Austerity: 

The pain after the party

“If European policy makers, like medical doctors, had to swear “to do no harm,” they would all be banned from ‘practicing' economics”

Reading ‘Austerity’ from Mark Blyth makes for an uncomfortable sitting, he eloquently picks apart the fallacies of austerity and presents the reader with a disturbing history.  Blyth sets about depicting its limited success and cataloguing attempts of “growth friendly fiscal consolidation”, a term used by the G20 that Blyth sees akin to ‘a unicorn with a magic bag of salt’. Demystifying certain assumptions of austerity and its common sense appeal that “…austerity intuitively makes sense, right?… Austerity is intuitive, appealing and handily summed up in the phrase you cannot cure debt with more debt”. Examining the causal factors, Blyth highlights (somewhat obviously) that the 2008 financial crisis and bail-out of multinational banks shifted the mountains of private debt (owned by banks) onto the state and consequentially the tax payers. Speaking of the US banking system he states that “The price of not allowing it to fail was to turn the Federal Reserve into a “bad bank” while the federal government blew a hole in its finances”. This same thing took place in other central banks such as the BofE and the ECB. This new hole in state balance sheets demanded drastic fiscal policy, hence we come to austerity. “Having already bailed out the banks, we have to make sure that there is room on the public balance sheet to backstop them. That’s why we have austerity. It’s all about saving the banks.”.

Austerity can be done right, and as Blyth demonstrates, it has been put to good use in the past. However, with the phenomenon that was the credit crunch and subsequent financial crisis effecting such a large portion of the global finance game, most of those effected opted for austerity at the same time. Here we come to the “‘fallacy of composition’”, or as John Maynard Keynes referred to as “the paradox of thrift”. Austerity, though only in very specific cases, is a viable option. The problem with austerity arrises when everyone is tightening their belts at the same time. “We cannot all be austere at once. All that does is shrink the economy for everyone”. If both the private and public sector are paying back debt, the only way to grow is to export preferably with a lower exchange rate, but if everyone is trying the same strategy of not spending, as is happening in Europe today, it is self-defeating.

Blyth asserts that debt is the core issue. That there is far too much of it around the world, and a leveraged world is susceptible to a small shock turning into a second financial crisis. “US debt is indeed a threat, but what really matters is the international debt and foreign borrowing the that lies behind it”. Blyth shows that the interconnectedness of the international debt market poses a real threat. He goes on to argue that most misunderstand and misrepresent cause and effect, taking on a morality play between “good austerity” and “bad spending” and that this could potentially lead us into a series of self-defeating budget cuts. 

Blyth shows the practical implications and material benefits of austerity to be null and void while a ‘fallacy of composition’ is present. However, he then outlines that within austere budget cuts, the ‘cost’ is not spread evenly throughout. First to be cut is pubic services, something the higher earners are not likely to make use of anyhow. “…those who lie in the bottom 40 percent of the income distribution who haven’t had a real wage increase since 1979. These are the folks who actually rely upon government services”. This unequal distribution of cost serves to antagonise the bottom 40%, “populism, nationalism, and call for the return of ‘God and gold’ in equal doses are what unequal austerity generates”, as we have seen recently in the Brexit referendum and Donald Trump’s presidential election win. Austerity's most expensive cost been political stability and as Blyth argues, austerity’s main goal is to keep liquidity in the banks, for the time being.

The conclusion is bleak. Austerity as an idea has had a long history but a seldom positive one. “The few positive cases we can find are easily explained by currency devaluations and accommodative pacts with trade unions”. Austerity has brought class politics, riots, political instability and more rather than less debt (though the deficit has been cut, on a happier note).

The difference between Iceland and Ireland is more than one letter and provides a good case study to the alternative of austerity. Iceland had a debt-to-GDP ratio of nearly 1000% and let its banks fail. Now it is a poster child for post-crisis growth at nearly 3.5% (as of 2013), while Ireland endures yet crippling austerity with no end in sight. Yes, Icelands unemployment peaked at around 10% in 2010 but there is now real growth in the economy. Ireland’s economy is nominally inflated by the likes of Google, Facebook and Apple, doing little for the Irish people.

In closing, Blyth states the only real alternative to Austerity is taxation on those who can afford it, and rather than labelling these events as a sovereign debt crisis (in Europe), and to call it what it is; a banking crisis. Tax the banks, tax the highest earners (surprisingly likely to be in finance) and take the cost of this crisis off the shoulders of those who had nothing to do with it: The poorest 40%.

Bibliography: 

Blyth, M., 2013. Austerity: The history of a dangerous idea. Oxford University Press.