Wednesday, January 11, 2012

Austerity Experiments Show Neoliberal Failure

As an erstwhile scientist, I like experiments to test theory. Economic theory, however, is generally considered impossible to test, because there is little control of variables. Nevertheless, there have been times in our history when economic theories have been tested reasonably well. One of those times coincides with the present crisis.
Currently, neoliberal orthodoxy is prevailing in most advanced economies in the world. It demands slashing government spending to appease the bond vigilantes, who will, as the story goes, demand high interest rates on government debt refinancing. This adoption of government austerity is the experiment, and the results are coming in. 
In The Guardian, David Blanchflower sums up the current situation in Europe as follows.
“Signs of an improving jobs market in the United States stands in direct contrast to what is happening in Europe. On the same day as the BLS announcement, the European statistical office Eurostat published unemployment rates for the EU27, which showed unemployment increasing on the month in Denmark (7.8%), France (9.8%), Greece (18.8), Italy (8.6%), the Netherlands (4.9%), Portugal (13.2%), Spain (22.9%) and the UK (8.3%), although it did fall in Germany (5.5%). Youth unemployment rates in Europe are especially rising fast and are over 30% in Italy, Portugal and Spain – approximately double US rates.
The evidence from the labor market is also consistent with evidence on consumer confidence, which is worsening in Europe and improving in the US. Eurostat also published its monthly consumer confidence survey, which is falling fast in both the EU27 and in the euro area. In contrast, consumer confidence in the US is rising; for example, the Conference Board's consumer confidence index was up from 40.9 in October, to 55.2 in November to 64.5 in December.”
The UK has done this to itself by voluntarily imposing austerity measures, and David Cameron has said 2012 will be “another tough year.” Apparently unable to learn from its mistakes, the UK has tightened the austerity screws as the situation has deteriorated. The UK has a sovereign currency just like the United States, which gives it policy space to maintain Aggregate Demand with government spending. Fortunately, in spite of strong neoliberal headwinds, the US has managed to support AD enough to keep its nose out of the water. 
The Euro Zone suffers under severe austerity measures imposed by the richest countries, Germany and France. Germany still in great trepidation of another Weimar hyperinflation, which opened the door for Hitler, will not countenance any fiscal expansion in the EZ. As the EZ countries all share the euro as a common non-sovereign currency, none can opt to run deficits without incurring the wrath of the bond vigilantes, who can prey only on those not enjoying sovereign currencies. 

A Modern Money T shirt comments on the effect of the euro on the EZ countries.

The alternative is for the European Central Bank (ECB) to act as the lender of last resort and allow a measure of reflation (a bit of inflation) to counter the devastating deflationary effects of austerity. Germany will not allow it. Either Germany does not understand or does not care that its relative affluence comes at the expense of the peripheral EZ countries. Germany has benefitted from exports to the other EZ countries and, in the process, drained their wealth away. That is what happens to countries with constrained, non-sovereign currencies. They can go broke, they have, and the flawed European Monetary Union is threatened with extinction or long-term hardship for its citizens.
So far, the US has been the counter example in this experiment. So long as it continues to support AD with deficit spending, it might not follow the disastrous european calamity. But, powerful neoliberal forces are gathering to cut the deficit and send us down the road to austerity.
It is ironic that politicians, who usually disdain european policies, would embrace austerity so thoroughly. It is not necessary, it should not happen, and we will look at deficits and debts more closely in the future.
Past Experiments
The best known and most discussed experiment was the recovery from the Great Depression under Roosevelt, which followed the Wall Street crash of 1929 and Hoover’s austerity policies. Government spending and suspension of the gold standard started the recovery, which was topped off with spending for World War II. Further, in 1937, spending was cut under austerian influence, and the economy fell back until spending was resumed.
Again in 1981, the Reagan tax cuts were supposed to bring in revenue via the “trickle down,” supply side theory. Instead, large deficits occurred and stimulated the economy, which set up Reagan very nicely for a second term. Though present-day neoliberals might not agree, Reagan disproved supply side theory and supported Keynesian-like spending at the same time.


  1. Hi, Dan, Thanks for the short seminar on blogging at the MLB. After banging my head against the wall for 6 hours, my wife found out how to send you a comment. We hope it goes through. If you can, let me know.
    Thanks again, Stan

  2. Stan,
    You did it. Sorry it took so long.

  3. Why is this restrictive monetary policy called "neoliberal?" Where does this label come from? I would call it neoconservative (or just conservative).

  4. @ JAVS That's a good question, thanks for asking. The following quote is from Wikipedia and says it briefly. More info about specific ideology and origin can be found there also.

    "Neoliberalism is a contemporary form of economic liberalism that emphasizes the efficiency of private enterprise, liberalized trade and relatively open markets to promote globalization. Neoliberals therefore seek to maximize the role of the private sector in determining the political and economic priorities of the world."