Another instalment in the new draft chapter on Expansionary Austerity, which I’m writing for the paperback edition of Zombie Economics. Comments and criticism much appreciated
Austerity measures of various kinds have been advocated, and implemented, in a wide variety of contexts. The term is used particularly in contexts like that of the present day, where government budget deficits arise as a result of (or at least in the context of) a recession, and where it is proposed to return to budget balance through some combination of lower expenditure and higher taxes, usually with an emphasis on the former.
‘Austerity’ can also be used more generally, to apply to any situation where governments seek to reduce levels of public debt by running budgeted surpluses. A notable example, with which the term ‘austerity’ is particularly associated, was that of Britain in the years after 1945. Victory in World War II had come at a huge cost. Britain was heavily indebted, particularly to the United States, and much of its overseas wealth had been destroyed. In these circumstances, there was little alternative to a policy designed to reduce imports, through rationing of a wide range of goods including food, and to maintain budget surpluses.
Nevertheless, the austerity of the 1940s and early 1950s was combined with policies that laid the foundation for widely-shared postwar prosperity. For the first time since the early 20th century, full employment was achieved and maintained for several decades. The National Health Service, which provided free medical and dental care to all was established, along with many other programs of the postwar welfare state.
The critical difference between these policies and the austerity programs now being adopted in Britain and elsewhere was the fact that they were introduced at a time of full employment, sustained by demand that had been suppressed during the war years and by expansionary monetary policy. The result was that austerity policies, combined with devaluation succeeded in restoring external balance and reducing the ratio of public debt to national income. By contrast, under conditions of high unemployment, austerity measures reduce aggregate demand, and lead to further waste of resources through unemployment.
From the viewpoint of believer’s in Say’s Law, this distinction is meaningless. According to Say’s Law, unemployment can never arise through a deficiency in demand. It follows that, whenever government budgets are in deficit and public debt is excessive, austerity is the appropriate response. By reducing public demands on capital markets, it is claimed, austerity will make it easier for provide firms to investment. Thus, austerity is presented as an expansionary policy that will promote economic growth.
This idea of expansionary austerity can be traced at least as far back as the ‘Treasury View’ which determined the official policy response to the Great Depression in Britain. The most famous statement of the Treasury view is that of Winston Churchill, then Chancellor of the Exchequer, who defended
the orthodox Treasury doctrine which has steadfastly held that, whatever might be the political and social advantages, very little additional employment, and no permanent additional employment can, in fact, and as a general rule, be created by state borrowing and state expenditure” (House of Commons 1929, p. 54).
In his Budget speech of that year
“The orthodox Treasury view … is that when the Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process raises the rent of money to all who have need of it.”
The Treasury view, stated in this way, is a restatement of Say’s Law, or, in more modern terminology, the claim that public expenditure, by driving up interest rates (the “rent of money”) will always crowd out an equal amount of (typically more productive) private investment or private consumption.
There was, in a sense, nothing new in the Treasury view except the need to offer an explicit statement of what had been, for most of the 19th century, an unchallenged orthodoxy. As the chronic unemployment of the 1920s deepened into the Great Depression in 1929, the Liberal Party, supported by John Maynard Keynes advocated public works to stimulate the economy.
The Treasury opposed these policies. This was partly because of their adherence to the classical model of macroeconomics, now described as the Treasury view, in which sustained unemployment could only arise as a result of problems specific to labor markets, such as minimum wages or recalcitrant unions.
Underlying their opposition to fiscal stimulus, however, was a fear, entirely justified in its own terms, that an interventionist macroeconomic policy would pave the way for intervention in other areas and for the end of the liberal economic order based on the gold standard, unregulated financial markets and a minimal state. These fears were to be realised in the decades after 1945, when the combination of full employment and Keynesian macroeconomic management provided supported for the expansion of the welfare state, tight control of the financial sector and extensive government intervention in the economy.