Economic Myth 2: Deficit reduction is the only way out of a slump
In April 2009 I was invited to appear on the BBC News Channel. The G20 group of rich countries was staging a Summit in London. World leaders were in a state of ill-concealed panic about the financial crisis. None seemed to have the faintest idea what was going on. I was asked by the BBC presenter: ‘Is this the end of capitalism as we know it, then?’ It did for once seem like a reasonable question to be asked, even by the makers of BBC News.
At the time, limitless quantities of public treasure were being poured into the collapsed financial ‘architecture’. Yet more public treasure was being lavished on a ‘fiscal stimulus’ to salvage the ‘real’ economy. Old cars were bought up and scrapped so that more new ones might be sold, and fewer jobs lost. General Motors – once the biggest corporation in the world – was to be saved from bankruptcy.
At the time, no-one dared suggest anything else. Not even neoliberal economists. For a generation it was they who had been directing government policies, secure in the knowledge that markets always ‘self-correct’. None of this was supposed to be happening. For once, they were lost for words.
Where had all that money come from? Where had it gone? Why had no-one seen it coming? What next? No-one could say. You did not need to be an economic genius to sense that private debts were once more being dumped on the public, just as they had been by an escalating series of financial crises around the world, starting with the ‘Third World’ financial crises of the 1980s.
But you would have had to live through the experience of ‘structural adjustment’ in the Majority World to foresee that by the end of that same year, 2009, the neoliberals would be back in the saddle, brazenly suggesting that the calamity had been caused by ‘too much government spending’.
As soon as financial markets had been bailed out, fiscal stimulus for the real economy was stopped. Instead, supposedly independent central banks – in reality the creatures of governments – started handing free ‘helicopter’ money to private banks and financial markets, leaving them to decide what to do with it. In other words, the very institutions that had caused the Great Recession would be relied on to end it. With interest rates now lower and for longer than in recorded economic history, quantitative easing* has risen to $5 trillion worldwide, and counting.1
It was, and remains, little more than an ingenious accounting trick. Quantitative easing features in the accounts of central banks, not governments. Now that the banks no longer needed government funds, the priority was to cut government budget deficits, public employment and services – indeed, to cut the very notion of ‘too much government spending’ to ‘too much government, full stop’.
All of this because of one quite blatant falsehood – the claim that governments had been ‘borrowing too much’. In fact, research by the International Monetary Fund shows the opposite to be true (see graph).
Before the ‘credit crunch’ in 2007, public debt and budget deficits were in fact falling quite sharply. Both had been higher and rising faster towards the end of the 1980s, when the impact of neoliberal economic policies was first being felt. Both were very much higher during the two World Wars, the second of which cost just about as much treasure as the Great Recession has thus far.2
The difference was that huge government borrowing and budget deficits during the Second World War had to be spent on the real economy and employment, even though that often meant real guns, tanks, death and destruction. This finally brought an end to the protracted Depression of the 1930s. A ‘Golden Age’ of capitalist prosperity followed in the 1950s and 1960s, reducing both the debts and the budget deficits of governments.
Since 2008, by contrast, public funds have been given to financial markets, not to the real economy and employment. So the Great Recession has continued, just like the Depression. We might well be left to conclude that it would take even bigger wars to put an end to the Great Recession.
The world as a whole is never in debt or deficit: for every debtor there is always a creditor, for every deficit a surplus. As the chief economist of none other than Goldman Sachs – the financial ‘vampire squid’ at the heart of the financial crisis – has pointed out, public debts are always matched by private savings.3 Crises happen, as in 2007, when private savings rise, withdrawn from the real economy. Public debt rises at the same time. If it isn’t spent on the real economy to replace private saving, the crisis continues.
In truth, at the root of the Great Recession lies a ‘liquidity trap’ – too many people with too little income to make the real economy healthy enough for private savings to be invested in it.4 So long as this has continued, so has the Great Recession.
If you’re more interested in a certain brand of politics, the exercise has been a great success. An economic myth has prevailed over the truth. Reactionary policies verging on the deranged have become the hallmark of sound economic management.
Neoliberals like to ask how a crisis caused by debt can be resolved by more debt. The rest of us might ask how a catastrophe caused by financial markets can be resolved by financial markets.
* Quantitative easing (QE) is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy financial assets, like government bonds. The aim is to increase private-sector spending in the economy.
Illustration copyright Belle Mellor.
Martin Wolf, The Shifts and the Shocks – what we’ve learned from the financial crisis, Penguin, 2014. ↩
Paul Krugman, End This Depression Now, WW Norton, 2013. ↩