Austerity versus Stimulus Prabhat Patnaik

It is obviously silly to push for austerity in the midst of a recession, not just silly but cruel, since it prolongs the pain of unemployment. The recession is caused by a deficiency of aggregate demand. To overcome it what is necessary is an increase in demand which requires larger expenditure. Since private expenditure on consumption is restrained in a recession by the fact of unemployment and low income, since private expenditure on investment is restrained by the fact that when markets are not expanding capitalists have little desire to increase their productive capacity, and since the rest of the world’s net expenditure on the country’s goods can increase only through a shift of its demand from elsewhere, i.e. by a ”beggar-my-neighbour” policy, which is no solution to the overall problem and will invite retaliation from others, the sole plausible way that the recession can be overcome is through an increase in government expenditure, i.e. through a fiscal stimulus. Austerity being the very opposite of this will clearly worsen rather than improve things.

But then why is there a push for austerity even in the midst of a recession? The obvious answer is that finance capital does not want a proactive State engaged in demand management. If the State intervenes to fix the level of activity in a capitalist economy, then the ”state of confidence” of the capitalists which determines it otherwise, i.e. in the absence of such State intervention, ceases to matter. This removes any need to appease capitalists, to bolster their ”state of confidence” through all kinds of inducements, in the ”interests of society”, i.e. for the amelioration of socially pressing problems like unemployment. Since a prominent measure of appeasement of the capitalists is to bolster the stock market, i.e. to act in conformity with the caprices of finance capital, State intervention in demand management through fiscal means is anathema for finance capital, which therefore uses all the resources at its command for preaching the virtues of ”sound finance” (i.e. of balancing budgets). The demand for austerity in the midst of a recession, i.e. for cutting down government expenditure in tandem with the reduction in tax revenue that occurs in such a period, is thus in keeping with the predilections of finance capital. To effect this self-serving policy, finance capital and its spokesmen advance the argument that such austerity will actually overcome the recession, which, as already mentioned, is a silly argument.

But just as ”false consciousness” also has an element of ”truth”, this patently silly argument for austerity is not without a rationale within its own context. And that context is the following. Since finance capital believes, even if completely wrongly, that a fiscal stimulus, in the form of a larger fiscal deficit, is harmful for the economy, such a deficit may well undermine the ”state of confidence” of the financiers, and hence, via its impact on the stock market and other financial markets, of the capitalists as a whole. Now, those who advocate a fiscal stimulus typically have in mind a scenario where the revival of activity following such a stimulus, brings about, in turn, larger private investment and consumption expenditure, such that the need for such a stimulus disappears after a while; in other words they visualize the stimulus necessarily as a temporary phenomenon, simply to get the economy ”out of the woods”, after which ”business as usual” can take over. This, to repeat, is based on the understanding that private investment picks up once the level of activity picks up, that it simply follows changes in the level of activity. But if the act of stimulating the economy by the State also has the effect of undermining the state of confidence of the capitalists, then the revival of activity may not be followed by the hoped-for revival of private investment expenditure, or may at best be followed by an anemic revival of such expenditure, in which case the sustenance of the revival would require the persistence of the fiscal stimulus. The fiscal stimulus in short may not be the temporary phenomenon it is supposed to be but may well turn out to be a more durable affair.

This of course should not matter in itself. A fiscal deficit which increases government borrowing, actually puts the extra savings in the hands of the capitalists that finance such borrowing. The extra government borrowing in other words does not come out of any pre-existing pool of private savings, i.e. it does not cause any diversion of a pre-existing pool from other uses to lending to the government.

This is a point so little understood, even by well-known professional economists, that a word on it may be in order. If the government decides to increase its spending by 100 which it borrows, then demand increases for domestic and foreign goods by that amount. This raises domestic and foreign output, which increases employment, and hence further increases demand and output. This process goes on until an amount of additional savings to the tune of 100 has been generated out of this additional output in the hands of the domestic private sector and of the rest of the world. In other words, whatever the government borrows, generates an equal amount of loanable resources in the hands of the private sector and the rest of the world.

There should in principle therefore be no limits to government borrowing. Besides, the government differs from any private individual in the obvious sense that it has the power to tax, so that the problem of repayment of debt is also not a matter of concern. True, if the tax-GDP ratio has to rise continuously to service government debt, then beyond a point this debt may become unsustainable (unless the government decides to repudiate it); but even this problem is not of any concern as long as the average interest rate on government debt is less than the rate of growth of the economy, which is not a particularly stringent requirement. It follows then that even if the fiscal stimulus becomes a durable affair, this in itself should not be a matter of much concern.

But the real hurdle to the persistence of a fiscal deficit is the loss of ”confidence” of the financiers in the government. This may sound ironical, and indeed is, but no less real for that. The loanable resources that any government fiscal deficit generates are borrowed by the government through the intermediation of the financiers. In other words, the loanable resources generated in the hands of the domestic private sector or of the rest of the world are held as deposits of (or loans to) financial intermediaries like banks which in turn buy government securities with them. Even when the domestic private sector or the rest of the world directly buy government securities (as the Chinese are doing in the U.S.), their willingness and eagerness to do so may still be influenced by the opinions of the financiers about the government’s creditworthiness. Again, it is not a matter of whether those opinions are ”right” or ”wrong”; they count. It follows that the loanable resources generated in the event of government borrowing can flow back to the government as borrowing (with which it can cover the fiscal deficit) only if the financiers have ”confidence” in the government. If because of the very fact of the fiscal deficit, which they dislike anyway, they lose this ”confidence” in the government’s creditworthiness (this would happen especially if the fiscal deficit persists), then the government cannot continue to run fiscal deficits. This is exactly what has happened in countries like Greece, and the S&P’s downgrading of the US government debt shows that it can happen even to the United States.

It follows that State intervention through a fiscal stimulus to overcome the recession must reckon with the need to confront finance capital: the State must be willing to run fiscal deficits not just as a temporary phenomenon but even persistently, (since the ”state of confidence” of the capitalists may get undermined by the very fact of fiscal deficits to a point where private investment does not easily revive); and it must also be willing to exert adequate control over the financial system to ensure that public borrowing is always financed, so that the State does not become a prisoner to the caprices of financiers. The problem with the economists in the United States who are arguing for a fiscal stimulus is that they underplay the need for the State to confront and control finance capital as a complement to the strategy of a fiscal stimulus. This is like arguing that one can eat ”one’s cake and have it too”. Notwithstanding their correct theoretical position on what is immediately required to alleviate unemployment, and their humane concern for the plight of the unemployed, their argument is marred by this contradiction. And the element of truth in those who push for austerity, notwithstanding their silly theoretical position and dubious ethical stance (since they are acting in effect as spokesmen of finance capital and are unconcerned about the cruelty that the system is perpetrating on the unemployed), is that they are, even if unconsciously, highlighting this contradiction.

To say, as many ”progressive” American economists do, that the only impediment to a fiscal stimulus, which, let us agree, can alleviate the problem of the recession, is the intellectual failure of its opponents who are stuck with a wrong theory, is to underestimate the systemic opposition to it; it is to see the crisis as a mere policy failure, and not as being embedded in the system itself. The opponents of a fiscal stimulus no doubt have an intellectual position that is shallow; but that position is the outcome of a systemic reality that is deep. If the crisis is embedded in the system itself then overcoming it must entail some systemic change, in the absence of which it would persist. The debate in America between ”austerity” and ”stimulus” alas is occurring within a problematic that is inadequate. That problematic posits that an economic crisis can be overcome through a change in economic policy that is completely divorced from any class realities, that the pursuit of ”right” or ”wrong” economic policy is a matter of intelligence and intellectual ability and not class interests.

Of course it may be argued that for ”progressive economists” in the U.S. to start talking of controlling and confronting finance in a milieu that is otherwise so conservative, would entail abandoning whatever residual hopes there may be for a fiscal stimulus. But covering up ”truth” is never an option that progressive opinion should choose.