Austerity’s inauspicious historical precedents

By Felix Salmon
February 23, 2011
my favorite book on the history of sovereign debt.

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One of the best aspects of being a journalist is that you get to talk at length to the most knowledgeable and interesting experts on just about any subject you can think of. For me, yesterday was a prime case in point: a long and fascinating lunch with James Macdonald, the author of my favorite book on the history of sovereign debt. Turns out he also has a microscopic vineyard in Tuscany, so the conversation ebbed wonderfully from economics to wine and back.

Macdonald has an economic historian’s view of the current austerity debate, and he was very clear: if you look at the history of countries trying to cut and deflate their way to prosperity while keeping their currencies pegged, it’s pretty grim — all the way back to Napoleonic times. Sometimes, the peg is gold. For a good example of the destructive abilities of that particular peg, look at the UK in the 1920s, which Macdonald says was arguably worse than the US in the 1930s: shallower, to be sure, but substantially longer. The devaluation of the pound, when it finally came, was very long overdue.

At other times, the peg is simply political: Macdonald gives the example of southern Italy being locked into what was essentially the Piedmontese monetary system at the time of the Risorgimento. That might have been well over a century ago, but there’s a case to be made that it has hobbled just about everywhere south of Rome to this day — and that’s in a country with about as much internal labor mobility as between EU countries.

So from a historical perspective, the prospects for countries like Portugal, Ireland and Greece are pretty grim. They can cut their budgets drastically and stay pegged to the euro, but most of them would be better off in the position of Iceland, which can and did devalue in a crisis (and allowed its banks to default, too). So far, the Baltic states have stuck to their deflationary guns with the most determination and discipline, but such things work until they don’t: at some point it’s entirely possible that Latvia or Estonia could pull an Argentina and kickstart growth by devaluing.

All of this is relevant for the US states, of course, which are also locked into a currency union and facing very tough fiscal cuts, as Steven Pearlstein says today:

Will the pain come in the form of prolonged high unemployment? Or wage and salary cuts? Or reduction in the value of homes and financial assets? Or loss of ownership of American companies? Or price inflation? Or higher taxes? Or reductions in government services and benefits?

The right answer, of course, is “all of the above.”

Meanwhile, David Leonhardt takes an important look at Germany, which you might think was benefiting, in some kind of zero-sum mathematics, from the pain of the European periphery. It isn’t: German GDP is still significantly lower than it was in the first quarter of 2008, while US GDP is now back above its pre-crisis levels. (Britain is doing significantly worse than either.)

“The historical lesson of postcrisis austerity movements,” writes Leonhardt, “is a rich one,” and also clear: they don’t work, even if they’re “morally satisfying.”

The answer, it seems, would be for crisis-hit countries to do the equivalent of what Macdonald and I did at lunch yesterday. I was coming off a slightly feverish and bed-ridden Monday, but we still went ahead and ordered the macvin, a spectacular fortified late-harvest white (yellow, really) pinot noir from the Jura. It goes very well indeed with mangalitsa ham. And I feel much better today, thanks.


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Kudos to Felix for not kowtowing to the Peter Peterson Foundation and showing why austerity measures are suicidal.

Posted by petertemplar | Report as abusive

A year or two ago, I read a suggestion that recessions are essentially a mechanism for “wealth destruction”. No matter how they play out, you end up with (on a real basis) lower profits, lower wages, and lower asset values than you had at the beginning. Moreover, it was postulated that this is a necessary economic correction from time to time. A recession/depression will continue until an sufficient amount of wealth has been destroyed, leaving room for growth to occur.

Two implications of this idea:
(1) The various government programs to support the economy and support the housing market may soften the crash, but in doing so they also drag it out.

(2) A society must necessarily choose between deflationary wealth destruction (in which the capitalists retain a greater portion of their wealth than the laborers) or inflationary wealth destruction (in which the pain is distributed more equally). Of course there are many other ways of redistributing the wealth/pain.

Deflationary recessions have always seemed very destabilizing to me. Inflation isn’t much fun either, but preferable to the alternative.

Posted by TFF | Report as abusive

When trying to chose the least bad option it makes sence to think about who you wish to place at a comparative advantage and who you place at a comparative disadvantage.

All wealth is created through use of natural resources via the productive economy. Those who perform useful work should and must be compensated. Those who invest rather than consume should and must be compensated.

To maximize the economic benifit of a population as a whole we must specifically try and maximize the benifits that flow to workers and investors. In a global economy the best and the brightest workers move at will and they take their capital with them.

I imagine the goverment spends roughly equal amounts on 1 year of grade school for a 7 year old and one hip replacement for a 70 year old. Both are noble endevors and in utopia both would be fully funded. In the world where scaracity of resources is the reality which use of goverment funds returns the larger benifit to society?

Posted by y2kurtus | Report as abusive

y2kurtus, we’ve been starvation-funding public education for at least the last 20 years (personal experience with shrinking budgets in multiple districts). Meanwhile, Medicare costs continue to escalate faster than inflation, even on a per-individual basis.

I dunno which is more valuable to our society’s future, but the above attests to which one has the stronger voting constituency.

Posted by TFF | Report as abusive

It would be interesting to learn if the fiscal state of the government prior to the crises matters (ours, and those of the several EU economies, were pretty poor to begin with). Is it the initial state that causes post-crisis issues with austerity?

The same might apply to US states. Places like CA, IL, and NY were in pretty bad shape to begin with, and seem to be getting worse. Others, not so bad.

Posted by Curmudgeon | Report as abusive