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Deficit Mania could bring down the Coalition

Treating the ‘deficits’ as the primary problem for the British and other economies is essentially an ideological diversion, a way of defending the neo-liberal market system from urgently needed reforms
Mike Rustin
2 June 2010

This analytical essay argues that treating the ‘deficits’ as the primary problem for the British and other economies is essentially an ideological diversion, a way of defending the neo-liberal market system from urgently needed reforms. The arguments for ‘balanced budgets’ and seeing national economies as if they were household economies represents a return to the pre-Keynesian economic thinking of the 1930s. It threatens to have similar disastrous consequences, not least for the European Union and democracy across the continent.

In two earlier articles,  (2009 and 2010) I have explored the current economic crisis as the implosion of an unsustainable free-market system, which systematically mis-allocated resources into speculative bubbles divorced from investment in the production of real goods and services. It was the bursting of these bubbles (e.g. in the sub-prime property markets) that brought about the insolvency of much of the banking sector, and the necessity for government  bail-outs  through large payments from their own exchequers.  At the same time, other unsustainable features of the neo-liberal market order have become apparent.

One is the imbalance between the ‘excessive’ export surpluses of economies like China and Germany, and the excessive propensity to import  (and consume on finance borrowed from exporter nations) of economies like the United States. We can now see that the economic difficulties of the ‘weak’ economies of the European Union (Greece, Ireland, Portugal, Spain, Italy, and Iceland) are related to this, since they have been  enjoying levels of consumption, within the  barrier set up by the Euro, that  their own productive capacity could not sustain. 

The tendency of this system, both in its Anglo-American free market  and in its Chinese state capitalist version to generate cumulative inequalities  contributed to this situation,  which shows many  the attributes of a crisis of ‘underconsumption’ theorised in the pre-war context by J.M. Keynes.   An expanding capitalist system needs expanding demand to provide for its ever-growing productive capacity, but this system has called into being a ‘virtual’ instead of a real demand,  through the expansion of credit, unsustainable public expenditure (e.g. in Greece), and through China’s willingness to offset its own deficient domestic demand by exporting loan capital to debtor nations.

The hypertrophy of the financial sector has brought increasing disparities of income and wealth, between those engaged in the financial sector and everyone else, and  also between the entire class of top managers in private and public sectors alike, and their middle and lower-level employees. Although the justification given for this increasingly steep gradient of rewards is economic (‘paying the competitive rate for the job’)  its real explanation is that there has been  a perverse emulation   of the rewards granted to financial elites in their  economic niche (they can  cream  ‘rent’ off their   vast volume of financial transactions)  by other top  managers, including  those in the public sector.  As Doreen Massey has pointed out in World City, the hypertrophy of finance has had major regional effects  in Britain, where London and the South-East enjoys much higher levels of income and wealth than other parts of the country.  Democratic institutions have simply been too weak to give political effect to the widespread belief among the majority of citizens that this degree of inequality is unacceptable. Another side-effect of this situation  is  the developing crisis of ‘global warming’, brought about by  economic actors   engaging in activities whose ‘external’ costs to others, and to the earth at large, they are not required to  take responsibility for.

The remedies which are relevant to this crisis should be clear to all, in light of what should have been learned from the Great Crash of 1929 and the ensuing  Great Depression. Governments need to step in to restore order in the out-of-control financial markets, and then have to provide the ‘demand’  (through initiating investment programmes or through funding popular consumption) which can enable the economy to return to full-employment equilibrium. Robert Skidelsky, noted Keynesian scholar, recently argued, that the best response to the financial meltdown in Britain would have been to give out time-limited vouchers to all for British-made goods and services. (Simon Jenkins had earlier made a similar argument). 

All this is classical Keynesian and New Deal economics.  A return to Keynes, though not this one,  was indeed the first response of some  governments when they  found  themselves staring at a melt-down of the economic system.  Gordon Brown grasped the necessity of the hour more quickly and deeply than most, and set about coordinating on an international scale the funding of the insolvent banks, and the take-overs of those that could no longer function independently.  But while this response to the financial emergency was at first welcomed, the re-orientation of economic policy which should have followed has not happened.  On the contrary, we have lurched back into deflationary, nationalist economics.

In Britain, we’ve seen vast sums lent to banks, which then refused to resume loans to enterprises, preferring to refill their own balance sheets, and  to resume  their speculations.  Although there have been increases in taxation on the financial sector  (a bank bonus tax, a 50% income tax rate on high earnings) it has  proved impossible to curtail the bonus culture – large bonuses are being paid by banks  which are dependent on public  funding.    No-one even seems to ask what is ethically the matter with people who are only motivated to work by the prospect of these excessive rewards.  Despite the negotiations on financial regulation which are continuing, it does not seem that governments are united enough to be able to win this battle. Meanwhile progress on one of the other pressing areas of ‘market failure’, namely the crisis of climate change, has ground to a halt.

In my earlier articles, I argued that we can understand this crisis in the Gramscian theoretical framework of a conjuncture in the balance of forces in society, between contending classes, and between states and markets.  In the earlier  crisis of the 1970s this aspect was obvious and explicit  - both Thatcher and Reagan made it plain that the defeat of collectivism and socialism were the primary aims of their political programme. Class conflict made its presence felt in large-scale strikes, and in the pressures from collectivist organisation in the  increasing proportion of public and welfare expenditures in national budgets.  Reagan made the defeat of the US Airline Pilots Union, and the Thatcher the defeat of the National Union of Mineworkers, decisive battles for their governments.

In the crisis of 2008-2010, this dimension of ‘class relations’ has been less evident,  since the labour organisations which were powerful in the 1960s and 1970s are much weaker today, and since the industrial working class itself has diminished to a smaller proportion of the workforce.  How can one reasonably describe a crisis as one of class relations, when the language of class has almost disappeared from public debate?   When a  majority thinks of itself as ‘middle class’  (in the United States the term ‘middle class’ now virtually means  working class), how can we talk about a crisis of class relations?

But my argument is that the changes which are necessary to correct the dysfunctions  of the neo-liberal free-market order do require a  redistribution of power away from the owners of property and capital (especially capital in its most abstract financial form) and towards the people as they are  represented  through democratic political institutions.  It would be in the name of popular sovereignty that governments should curtail the power of financial institutions, redress inequalities of wealth between classes and regions generated by markets, give priority to growth in the production of real goods and services, and protect the interests of future generations through protection of the earth and its climate from abuse.

This is indeed what majorities of the people appear to desire.  Public opinion, even though it no longer expresses itself mainly through ‘mass’ institutions such as trade unions and political parties,  appears to have arrived at a consensus on the need for changes of these kinds.  This is why nearly all UK politicians started to pay lip service to the need for greater fairness and equality, for the regulation of the banks, and for a more transparent political process. In this climate, the entire political spectrum was shunted sideways to the point where it appeared that on some issues the Liberal Democrat-Tory Coalition is advocating measures to the left of those of the previous Labour government. (The proposal for a 40% capital gains tax is the best example of such an ideological crossover; Brown had reduced capital gains tax to 18%).

Such changes, if implemented, would be far from radical (still less socialist) by post-war historical standards. They would merely seek to manage the capitalist order in the interests of its own sustainable growth and equilibrium, and to limit the dysfunctions to which this market system inevitably gives rise unless it is democratically regulated.  It is a mark of how far we have travelled economically and politically since the 1960s that such a moderate programme of Keynesian reforms is in fact now being resisted so determinedly.

Resistance is however mostly covert, and diversionary.  There are many examples of the displacement of criticism from what should have been its primary objects, in the dysfunctions of the market system, on to the public sector instead.  The huge row over Parliamentary expenses took place at a time when a much greater scandal, in economic and moral terms, was the misappropriation of wealth involved in the bankers’ bonuses and severance payments, for example those of Fred the Shred  of RBS. Attacks on MPs for their duckhouses and petty expenses displaced a debate about much more significant misappropriations of wealth.  The demand that top public sector salaries should be curbed is of a similar kind. No doubt they should be, but what about salaries and bonuses in the private sector? The argument for higher top salaries in the public sector was based on comparisons with the private sector, where they were all the more plausible as the boundaries between them became so indistinct and permeable. (Is a Vice-Chancellor now a leading academic, or an entrepreneur?)   

Thus at a moment when huge market failures make necessary an enhancement of the role of government, in some form or other, a clever conservative defence has turned the argument against government and the public sector, making it appear that this is where the problems originated., But of course they didn’t originate here.  The credit crunch was the failure of the market system, and only of the state in so far as it had been suborned into becoming the market’s agent instead of its regulator, and, as J.K. Galbraith once put it, its necessary countervailing power.

The current obsession with the reduction of the deficit is the same ideological diversion, writ large. There is a looming public sector deficit primarily because in a recession, tax revenues fall, and government expenditures on benefits increase.  The Labour government had depended on continuing economic growth to generate the tax revenues to pay for its belated public sector investments. New Labour made a Faustian pact with the financial sector whereby the latter was encouraged to become the leading edge of the economy, while providing tax revenues to support public investment and welfare.  This was not a wholly sustainable economic model, it turns out, although Britain’s competitive advantage in this sector is a fact of economic life that will not go away.  But it was not only the public sector that lived on the ‘credit’ of anticipated growth, but the private sector too, in all the borrowing and spending that individuals did in the expectation that their wages, salaries and profits will continue to rise.

The idea, proclaimed among conservatives in all parties, that the problem now lies largely in the public sector, and its deficits, is a displacement of the primary issue, which is the setback to economic growth, in the ideological cause of attacking the balance between public and private sectors of the economy.  At a moment when massive market failure makes imperative a stronger role for government, in regulation, investment and redistribution,   the neo-liberal counter-attack demands that the state should retreat, or rather should deploy its power mainly to attack the public sector of the economy.

Economists have pointed out that such measures at this point are liable to be suicidal.  If one attacks a failure of economic growth by reducing expenditure and employment, even further economic contraction will happen. This is liable then to produce larger ‘deficits’ (since tax revenues will fall further, and the burden of benefits rise), then a demand for even more cuts, and so on. This cycle only ends when governments faced with mass unrest  eventually  see the error of their ways, as the Conservative governments ultimately  did in the 1980s when they abandoned ‘monetarism’ and once again began to expand the economy.

Unfortunately this deflationary pattern is now being repeated across the entire European Union, as commentators such as Will HuttonMartin Wolf and George Irvin have pointed out. No solution to the economic problems of the  European region can be found without an expansion of the economy of the entire zone, led by its strongest surplus nations (notably Germany), and with stronger arrangements for economic harmonisation (which will involve transfer payments like those which take place within normal single-currency regions   like the UK or the USA).  Without such measures, disaster threatens, as unsustainable burdens are imposed on the political and social systems of nations such as Greece, Spain and Italy.  Precedent would suggest that Britain, if the regime of contraction continues for two or three years, will suffer its own weaker version of this tension and unrest. (It was J.K. Galbraith who once wittily suggested that Britain would be a more patient guinea pig for monetarist experiments than other nations, and so it then proved, and may prove again.) 

Political Dimensions of the Crisis

Unfortunately, although political parties in Britain have adjusted to the crisis to a degree, their adjustment, after Gordon Brown’s first initiative, has been largely misguided.  Nearly everyone has accepted the idea that it is the deficit, not the recession, which is the problem.  The primary issue between the parties in the General Election was not about whether there should be cuts, or how large these should be, but merely when they should begin, in this year or next.  Alastair Darling signed up to reducing the scale of government borrowing to the same degree as Vince Cable and George Osborne, only his time-scale being different.  The successive chancellors have competed with one another in declaring how much austerity there is going to be. One can see why for the Liberal Democrats entering the Coalition, six months here or there was not in these circumstances a grave issue of principle, though the choice of David Laws as Chief Secretary to the Treasury did indicate that the right had assumed full control of the economic agenda.

Even Compass, on the moderate left, did not altogether dispute the necessity to attack the deficit,  though  arguing  persuasively for a different way of doing this – via harmless or even desirable  ‘big ticket’  cuts such as ID cards, Trident, Heathrow 3,  (some of these have gone, under the Coalition) and via redistributive  taxation from the rich to the majority of households. One does not have to be arguing that all public expenditure is sacrosanct (of course it is not) to recognise that there are serious strategic consequences in allowing government deficits to become the main focus of debate, as has now happened.

Some economists have been arguing that these apparently commonsensical assumptions about the significance of the deficits are wrong. Among these are David Blanchflower, formerly of the Bank of England Monetary Policy Committee, and the only one of its members to anticipate the crisis; James Galbraith at the University of Texas, and Ann Pettifor of the New Economics Foundation. 

Their contentions are essentially Keynesian ones. There is no problem inflating an economy through borrowing, printing money, etc., where there is surplus capacity, since in these circumstances the injection of new credit will give rise to additional demand, supply, and subsequent investment to increase capacity. Problems only arise when there is no surplus capacity, when the consequence of the creation of new money or credit will merely be inflation. This was the situation in the 1960s and 1970s, when the Keynesian model came under severe pressure. At this time, governments were induced to borrow and print money by the irresistible demands for higher spending in the excitable conditions, which then prevail of full employment and little excess productive capacity. The  prices and incomes policies of both Conservative and Labour governments (Harold Wilson and Barbara Castle’s ‘In Place of Strife’, for example) were failed attempts to contain these pressures without resorting to deflation.

But we are now in conditions more approximating to the 1930s than the 1970s.  There is surplus capacity, and little risk of inflation. There is no reason not to use deficit spending, if it were coordinated on an international basis, to restore growth. The important thing  is to ensure that  credit should not again be created by banks and blown up in bubbles, but instead  be invested in the real economy  - in capital investment and the real purchases of those on middle and low incomes.  Of course there are strong arguments for a more discriminating approach to economic growth than has previously been followed, for example in the arguments for a ‘Green New Deal’. 

Unfortunately we are far from this progressive course of action.  One force defeating it is the ‘divide and rule’ tactics of the bond markets, which are picking off each individual country discovered  to be in deficit, and  forcing  contraction (lower spending, higher taxes)  upon it.  Another is the disharmony and weakness of the international system in responding  in responding to this situation collectively, and the misguided  approach of key nations such as Germany, which appears paralysed by memory of its 1930s history, although in danger because of this preoccupation of bringing  about a repetition of the mistakes of that decade.  It is clear that the Eurozone, and the European Union more broadly, can only function effectively if it takes measures to ensure transfers between its strong and weak zones, and to ensure the modernisation and harmonisation of its entire economy.  The German government understood the necessity of this integration in its reunification with East Germany, but declines to see the necessity of a comparable breadth of action in regard to the broader European Union.

Why are the voices, such as those cited above, who are criticising the view that deficits are the crucial issue, so few and so isolated?  And furthermore, how can one reconcile the relatively hopeful view of the crisis that I have earlier put forward, with the ‘deficit mania’ that now rules. The grounds for my optimism was my view that there was an ‘objective necessity’ for greater governmental action both nationally and internationally, for greater equality (for economic not merely ‘social’ and ‘ethical’ reasons), for tighter regulation of the financial sector, and for action on climate change, et al., from which the system as a whole would benefit.  But what is happening instead is a  concerted deflationary attack on government spending across most of Europe, and a weakening of cooperation between nations. 

I recalled in my previous two articles Gramsci’s idea that in crises or conjunctures like this, ruling classes cling on to the status quo, making the minimum concessions necessary to retain power. (See also Hall and Massey 2010.)  

This is what appears now to be happening, even though the threat to the status quo that a ‘Keynesian’ response to the crisis would bring is by historical standards a modest one.  It is not the ‘spectre of Communism’ that now looms, but just the possibility of a more democratically-managed and more internationally-coordinated capitalism. It shows how far the political spectrum has moved to the right, since the earlier crisis of the 1970s, and how much higher are neo-liberal expectations of exercising absolute sway over the globe, that the necessary reforms are now meeting such resistance. 

Politics in Britain

Although there were undoubtedly progressive elements in the joint programme negotiated by the Conservative-Liberal Democrat Coalition, it now seems that these are subordinate to the new government’s commitment to a conservative economic strategy.   The fact that in David Laws the Coalition found a Chief Secretary as far economically to the right as could have been found in the Tory Party is an indication of how this negotiation worked out to the Conservatives’ advantage. This situation presents great problems for more progressive Lib Dems, who now face the prospect of being discredited and destroyed by the effects of their Coalition Government’s economic policies.  (Might it not have been preferable for them to stay out of government, allowing the largest party to assume office and judging its policies issue by issue?).  But there is also a great problem for Labour, which is now compromised by its endorsement of the conservative view of the priority of deficit reduction over growth.  (One wonders whether Gordon Brown’s reported antipathy to the Treasury’s ‘realism’ about the deficit in 2009 may have been less electorally opportunistic and more Keynesian-principled than was suggested by his opponents at the time).

Progressives now need to devise a new map, which can expose the obsession with ‘balanced budgets’ and ‘deficits’ as the neo-conservative apologia that it is. The lessons of the crisis are:

  • Priority needs to be given to growth over balanced budgets
  • The financial market system needs to be more regulated
  • There needs to be more not less international coordination
  • Europe is of fundamental importance to economic policy
  • Modern economies need to avoid extremes of inequality if they are to function properly
  •  Issues of climate change (and soon ‘peak oil’) must have priority, with the economic possibility of a ‘Green New Deal’.
  • Democratic institutions and processes need to be strengthened, if the complex understandings and negotiations needed to achieve these adjustments are to be achieved

There needs to be a rethinking at the level of theory, as well as policy, if the foundations of a progressive coalition, or indeed majority government, are to be established.  This is an urgent task, as opportunities and risks may emerge in a time-scale much shorter than the five years, which David Cameron and Nick Clegg have set out for their government.

Michael Rustin is Professor of Sociology at the University of East London, and a founding editor of Soundings.  

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