Austerity and the barbarian horde

Here’s a book that does what it says on the cover:  by Mark Blyth.

[amazon_image id=”019982830X” link=”true” target=”_blank” size=”medium” ]Austerity: The History of a Dangerous Idea[/amazon_image]

Actually, the first few chapters start with the ‘dangerous idea’ part, with the author’s arguments about why austerity (ie. cutting the government’s budget deficits to reduce the level of its debt) is a bad thing in general, and a particularly bad thing when everyone tries to do so at the same time. This part will be somewhat familiar to readers of Paul Krugman’s blog, or Jonathan Portes on this side of the Atlantic. It overlooks some points I think are important – for example, glossing over the way tax increases and spending cuts will have different distributional implications; or ignoring the effects of inflation on real wages for low earners to focus on the redistribution from savers to borrowers. I also don’t agree with his argument about the specific causes of the financial crisis, which he pins on the securitised mortgages and the US repo market, but that’s not the heart of the book. Besides, Blyth is surely right to say morality tales about lazy Greeks and virtuous Germans, and other similar tropes of public debate about the crisis, do not amount to an economic analysis.

The main section is far more interesting, an account of the history of the idea that austerity is a good policy, that reducing the debt burden only requires reduced borrowing and less government. He traces the idea back to the late 17th century and ranges over the continent as well as the US and UK. Although there’s no mistaking this author’s political perspective, there is plenty of interesting material in this section. The book ends by asking whether or not current austerity policies will work. When the IMF has now said not, and a great majority of economists advocate bringing forward necessary infrastructure investment, Blyth’s answer will come as no surprise, albeit expressed more colourfully: “The deployment of austerity as an economic policy has been as effective in bringing us peace, prosperity and crucially a sustained reduction of debt as the Mongol Horde has been in furthering the development of dressage.”

The book will give opponents of the austerity strategy more ammunition, if they want it. I’m not sure it will change the mind of any proponents of the policy, however, given how obvious the conclusion is from page one. But then, as Blyth argues, this is not a rational economic debate. Austerity has a different kind of hold on its advocates.



Capitalism, democracy and pessimism?

On Wednesday evening I attended Professor Raghuram Rajan’s Wincott Lecture, which had the provocative title Are Capitalism and Democracy Failing Us? (He’s also written a couple of columns outlining the themes, in the FT and Project syndicate.) Professor Rajan is the author of , a terrific and thought-provoking book about the political economy origins of the sub-prime crisis – a crisis he was one of the economists to predict publicly, in 2005.  So clearly it’s worth paying careful attention to what he has to say.

[amazon_image id=”0691152632″ link=”true” target=”_blank” size=”medium” ]Fault Lines: How Hidden Fractures Still Threaten the World Economy (New in Paper)[/amazon_image]

The argument in the lecture was that there is an interaction between capitalism and democracy. In good times this is positive, the beneficial economic and political structures are mutually reinforcing. But the crisis is giving us technocracy in some countries, oligarchy  in others, and these political structures are depleting the sense of fairness and trust on which democracy has to rest. There is an urgent need to restore to the middle classes a sense of opportunity, he argued.

The lecture covered the hollowing out of jobs in the middle of the labour market, the division of people into those who tell computers what to do, and those who are told what to do by the computers. Prof Rajan cited Claudia Goldin and Lawrence Katz’s book on skills, , and Charles Murray’s . He tied the problem of the squeezed middle into his own book, Fault Lines, arguing that politicians had responded to the hollowing out of the income distribution by means of credit – affordable housing, loans for consumption. In Fault Lines, this was presented as the political mechanism that paved the way for the subprime crisis. Consumption inequality did not increase as much as income inequality.

The question now is whether the technocratic policy responses we are seeing, from structural reforms in Eurozone countries to all the waves of QE, will end up only violating the quasi-property rights of those on low and middle incomes? It seems so – bondholders have been more or less entirely protected, and default avoided at almost any cost, and bank bonuses are as yet barely affected, whereas the rest of us can be sure we will get some mix of higher taxes and inflation. This mix, Prof Rajan argued, would undermine the legitimacy of capitalism and democracy.

An obvious question raised by Roger Bootle in his comment on the lecture – and in his own book () which distinguishes between creative and merely distributive varieties of capitalism – is whether there is an alternative path. He agreed with much of the lecture, saying financial capitalism had become baleful in its influence. The answer, he agreed, appears to be education, although, as Professor Rajan pointed out, this is an inevitably slow response. But only an increased supply of highly skilled people can tackle the soaring skill premium and the elite society that has been shaped by the shortage of people who can tell the computers what to do.

Personally, I would add institutional and governance reform to the list – it is imperative to find policies that will have a visible impact much faster. (I talked about this in my Joseph Rowntree Foundation lecture earlier this year.) But yes, certainly education. Very few young people emerge from education systems equipped with the cognitive and non-cognitive skills they need now; indeed, a shocking number do not even have the basic skills to fill ‘low-skill’ jobs, according to employers. And its hard to be optimistic that any country has figured out for sure yet how to deliver better education. When we do, it will still take 15 or 20 years for it to affect the labour market.

So, a stimulating, but pretty depressing evening.

Professor Rajan, at the Wincott Lecture


I really want to read this book

‘This book’ is Mark Mazower’s latest, . There’s an extract in the current issue of The Nation that gives a good flavour of its themes in discussing the international (dis)order and what replacement for it might stagger out of the mists of the current crisis.

It will be interesting to compare it to Philip Bobbitt’s , which also looked at the clash between nation state-based organisation and globalized financial markets, but in far happier times. And to Tony Judt’s amazing .

I loved Mazower’s book , and his . He also wrote an op-ed in the Financial Times recently, and the new book was reviewed positively by Paul Kennedy in the FT, and negatively in Standpoint.

[amazon_image id=”0713996838″ link=”true” target=”_blank” size=”medium” ]Governing the World: The History of an Idea (Allen Lane History)[/amazon_image]


A mess beyond fixing?

I’ve thoroughly enjoyed reading Robert Peston’s  Its author is so famous, as the BBC’s Business Editor, that his photo is on the front cover. Yet he’s modest enough to start the book with: “I don’t know. But don’t stop reading now.” Indeed, the title is misleading because he sensibly does not try to dole out generalised policy prescriptions. (Oh and – note to publishers – that’s enough long and chatty subtitles, thank you. They’re becoming annoying.)

[amazon_image id=”1444757091″ link=”true” target=”_blank” size=”medium” ]How Do We Fix This Mess?: The Economic Price of Having it All, and the Route to Lasting Prosperity[/amazon_image]

The book draws on Robert’s long experience as a journalist covering the banking industry. (I should say that I’ve known him for years and followed, albeit far less successfully, in his footsteps at The Investors Chronicle and then a national newspaper, The Independent in my case, the FT and Sunday Telegraph in his.) As he says, it must seem to others to have been a boring reporting beat, but it has paid off handsomely in equipping him with the knowledge and the contacts to report superbly on the financial crisis to UK and worldwide audiences.

How Do We Fix This Mess combines chapters giving the context for the crisis, and – the heart of the book – chapters describing what happened in the course of the crucial events starting in late 2007. Scene-setting chapters describe the process of innovation and growth in financial markets and the creation of new kinds of derivatives; the inadequacy of the regulatory regime, and how it came to be so feeble; and the globalisation of the world economy and rise of China. These are all excellent overviews, although some readers will find this familiar territory.

I found the chapters on the early days of the unfolding crisis the most interesting, from the warning signs about Northern Rock through 2007 and the extraordinary run on the Rock in September that year. As Robert points out, the fact that Northern Rock’s business model involved online banking, with very few branches, meant that even a small proportion of depositors wanting to withdraw their money (my sister was one of them) translated into a big queue outside the branch. Some people accused him of causing the crisis, as if the drying up of credit markets and an unsustainable business model were somehow caused by the reporting of it. He is also very interesting on the part played by the Bank of England, much criticised for its handling. As Robert says, Mervyn King was right to say bailing out the banks would contribute to moral hazard – look at where we are now, still hostage to these titanic, toxic institutions – but the book criticises the Bank of England for not raising interest rates or taking other actions in the years before 2007 to puncture the evident bubble in asset markets. MPC minutes from 2005 and 2006 show little concern with its unsustainability or the need to raise interest rates: they were reduced once in 2005, and raised twice in 2006, but by just 0,25% points each time.

The book then turns to the Euro crisis and ends with the Libor scandal, and, rather than a list of things governments and regulators must do, Robert writes: “Perhaps the most important [cause of sluggish growth] is that there is a growing realisation that we have to take steps to live within our means, over the longer term….  The innocent pay a price for the national indebtedness that they did not cause or choose.” He professes himself optimistic:

“The clean up will take years. And there is no quick fix, so you need to brace yourself for perhaps a decade of economic stagnation. As it happens, I don’t think that is reason to weep. We are a very rich country. And we can be a very happy country if we learn how to make the most of what we have got.”

I must say, I’m far less optimistic about the way the economics and politics of the coming lost decade will play into each other. Let’s hope I’m wrong and the mess is fixable. Either way, this is a terrifically interesting and well-written book, which benefits greatly from its author’s detailed knowledge of the banking industry that is at the heart of this crisis.


Deficits, fiscal and democratic

There’s an interesting new research summary on VoxEU by Caroline van Rijckeghem and Beatrice Weder di Mauro, Learning from past crises: Into the safety zone, which looks at the history of sovereign defaults. The conclusion is that political system and default are related – parliamentary democracies don’t and dictatorships do. However, the causality between politics and economics is not simple, and growth is essential to prevent political polarisation. So what at first glance appeared an optimistic conclusion turns out to be a rather pessimistic one.

“Growing discontent as the result of austerity may be the most important factor yet in influencing the probability of default. …[O]ur research shows that in democracies budget deficits smaller than 4.4% are sufficient historically to avoid default on external sovereign debt at times when international liquidity is plentiful. The latter condition is fulfilled in today’s world. But the former is not. In fact many developed economies have current deficits well above 4.4%. In particular the UK, US, and Japan have deficits above 8% and among periphery countries in the Eurozone Greece and Ireland and Spain are above 7%. Based on this criterion, these countries are in a zone of vulnerability.”

The authors go on to say the Eurozone is a special case, historically, so one cannot apply this evidence from the past mechanically. It might be possible to bring down deficits gradually, without adding to austerity measures. They write:

“[T]he solution suggested by the German Council of Economic Experts, the European Debt Redemption Pact, has the advantage that it represents a transparent and credible long-term commitment device. It aims at reducing debt slowly to 60% over 20 years, thereby protecting growth and requires collateral, earmarking of revenues and European control. In turn, the joint and several guarantee for all participants for interim debts over 60%, signals a long-term political and economic commitment from the stronger Eurozone countries to maintaining the integrity of the Eurozone. Together, this would constitute a grand bargain.”

This column put me in mind of Ben Friedman’s marvellous 2005 book, , in which he makes a powerful – and it now seems clear, prescient – case for growth on exactly this kind of political economy ground. He writes:

“The value of a rising standard of living lies not just in the concrete improvements it brings to how individuals live but in how it shapes the social, political and ultimately moral character of a people.”

[amazon_image id=”1400095719″ link=”true” target=”_blank” size=”medium” ]The Moral Consequences of Economic Growth[/amazon_image]