Two economic papers added intellectual heft to pro-austerity policies and demonstrated the end of any consensus among economists for continued Keynesianism. In October 2009, Alberto Alesina and Silvia Ardagna published a National Bureau of Economic Research (NBER) paper in which they made multiple pro-austerity arguments. The opening of the paper framed the problem: “After the large reduction in government deficits of the nineties and early new century, public finances in the OECD are back in the deep red.”138 Alesina and Ardagna suggested that fiscal consolidation could boost economic growth by bolstering private actors’ confidence in the stability of public finances. They concluded that the superior way to exit from deficit spending was through reducing government spending rather than increasing taxes.
In January 2010, Carmen Reinhart and Kenneth Rogoff also published an NBER paper, “Growth in a Time of Debt,” that buttressed the argument for fiscal austerity from a different angle. Their main result: “whereas the link between growth and debt seems relatively weak at ‘normal’ debt levels, median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.”139 In other words, the 90 percent level was deemed to be a tipping point, after which debt could have nonlinear and negative effects on economic growth. As Reinhart and Rogoff’s paper was being published, the debt-to-GDP ratios of several advanced industrialized countries, including the United States, were about to exceed that 90 percent threshold.140
Both papers framed Europe’s sovereign debt crisis and America’s tepid economic recovery as a failure of Keynesianism. Key policy-makers in the developed world imbibed their pro-austerity arguments. In April 2010, Alesina presented a similar paper to European finance ministers that was based on his previous work with Ardagna. It opened with the assertion that “many OECD countries now need to reduce large public sector deficits and debts.” Alesina further argued that “large, credible and decisive” spending cuts could boost economic growth and bolster the political fortunes of incumbent governments.141 Christina Romer, then the chair of the Council of Economic Advisers in the United States, complained publicly that everyone was citing Alesina and Ardagna’s paper.142 The IMF noted in fall 2010 that Alesina and Ardagna’s research had been “extremely influential in the debate regarding the consequences of fiscal adjustment.”143
Reinhart and Rogoff’s paper made similar waves.144 Reinhart presented her findings to the bipartisan Simpson-Bowles Commission on Fiscal Responsibility and Reform.145 Other senior policymakers, including the European Union’s economic commissioner Olli Rehn, began to quote the Reinhart and Rogoff finding.146 Paul Krugman went so far as to assert, “Reinhart-Rogoff may have had more immediate influence on public debate than any previous paper in the history of economics.”147 Furthermore, these economists went beyond their scholarly findings in delivering policy recommendations. Alesina stated in mid-2010 that he agreed with the German position on austerity, concluding, “I don’t see how anyone can argue that we should push even more on the fiscal accelerator.” Similarly, when Reinhart presented her findings to the bipartisan fiscal commission, she said, “I have no positive news to give. Fiscal austerity is something nobody wants, but it is a fact.”148
Foreign affairs commentators in the United States made a parallel intellectual case for deficit reduction based on misguided geopolitical considerations.149 In Foreign Affairs, Niall Ferguson compared the United States to other empires that had collapsed suddenly. He suggested that a sudden shift in expectations could destroy America’s ability to recover from the crisis: “Neither interest rates at zero nor fiscal stimulus can achieve a sustainable recovery if people in the United States and abroad collectively decide, overnight, that such measures will lead to much higher inflation rates or outright default.”150 Commentators at the Council on Foreign Relations, concerned about the spike in developed-country debt, warned about the ways foreign indebtedness threatened to constrain the power of the West.151 The council’s director of international economics went further, arguing that Keynesian macroeconomic policies were perpetuating the bubbles and imbalances of the pre-crisis economy.152
As 2010 progressed, the Keynesian consensus disintegrated within official policy circles. The G7 rejected any lingering American enthusiasm for expansionary fiscal policies at the February 2010 finance ministers summit in Iqaluit.153 The OECD began to urge fiscal consolidation and tighter monetary policy. In the run-up to the June 2010 Toronto G20 summit, key policymakers penned op-eds in the Financial Times to make their case, echoing points made by Alesina and Ardagna and Reinhart and Rogoff. German finance minister Wolfgang Schäuble opened his piece by blasting the “excessive budget deficits” in European countries, and pledging a German exit to deficit spending.154 While the Obama administration retained the support of some developing countries, such as Brazil, a coalition that included Germany, Britain, Canada, France, Germany, and China advocated shifting to austerity. Canadian prime minister Stephen Harper proposed that governments pledge to cut their budget deficits as a percentage of GDP in half over the next three years.155
Following the summit, the European Central Bank’s then president Jean-Claude Trichet encapsulated the views of fiscal austerity advocates in a Financial Times op-ed in which he declared, “Now is the time to restore fiscal sustainability.”156
[G]iven the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors. My understanding is that an overwhelming majority of industrial countries are now in those uncharted waters, where confidence is potentially at stake. Consolidation is a must in such circumstances. …
With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: “stimulate,” “activate,” “spend”! A large number fortunately had room for manoeuvre; others had little room; and some had no room at all and should have already started to consolidate. Specific strategies should always be tailored to individual economies. But there is little doubt that the need to implement a credible medium-term fiscal consolidation strategy is valid for all countries now.
Trichet’s logic encapsulates both the “expectations” mechanism that Alesina and Ardagna stressed in their work and the notion of threshold effects that Reinhart and Rogoff posited in their work.
The ensuing macroeconomic policies in Europe and the United States soon shifted toward austerity. In the United Kingdom, the coalition government led by conservative David Cameron quickly implemented an austerity budget. On the continent, Germany followed through on its austerity pledge. The European Central Bank, led by Trichet, began raising interest rates in early 2011, despite mounting evidence of a double-dip recession. The sovereign debt crisis forced the Southern European economies to implement austere budgets. The United States continued to pursue relatively expansionary policies throughout 2010, including a December deal to extend tax cuts for another two years. The GOP’s victory in the congressional mid-term elections acted as an inflection point, however. From January 2011 onward, the House GOP majority acted as a hard political constraint on further Keynesianism. The 2011 Budget Control Act—and its effects on the fiscal cliff and sequestration eighteen months later—meant that by 2013, the US federal government was effectively pursuing austerity policies. Indeed, after 2009, the US budget deficit as a percentage of GDP fell at the fastest rate in postwar history.
Mark Blyth has argued that policymakers pushed austerity policies to benefit particular interest groups. The proposed budget cuts to social safety nets, entitlement spending, and government jobs and salaries would have distributional and deflationary effects that benefit the wealthy more than the med
ian voter.157 It buttressed Blyth’s argument that conservative parties were the biggest boosters of reining in government spending in the United States and the United Kingdom.
This thesis is plausible, but it is worth considering that the pro-austerity position resonated beyond conservative quarters. In part, this was because left-leaning economists—including, most prominently, Paul Krugman—had sounded warnings about the perils of rising debt well before the 2008 financial crisis. In a February 2006 column, for example, Krugman bemoaned the mounting levels of government and personal debt, concluding, “serious analysts know that America’s borrowing binge is unsustainable. Sooner or later the trade deficit will have to come down, the housing boom will have to end, and both American consumers and the U.S. government will have to start living within their means.”158 In January 2009, noted Keynes biographer Robert Skidelsky argued that “the crisis also represents a moral failure: that of a system built on debt.”159 To be sure, there are differences between amassing large deficits during a boom and amassing them during a bust. There are also profound differences between when households and firms accumulate debt and when national governments engage in deficit spending. Nevertheless, it was a challenging rhetorical task for Keynesians to explain why ballooning private debt was bad before the Great Recession, but ballooning public debt after the 2008 crisis was a good idea.
As Skidelsky’s observation suggests, the desire for austerity had a moral resonance as well. For example, Krugman notes, “When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it—and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process.”160 Advocates for austerity repeatedly compared public finances to personal finances, arguing that governments should balance their budgets just like households. This gave their ideas a moral and personal dimension that was intuitively plausible to citizens, even if the comparison of households to governments was fatally flawed. Furthermore, in contrast to the challenges to the Washington Consensus, the austerity argument was coherent, simple, and connected with preexisting ideas in economic and moral theory.161
The moral resonance of austerity helps to explain the reaction to the intellectual and policy failures of austerity. Three years after it gained intellectual traction, the outcomes of austerity policies seem clear cut. The economies that had vigorously embraced austerity experienced stagnant rates of economic growth.162 Low growth rates reduced tax receipts, which in turn increased the budget deficits that were supposed to fall. In 2013, the Red Cross issued a report blasting European policy-makers for “obsolete austerity-based policies that were increasing poverty rates—and suicide rates.”163 In contrast, the United States—the primary developed country that enacted the largest stimulus and was the last to turn to austerity—found that its fiscal picture had brightened considerably by 2013. The Congressional Budget Office projected the federal budget deficit to fall to 2.1 percent of GDP by 2015—an astonishing turnaround from the 10.1 percent figure in 2009.164
At the same time, the intellectual underpinnings of the austerity argument encountered some significant reversals from global governance structures. In October 2010, the IMF critiqued Alesina and Ardagna’s methodology and findings. It concluded that fiscal retrenchment equivalent to 1 percent of GDP led to a reduction in growth by 0.5 percent and raised unemployment by 0.3 percentage points.165 That finding also received media play.166 In April 2013, three researchers from the University of Massachusetts revealed significant methodological problems with Reinhart and Rogoff’s coding and data selection—including an embarrassing Excel spreadsheet error.167 This also generated considerable negative publicity for the pro-austerity argument.168 IMF managing director Christine Lagarde criticized US efforts to cut the budget deficit too steeply, as the cuts would threaten the economic recovery.169
It is therefore intriguing to note that public support for austerity policies in the developed world remained robust—even in many of the most hard-hit countries. When the Pew Global Attitudes Project surveyed eight European countries in March 2013 about the best way to stimulate economic growth, 59 percent of respondents preferred reducing public debt over providing fiscal stimulus. In France and Germany, the support for austerity policies was at 81 percent and 67 percent, respectively. In Spain and Italy—the two countries that have borne the brunt of austerity policies—support for austerity was at 67 and 59 percent, respectively.170 Similarly, political support for fiscal retrenchment in the United States remained strong. News coverage focused far more on deficits than unemployment. US public opinion polls in 2013 revealed that only 6 percent of Americans believed that the budget deficit was, in fact, shrinking.171 One February 2013 poll showed that more than 73 percent of Americans wanted the government to cut spending to boost the economy; whereas less than 15 percent wanted spending to increase. This poll also showed that 60 percent of Americans believed that the 2009 fiscal stimulus had not worked.172
As the continental economy sagged, European policymakers did soften the edges of their austerity programs. On the monetary side, European Central Bank president Mario Draghi’s summer 2012 declaration that he would do “whatever it takes” to save the euro angered the Bundesbank but calmed financial markets, lowering borrowing rates for distressed eurozone economies.173 By the summer of 2013, both the European Central Bank and the Bank of England indicated that they would continue quantitative easing measures indefinitely. On the fiscal side, German policymakers demonstrated more flexibility in delaying the deadline for France, Portugal, Italy, and Spain to reduce their deficits to the European Union target.174 This permitted these nations to continue pursuing expansionary fiscal policies in the short term. At home, Chancellor Merkel hinted at a more expansionary fiscal policy following the fall 2013 elections.175 In the United States, Democrats seized on the errors in the Reinhart and Rogoff paper to push back against those calling for further austerity.176
Yet despite this softening, policymaking and political elites on both sides of the Atlantic continued to push for austerity. In the United States, prominent foreign affairs commentators, such as Council on Foreign Relations president Richard Haass, former chairman of the Joint Chiefs of Staff Michael Mullen, MSNBC host Joe Scarborough, and Washington Post columnist Charles Krauthammer, advocated for rapid deficit reduction, labeling rising levels of US debt as the biggest threat to national security.177 Congressional Republicans continued to lobby fiercely for severe budget cuts, leading to the budget sequester and government shutdown in 2013. European Commission president José Manuel Barroso noted in a June 2013 interview: “Let’s not forget why we came to this situation: in many cases because of high levels of public debt, and we have seen that growth fueled by debt is simply not sustainable.”178 The faith in austerity policies among large swaths of elites and the public remained powerful on both sides of the Atlantic.
While not dispositive, the contrast in the positions of global economic governance structures on the merits of China’s economic model and on the merits of austerity policies should be noted. On the former, the international financial institutions acknowledged the fallibility of some Washington Consensus policies but nevertheless remained uniformly critical of the future of the China model, as the China 2030 report demonstrates. On the subject of austerity policies, however, global governance structures were sharply divided. IMF authorities were skeptical of the merits of austerity programs, whereas OECD officials supported austerity measures and tight monetary policies. BIS officials were equally emphatic on the need to implement austerity policies. Indeed, in their 2012 and 2013 annual reports, the BIS urged central bank officials to taper off quantitative easing sooner rather than later.179 BIS’s 2013 report called repeatedly for greater fiscal consolidation and argued that quantitative easing was enabling fiscal profligacy: “Cheap money makes it easier to borrow than to save, easier to spend than to tax,
easier to remain the same than to change.”180 Given these divisions at the global level, it is not surprising that the state of global macroeconomic policy is more unsettled.
Conclusion
This chapter has considered the role of ideas in affecting the performance of global economic governance. The distribution of economic ideas clearly affected actor preferences as the crisis unfolded. The ideational depth of neoliberalism, for example, was a formidable barrier for any actor wanting to challenge its ideas, even after the shock of the 2008 crisis. China was best placed to challenge the Washington Consensus, but policy elites never converged around a coherent alternative. On the other hand, the state of macroeconomic thinking was in flux. This heterogeneity allowed a brief Keynesian consensus from late 2008 to early 2010. The sovereign debt crisis, however, led quickly to battles over the virtues of austerity. Paradoxically, even though China was perceived as more powerful, it was Europe that proved more capable at producing influential economic ideas. This is why China proved to be cooperative on questions of microeconomic policy coordination, whereas the European Union members proved to be far more resilient in advocating austerity.
The contrast between the state of economic ideas post-2008 and in the Depression era is worthy of note. As the Great Depression worsened during the 1930s, there was no expert consensus about the best way to resuscitate the global economy.181 Prominent economists, such as John Maynard Keynes, who had been staunch advocates of free trade a decade earlier reversed their ideas as the Depression worsened. There was little agreement on the proper policy responses to the downturn, particularly with respect to trade or exchange rates. In contrast, the post-2008 state of economic ideas remains relatively cohesive.182 While there remained areas of discord, a strong post-crisis consensus among economists constrained the search for alternative paradigms. After more than a half century of laying the intellectual groundwork for an open global economy and an increase in laissez-faire domestic economic policies, the ideas animating the Washington Consensus have proved to be more resilient than expected.183 As one intellectual history of free-market thought recently concluded, “The hold of market advocacy on the popular imagination has remained far stronger than in the early 1930s. … Capitalism may be in crisis, but the horizon of alternatives has narrowed.”184
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