continue with its policy of spending and borrowing and
not adopt the German way – or is it the Austrian (Austerian) way?
The Austerians reply, that without cutting back the huge overhang of
debt, business profitability will not recover sufficiently and growth
will suffer anyway (see my blog, The overhang of debt, 1 March 2010 ).
The word ‘Austerian’ is a sardonic pun made by the Keynesians on the
ideas of the Austrian school of economists. The Austrian school argues
economic crises would not happen if it were not for interference by
central banks and governments. The boom phase in the business cycle
takes place because the central bank supplies more money than the
public wishes to hold at the current rate of interest and thus the
latter starts to fall. Loanable funds exceed demand and then start to
be used in non-productive areas, as in the case of the boom 2002-07 in
the housing market. These mistakes during the boom are only revealed
by the market in the bust.
From an Austrian perspective, the eventual collapse of the house of
cards built on excessive credit represents not a failure of capitalism,
but a largely predictable failure of central banking and other forms of
government intervention. So the Great Recession was a product of the
excessive money creation and artificially low interest rates caused by
central banks that on this occasion went into housing.
The recession was necessary to correct the mistakes and
malinvestment caused by interference with the market pricing of
interest rates. As one Austrian economist correctly points out, “the recession is the economy attempting to shed capital and labour from where it is no longer profitable”.
And no amount of government spending and interference will help to
avoid that correction – this is in direct contradiction to the
Keynesian view. Putting more credit into the economy to solve the
recession is like giving more alcohol to a drunken man. As Krugman
says about the Austrian school, they reckon that a recession is like a
hangover after a heavy night of boozing.
The Austrian school has some useful insights in highlighting the
role of excessive credit (or what Marx called fictitious capital) in an
economic crisis. But it lacks the overall picture of capitalism. Is
the rate of interest really the driving force of capitalist investment
and the price signal that capitalists look for to make investment
decisions? As Marx explained, interest is just one part of surplus
value and it is the latter that is key to investment. Value and
surplus-value are created in the production process, in particular, in
the exchange of money for labour and through the productivity of labour
using capital goods.
What the Austrian school does not explain is why ‘excess credit’
eventually does not work. Apparently, there is a point when credit
loses its traction on economic growth and asset prices and then, for no
apparent cause, growth collapses. In Marxist terms, the Austrians are
really referring to fictitious capital being dramatically expanded to
compensate for a slowing of the accumulation in real capital. The
result is that ‘excess capital’ is even greater at the height of the
boom and, in the subsequent bust, the reduction in excess capital must
be even greater. This produces a Great Recession as opposed to any
recession.
But for the Austrians, as for the mainstream economic schools, there
is no problem with capitalist production for profit. As a result, the
policy prescription for the Austrians to deal with slumps and
recessions is just accept them and recognise them as the judgement on
the sin of not saving enough and letting credit rip. Ultimately, until
government interference in the money supply is removed, bubbles and
bursts will keep recurring.
Now it seems that this rather wacky view of capitalism has gained
credence among many economic advisors, people who cherry pick their
arguments according to circumstances. Before the crisis, deregulation
and ‘free markets’ along with credit expansion was fine. During the
crisis and the subsequent Great Recession, bank bailouts and
Keynesian-style public spending was the way out. Now, for most
governments (not the US yet it seems), it is fiscal austerity,
Austrian-style.
As I write, the new Chancellor (finance minister) of the UK
government, George Osborne, is telling parliament and the people of
Britain that there is no other way but austerity through slashing
public services and raising taxes for the average family(but lowering
taxes for corporations to ‘encourage’ them to invest). It was the
banks and the private sector that brought capitalism to its knees in
2008-9, but it is the public sector and working households that must
now pay. We cannot go on borrowing Keynesian-style. The Austerians
now call the shots.