<nettime> Amartya Sen: The economic consequences of austerity (New Statesman).

["Patrice Riemens" <patrice@xs4all.nl>]

Original to:
http://www.newstatesman.com/politics/2015/06/amartya-sen-economic-consequences-austerity


Amartya Sen: The economic consequences of austerity

The judgements of our financial and political leaders are
breathtakingly narrow. Nobel Prize-winning economist Amartya Sen
considers the alternatives.

by Amartya Sen Published 4 June, 2015


On 5 June 1919, John Maynard Keynes wrote to the prime minister of
Britain, David Lloyd George, ?I ought to let you know that on Saturday
I am slipping away from this scene of nightmare. I can do no more good
here.? Thus ended Keynes?s role as the official representative of the
British Treasury at the Paris Peace Conference. It liberated Keynes
from complicity in the Treaty of Versailles (to be signed later that
month), which he detested.

Why did Keynes dislike a treaty that ended the state of war between
Germany and the Allied Powers (surely a good thing)?

Keynes was not, of course, complaining about the end of the world
war, nor about the need for a treaty to end it, but about the terms
of the treaty ? and in particular the suffering and the economic
turmoil forced on the defeated enemy, the Germans, through imposed
austerity. Austerity is a subject of much contemporary interest in
Europe ? I would like to add the word ­?unfortunately? somewhere in
the sentence. Actually, the book that Keynes wrote attacking the
treaty, The Economic Consequences of the Peace, was very substantially
about the economic consequences of ?imposed austerity?. Germany had
lost the battle already, and the treaty was about what the defeated
enemy would be required to do, including what it should have to pay to
the victors. The terms of this Carthaginian peace, as Keynes saw it
(recollecting the Roman treatment of the ­defeated Carthage following
the Punic wars), included the imposition of an unrealistically huge
burden of reparation on Germany ? a task that Germany could not carry
out without ruining its economy. As the terms also had the effect of
fostering animosity between the victors and the vanquished and, in
addition, would economically do no good to the rest of Europe, Keynes
had nothing but contempt for the decision of the victorious four
(Britain, France, Italy and the United States) to demand something
from Germany that was hurtful for the vanquished and unhelpful for
all.

The high-minded moral rhetoric in favour of the harsh imposition of
austerity on Germany that Keynes complained about came particularly
from Lord Cunliffe and Lord Sumner, representing Britain on the
Reparation Commission, whom Keynes liked to call ?the Heavenly Twins?.
In his ­parting letter to Lloyd George, Keynes added, ?I leave the
Twins to gloat over the devastation of Europe.? Grand rhetoric on
the necessity of imposing austerity, to remove economic and moral
impropriety in Greece and elsewhere, may come more frequently these
days from Berlin itself, with the changed role of Germany in today?s
world. But the unfavourable consequences that Keynes feared would
follow from severe ? and in his judgement unreasoned ? imposition of
austerity remain relevant today (with an altered geography of the
morally upright discipliner and the errant to be disciplined).

Aside from Keynes?s fear of economic ruin of a country, in this case
Germany, through the merciless scheduling of demanded payments, he
also analysed the bad consequences on other countries in Europe of the
economic collapse of one of their partners. The thesis of economic
interdependence, which Keynes would pursue more fully later (including
in his most famous book, The General Theory of Employment, Interest
and Money, to be published in 1936), makes an early appearance in this
book, in the context of his critique of the Versailles Treaty.

?An inefficient, unemployed, disorganised Europe faces us,? says
Keynes, ?torn by internal strife and international hate, fighting,
starving, pillaging, and lying.? If some of these problems are visible
in Europe today (as I believe to some extent they are), we have to
ask: why is this so? After all, 2015 is not really anything like 1919,
and yet why do the same words, taken quite out of context, look as if
there is a fitting context for at least a part of them right now?

If austerity is as counterproductive as Keynes thought, how come it
seems to deliver electoral victories, at least in Britain? Indeed,
what truth is there in the explanatory statement in the Financial
Times, aired shortly after the Conservative victory in the general
election, and coming from a leading historian, Niall Ferguson (who, I
should explain, is a close friend ? our friendship seems to thrive on
our persistent disagreement): ?Labour should blame Keynes for their
election defeat.?

If the point of view that Ferguson airs is basically right (and that
reading is shared by several other commentators as well), the imposed
austerity we are going through is not a useless nightmare (as Keynes?s
analysis would make us believe), but more like a strenuous workout for
a healthier future, as the champions of austerity have always claimed.
And it is, in this view, a future that is beginning to unfold already
in our time, at least in Britain, appreciated by grateful voters.
Is that the real story now? And more generally, could ?the Heavenly
Twins? have been right all along?



***



There are many odd features of the experience of the world since the
crisis of 2008, beginning in the United States. One of them is that
what began as a clear failure of the market economy (particularly fed
by misbehaving financial institutions) soon looked like a problem
of the overstretched role of the state. The crisis, when it came,
was seen ? rightly, I believe ? as a failure of the operation of
the private financial institutions, and led to a huge demand for
reinstating some of the state ­regulations, particularly of the
financial markets, that had been gradually eliminated in the US
economy through piecemeal eradication (beginning in the Reagan
presidency but continuing through Democratic administrations).
However, after the massive decline in 2008 of financial markets and
of business confidence had been halted and to some extent reversed
through the intervention of the state, especially through stimulating
the economy, often paid for by heavy public borrowing, the state had
large debts to deal with. The demand for a smaller government which
had begun earlier, led by those who were sceptical of extensive public
services and state provision, now became a loud chorus, with political
leaders competing with each other in frightening people with the idea
that the economy could not but collapse under the burden of public
debt.

Similarly, at the international level, the global free fall following
the 2008 crisis was largely halted by the move, under the visionary
leadership of Gordon Brown, for a meeting of the governments of the
newly formed G20 in April 2009 in London, each promising to do its
best not to feed the downward spiral by domestic complicity. This
turned a page in the history of the crisis successfully, but soon the
story changed, with the governments being asked to get out of the way
before they ruined healthy business activities.

Turning to the management of debts, suddenly the idea of austerity as
a way out for the depressed and heavily indebted economies became the
dominant priority of the financial leaders of Europe. Those with an
interest in history could easily see in this a reminder of the days
of the Great Depression of the 1930s when cutting public expenditure
seemed like a solution, rather than a problem. This is, of course,
where Keynes made his definitive contribution in his classic book, the
General Theory, in 1936. Keynes ushered in the basic understanding
that demand is important as a determinant of economic activity, and
that expanding rather than cutting public expenditure may do a much
better job of expanding employment and activity in an economy with
unused capacity and idle labour. Austerity could do little, since a
reduction of public expenditure adds to the inadequacy of private
incomes and market demands, thereby tending to put even more people
out of work. There is, of course, more to Keynes?s full theory than
that, but the common-sense summary just presented is gist enough.

However, the financial leaders of Europe had a different reading ?
from Keynes and from a great many mainstream economists ? of what was
needed, and they were not going to budge from their understanding.
As it is quite common these days to blame economists for failing to
see the real world, I take this opportunity to note that very few
professionally trained economists were persuaded by the direction in
which those in charge of European finances decided to take Europe.
The European debacle demonstrated, in effect, that you do not need
economists to generate a holy mess: the financial sector can generate
its own gory calamity with the greatest of elegance and ease. Further,
if the policy of austerity deepened Europe?s economic problems, it did
not help in the aimed objective of reducing the ratio of debt to GDP
to any significant extent ? in fact, sometimes quite the contrary. If
things have started changing, over the past few years, even if quite
slowly, it is mainly because Europe has now started to pursue a hybrid
policy of somewhat weakened fiscal austerity with monetary expansion.
If that is a half-hearted gesture towards Keynes, the results are
half-hearted, too.

There is, in fact, plenty of evidence in the history of the world
that indicates that the most effective way of cutting deficits is
to resist recession and to combine deficit reduction with rapid
economic growth. The huge deficits after the Second World War were
easily tamed with fast economic growth in the postwar years (I will
come back to this issue later). Something similar happened during
the eight years of Bill Clinton?s presidency of the United States,
when Clinton began with a huge deficit and ended with none, thanks
largely to rapid economic growth. Again, the much-praised reduction
of the Swedish budget deficit during 1994-98 occurred in a period of
fairly fast growth of GDP. Despite political deadlocks and a largely
non-functional Congress, the United States has been much smarter than
Europe, on this occasion, in making use of this central understanding.
The ratio of deficit to GDP has fallen in the US thanks to economic
growth, which ? rather than austerity ? is of course the well-tried
way of achieving the desired result.

Had the policy leaders of Europe (adherents of a peculiarly narrow
view of financial priority) allowed more public discussion, rather
than taking unilateral decisions in secluded financial corridors ?
encouraging no public discussion ? it is possible that the policy
errors could have been prevented, through the standard procedures of
deliberation, scrutiny and critique. It is remarkable that this has
not happened in the continent that gave the world the basic ideas of
institutional democracy. The big epistemic failure in missing the
lessons of the past on revival, deficit reduction and economic growth
is not only a matter of wrong turns taken by the financial leaders,
including the European Central Bank, but also of the democratic
deficit in Europe today. It is no consolation that most of the
governments in the eurozone that deployed the strategy of austerity
lost office in public elections that followed. Democracy should be
about preventing mistakes through participatory deliberations, rather
than about making heads roll after mistakes have been made. This is
one of the reasons why John Stuart Mill saw democracy as ?government
by discussion? (a phrase coined, along Millian lines, by Walter
Bagehot), and this demands discussion preceding public decisions,
rather than following them.



***



How was it possible, it has to be asked, for the basic Keynesian
insights and analyses to be so badly lost in the making of European
economic policies that imposed austerity? Some of the dominant figures
in the financial world have had a long-standing scepticism of the
economic relations on which Keynes focused which is being emended only
now, with reality checks being made in observations of the penalty of
the neglect of Keynesian relations. The bold plan by the new president
of the European Central Bank, Mario Draghi, which we have every reason
to welcome, to deliver a trillion euros of ?quantitative easing? (not
unlike expanding the money supply) ? with decisive expansionary effect
? is a result of that belated recognition which is slowly changing the
European Central Bank: that expansion rather than contraction is what
the economy needs.

If failing to understand some basic Keynes­ian relations is a part of
the explanation of what happened, there was also another, and more
subtle, story behind the confounded economics of austerity. There
was an odd confusion in policy thinking between the real need for
institutional reform in Europe and the imagined need for austerity
? two quite different things. There can be little doubt that Europe
has needed, for quite some time, many serious institutional reforms ?
from the avoidance of tax evasion and the fixing of more reasonable
retiring ages to sensible working hours and the elimination of
institutional rigidities, including those in the labour markets.
But the real (and strong) case for institutional reform has to be
distinguished from an imagined case for indiscriminate austerity,
which does not do anything to change a ­system while hugely inflicting
pain. Through the bundling of the two together as a kind of chemical
compound, it became very difficult to advocate reform without
simultaneously cutting public expenditure all around. And this did not
serve the cause of reform at all.

This is a simple enough point, and it is surprising how difficult it
has proved to be to get this across. I have to confess to humbling
failure in making an impact on the policymakers through my efforts
on this by addressing the European Commission, the IMF, the Bank for
International Settlements, and joint meetings of the World Bank and
the OECD, starting in the summer of 2009.

An analogy can help to make the point clearer: it is as if a person
had asked for an antibiotic for his fever, and been given a mixed
tablet with antibiotic and rat poison. You cannot have the antibiotic
without also having the rat poison. We were in effect being told that
if you want economic reform then you must also have, along with it,
economic austerity, although there is absolutely no reason whatsoever
why the two must be put together as a chemical compound. For example,
having sensible retiring ages, which many European countries do not (a
much-needed institutional reform), is not similar to cutting severely
the pensions on which the lives of the working poor may depend (a
favourite of austeritarians). The compounding of the two ? not least
in the demands made on Greece ? has made it much harder to pursue
institutional reforms. And the shrinking of the Greek economy under
the influence mainly of austerity has created the most unfavourable
circumstances possible for bold institutional reforms.

Another counterproductive ­consequence of the policy of imposed
austerity and the resulting joblessness, for Keynesian reasons, has
been the loss of productive power ? and over time the loss of skill
as well ? resulting from continued unemployment of the young. The
rate of youth unemployment is astonishingly high in many European
countries today; more than half the young people in Greece have never
experienced having a job. The very process of the formation of human
capability, on which Adam Smith put emphasis as the real engine of
economic success and human progress, has been quite badly mishandled
through the tying together of uncalled-for austerity (which no country
really needed) with necessary reform (which many European countries
did need).

More than 200 years ago, Adam Smith specified with much clarity
in The Wealth of Nations how to judge the good functioning of a
well-run economy. Good political economy, Smith argued, has to have
?two distinct objects?: ?first, to provide a plentiful revenue or
subsistence for the people, or more properly to enable them to provide
such a revenue or subsistence for themselves; and secondly, to supply
the state or commonwealth with a revenue sufficient for the publick
services?.

The father of modern economics, and the pioneering champion of the
market system, did not have any doubt why the role of the state fits
integrally into the demands of a good society. Public reasoning over
generations has increasingly vindicated and supported Adam Smith?s
broad vision. There are good reasons to think that it would have done
the same today had open and informed public dialogue been given a
proper chance, rather than being ruled out by the alleged superiority
of the judgements of financial leaders, with their breathtakingly
narrow view of human society and a basic lack of interest in the
demands of a deliberative democracy.



***



It is certainly true that the policy of austerity has been advertised
as the reason behind the comparative success of the British economy.
This comparison is, however, with Europe, which has been in a bigger
hole than Britain, with a more vigorous imposition of austerity,
particularly in some countries (Greece is of course the extreme
example of that ? with the big shrinking of its economy, rather than
having economic growth). The relatively positive growth in recent
years does not make Britain?s overall experience of growth over the
period of austerity particularly impressive, if we look beyond Europe.
Not only is the price-adjusted GDP per capita in Britain today still
lower than what it was before the crisis in 2008, but also, in the
period of recovery from the low of 2009, GDP per capita has risen far
more slowly in the UK than in the US and Japan (not to mention some of
the faster-growing Asian economies).

Could the British voters, then, have missed the real story? That is
possible, and I shall come to that possibility presently, but the
voting figures do not quite bring out a groundswell of approval in
favour of austerity. There is no question that Labour had a severely
bad election, and has lost ground, not just in Scotland, and must
rethink its priorities as well as strategies quite radically. But
the parties forming the coalition government ? the Conservatives
and Liberal Democrats ? had support from more than 59 per cent of
the total vote in the election before last in 2010 (that is, before
they sprang the surprise of austerity on the British public); yet
the coalition parties together have managed to get only around 45
per cent in this election ? after the experience of austerity. Not
quite a heady success for the vote-getting ability of austerity. The
Tories did get a clear majority of seats on their own (and have good
reason to celebrate that outcome), but this achievement came with
only 37 per cent of the votes. The success here is just like that of
the Hindutva-oriented BJP in India in the elections last year, when
it got 31 per cent of the ballots cast but a substantial majority of
parliamentary seats. Before we start getting our economic theories
from the reading of election results, we have to scrutinise a bit more
the message that comes through from the votes and the seats in the
constituency-based electoral systems that the UK and, following it,
India happen to have.

What is not in doubt, however, is that the general public in the UK,
following the crisis of 2008, has become increasingly nervous about
the size of the public debt and also about the ratio of public debt
to GDP. What is overlooked here is that while a national debt may
have many costs (and it is not paranoiac to keep tracking it), it is
not quite like an individual person?s debt, which is owed to someone
else (someone quite different). An internal national debt is mainly
owed to another person in the same economy. Figures of seemingly large
public debt may be handy enough to frighten a population with imagined
stories of ruining the future generations, but the analysis of public
debt demands more critical thinking than that, rather than drawing on
a misleading analogy with private indebtedness.

There are two distinct issues here. First, even if we want to reduce
public debt quickly, austerity is not a particularly effective way of
achieving this (which the European and British experiences confirm).
For that, we need economic growth; and austerity, as Keynes noted,
is essentially anti-growth. Second, what is also important to note
is that while panic may be easy to generate, the existence of panic
does not show that there is reason for panic. No less importantly,
the public has not always been scared stiff by the size of the public
debt. The public debt-to-GDP ratio was very considerably larger in
Britain in every year for two decades, from the mid-1940s to the
mid-1960s, than it has been at any time since the crisis of 2008. And
yet there was no panic then (when Britain was confidently establishing
the welfare state), in contrast to the confused anxiety, not to
mention the orchestrated fear, that seems to run down the spine of
the terrorised British today, making austerity look like a fitting
response.

When Britain went for pioneering the welfare state and established
the National Health Service, among other ways of expanding the public
services, with Aneurin Bevan inaugurating the Park Hospital in
Manchester on 5 July 1948, the ratio of debt to GDP was larger than
200 per cent, much more than twice what it has been at any point in
recent years. Had the British public been as successfully frightened
about the debt ratio in those days, the NHS would never have been
born, and the great experiment of having a welfare state in Europe
(from which the whole world from China, Korea and Singapore to Brazil
and Mexico would learn) would not have found a foothold. A decade
later, when Harold Macmillan, as a buoyant new prime minister, told
the British people in July 1957 that they had ?never had it so good?,
the size of government debt was more than 120 per cent of GDP ?
immensely higher than the ratio of roughly 70 per cent in 2010 when
Gordon Brown was accused of mortgaging Britain?s future by profligacy.

The scare was not there from the late 1940s through the 1960s,
with Labour as well as Conservative governments in office, perhaps
because the scarers were more scarce then. And armed with good public
services and a flourishing market economy, Britain steadily reduced
its debt-to-GDP ratio through economic growth, while establishing the
welfare state and a huge array of new public services.

Public knowledge and understanding are indeed central to the ability
of a democratic government to make good policies. The Economic
Consequences of the Peace ends by pointing to the connection between
epistemology and politics, and arguing that we can make a difference
to the world only by (in Keynes?s words) ?setting in motion those
forces of instruction and imagination which change opinion?. The
last sentence in the book affirmed his hope: ?To the formation of
the general opinion of the future I dedicate this book.? In that
dedication, there is enlightenment as well as optimism, both of which
we strongly need today.

----

This is an edited version of a lecture delivered by Amartya Sen at the
Charleston Festival in Firle, East Sussex, on 23 May

Amartya Sen is professor of economics and philosophy at Harvard and
won the 1998 Nobel Prize for economics. He is the inaugural winner of
the Charleston-EFG John Maynard Keynes Prize and the author of many
books, including ?The Idea of Justice? (Penguin)






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