The Real Dangers from the New Austerity
To an economist, the current crusade by congressional Republicans to slash spending during a slow expansion seems to be about half ideology — the crude Tea Party view that most of what government does is corrupt or wasteful — and about half simple partisanship. But it’s hard to ignore the fact that so many governments have been gripped by a similar devotion to austerity; and this week, the Bank of International Settlements came on board as well. This is not the first time that this particular, political conventional wisdom has become dangerous economic nonsense. Austerity was the state-of-the-art view in the early 1930s of central bankers, Treasury officials, presidents and prime ministers — and, yes, most economists. So, the United States and most of Europe applied it, and turned a stock market collapse and nasty recession into a banking crisis, trade war and, finally, a great global depression.
This time, the call for economically destructive budget-cutting in this country has come largely from Republican politicians, although they’ve managed to bully many of their centrist Democratic colleagues to join. Still, the Federal Reserve, the IMF, the World Bank and, this time, virtually all economists are trying to hold the line for economic sanity; and Martin Wolf of the Financial Times, perhaps the leading economic commentator in the English-speaking world, wrote this past week that the new austerity “risks a disaster.†Yet, if the know-nothings have their way with our economic policy, as they did 80 years ago, the ultimate winner could well be China.
These stakes are so high that it’s worthwhile to walk through the actual economics in play here. The basic issue here is not whether both the public and private sectors, here and in most other advanced economies, have too much debt for our own good. They do. As for the private sector debt, yes, most Americans used their credit cards too freely for a decade. But the main reason for the high levels of personal debt, especially relative to people’s assets, is the housing meltdown: It destroyed much of the equity American held in their homes — the main asset for most families here — while leaving their mortgage debts largely untouched. And American households have responded sensibly: Personal saving is way up — which is why consumer spending is weak and, in turn, the expansion has been disappointing.
The only way to strengthen personal spending when most people are busy rebuilding their savings is to give them more money to spend. In principle, the additional money could come from higher wages, which recent productivity gains would support. In practice, with unemployment stuck at high levels, businesses feel little pressure to raise wages. In addition to raising wages, business has another way to inject demand into the economy: Invest at high levels. If they did that, the companies that produce equipment and other business assets would have to hire more workers, and when those workers got paid, consumer spending would increase. But most companies can’t justify investing more when most consumers are still on the sidelines, rebuilding their savings.
Just like American consumers, American businesses are saving more too: In the face of strong profits — much of them earned abroad, in stronger economies — they’ve increased their “retained earnings.†With everybody in the private economy holding back, the United States has slipped into what the Jerome Levy Forecasting Center calls a “contained depression,†when everybody but the government tries to strengthen their balance sheets at the same time.
Given that, what happens if the government decides to join everybody else and save more as well, by eliminating its own structural deficit at once? The austerity hawks promise it would restore “business confidence†and so drive an economic rebound. Only in their dreams would fiscal tightening in the face of weak consumer demand move businesses to unleash an investment boom — and most business people aren’t dreamers. In the real world, sharp government cutbacks shrink GDP and corporate profits, reinforcing the determination of consumers and businesses to save more.
To his credit, the President has tried to resist the new austerity. He argued for expanding public investments, and (alas) nobody listened. Now he’s trying to offer the Republicans a little stimulus in ways that under more normal conditions they couldn’t refuse — a temporary cut in both the employer and employee sides of the payroll tax. That would give consumers a little more money to spend, and it would give businesses a supply-side tax cut to hire more workers. The President even offers to assuage the jealous gods of budget restraint by offsetting the revenues with cuts in tax subsidies for unpopular industries. Yet, GOP leaders keep on saying no. That’s hard to reconcile with claims that the GOP’s current positions on the deficit and taxes represent a sincere economic perspective. And that only leaves partisanship to explain their insistence on austerity in the face of basic economics.
There is one other big difference between today and the 1930s: While the United States and Europe struggle today as they did 80 years ago, this time globalization has enabled the two-fifths of the world made up of emerging economies to enjoy something close to boom times. Introduce government austerity on top of a “contained depression†in the advanced economies, and the prices of western stocks and other assets will tumble. That’s the moment when the sovereign wealth funds, fledgling multinationals and recently-minted billionaires from China and other large developing countries will inject a bundle of new demand into our economy: They’ll start buying up our companies and other assets at fire-sale prices. The end game of the current fling with know-nothing austerity economics, then, is that our strongest and most ambitious rivals will walk away with a big slice of our future prosperity.