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AUSTERITY DOES NOT WORK! © 2014, Institute for Economic Futures A LOOK AT THE EVIDENCE THE CRISIS • In 2007, financial markets all over the world collapsed, dragging the real economy with it. • Behind the collapse was a huge bubble where asset prices had been reached unsustainable proportions. • The asset bubble had been financed by borrowing, which made the crisis into a debt crisis. • Other factors: • Increasing inequality forced normal people to borrow. • Low government revenue and bank bailouts forced governments to borrow. • For many countries, interest costs were pushed up to unsustainable levels. THE EVIDENCE IS IN: AUSTERITY DOES NOT WORK! • Countries owed more money then they could cope with. • The solution they came up with was austerity. Cut expenses in order to be able to pay down the debt! • This was done at a terrible cost to the economy: • • • • Increased unemployment. Contraction in the economy. Increase of poverty. And no end in sight. • What did these sacrifices accomplish? An INCREASE in debt! • The Evidence is in. And it is conclusive. AUSTERITY DOES NOT WORK! • As a result of the austerities, the debts of the indebted countries have increased, not reduced. WHAT IS AUSTERITY • Cut in total government non-interest spending! • • • • Cut in investments Cut in welfare spending Reduction of pensions Lay off of government workers • Sometimes accompanied by sale of government assets WHY AUSTERITY? • Government debt reached proportions that are unsustainable • Basically two reasons: • Fiscal crisis: The government has over time run large budget deficits to finance stimulus programs, bad investments, or government corruption. • Italy, Greece, Portugal, Romania • Banking crisis: The government forced borrow money to bail out banks. • Spain, Ireland, Iceland, Cyprus, • A fiscal crisis can turn into a banking crisis, if the government gets overextended (Greece). • A banking crisis can turn into a fiscal crisis if collapse of banking sector requires stimulus to restart economy. MEASURES TAKEN • Reduce government spending • • • • Cut in investments Cut in welfare spending Reduction of pensions Lay off of government workers • Sale of government assets AIM OF AUSTERITY MEASURES • Reduce fiscal deficits • Balance budgets • Reduce government debt as portion of GDP • This is supposed to put the economy back to recovery EFFECT OF MEASURES • Unemployment up • Growth reduced • Poverty increased • Inequality increased • DEBT AS PERCENTAGE OF GDP INCREASED GREECE Greek Government Debt Source: Eurostat 160.0 200 70.0 180 60.0 140.0 50.0 120.0 40.0 100.0 30.0 80.0 80 20.0 60.0 60 10.0 40.0 40 0.0 20.0 160 140 120 100 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 % of GDP Greece GDP (2000 = 100) Unenployment Greece 20 0 2006 2007 2008 2009 2010 2011 2012 2013 All Under 25 Source: Eurostat 0.0 CYPRUS 70 160.0 45.0 40.0 140.0 35.0 30.0 120.0 50 25.0 20.0 100.0 40 30 15.0 40.0 2012 2011 2010 2009 2008 2006 2007 Under 25 2013 All 2005 2004 0.0 2003 0 60.0 5.0 2002 10 10.0 2001 20 80.0 2000 % of GDP 60 Cyprus GDP (2000 = 100) Unemployment Cyprus 20.0 Source: Eurostat 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Cyprus Government Eurostat Debt ITALY % of GDP 140 Unenmployment Italy Eurostat Italy GDP (2000 = 100) 45.0 112.0 120 40.0 110.0 100 30.0 25.0 106.0 80 20.0 104.0 35.0 108.0 15.0 60 40 102.0 10.0 5.0 100.0 0.0 98.0 96.0 20 0 All Under 25 Source: Eurostat 94.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Italian Government DebtSource: SPAIN Spain GDP (2000 = 100) Unemployment Spain 140.0 60.0 120.0 50.0 100.0 40.0 80.0 30.0 60.0 20.0 10.0 40.0 0.0 20.0 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 Source: Eurostat 2004 Under 25 2003 All 2002 0.0 2001 100 90 80 70 60 50 40 30 20 10 0 Source: Eurostat 2000 % of GDP Spanish Government Debt PORTUGAL Source: Eurostat 45.0 140 40.0 120 35.0 100 Portugal GDP (2000 = 100) Unemployment Portugal 112.0 110.0 108.0 30.0 25.0 106.0 80 20.0 104.0 60 15.0 102.0 10.0 100.0 5.0 98.0 0.0 96.0 40 20 94.0 0 All Under 25 Source: Eurostat 92.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 % of GDP Portugese Government Debt IRELAND 140 % of GDP 120 Source: Eurostat Unemployment Ireland 35.0 Ireland GDP (2000 = 100) 160.0 140.0 30.0 120.0 25.0 100 20.0 100.0 80 15.0 80.0 60 10.0 60.0 40 5.0 40.0 20 0.0 20.0 0 All Under 25 Source: Eurostat 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Irish Government Debt FRANCE Source: Eurostat 90 80 70 60 50 40 30 20 10 0 France GDP (2000 = 100) Unemployment France 120.0 30.0 25.0 115.0 20.0 110.0 15.0 105.0 10.0 100.0 5.0 0.0 95.0 All Under 25 Source: Eurostat 90.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 % of GDP France Government Debt UK 140.0 25.0 120.0 20.0 100.0 15.0 80.0 10.0 60.0 40.0 5.0 20.0 0.0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: All Under 25 Eurostat 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 100 90 80 70 60 50 40 30 20 10 0 UK GDP (2000 = 100) Unemployment UK Eurostat 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 % of GDP UK Government DebtSource: UK – PROOF THAT AUSTERITY WORKS? • As we saw, the UK economy is starting to turn around. Growth is resuming and unemployment is coming down. • This has been taken as proof that austerity is working! • But is it? In reality, the economy turned around only after austerity measures abandoned! • The economy improved after government deficits started to increase! • If deficit increases and government spending contribute to growth it can no longer be called austerity! • Government rhetoric still austerity, but the actions are the reverse. • “If I keep hitting myself in the head with a baseball bat, and then I stop, I will start to feel better; this doesn’t mean that hitting yourself in the head with a baseball bat is a good thing!” – Paul Kruger Change in Government gross debt 2007-2013 as % of GDP 120 100 80 60 40 20 0 Greece Portugal Italy Ireland Belgium Cyprus France Spain United Kingdom EU Austria Hungary Germany Croatia Slovenia Malta Netherlands Finland Poland Slovakia Czech Republic Denmark Lithuania Sweden Latvia Romania Luxembourg Bulgaria Estonia Ireland Greece Portugal Spain Cyprus Slovenia United Kingdom Croatia Latvia Italy France Netherlands Romania Slovakia Lithuania Finland Czech Republic Denmark Belgium Austria Luxembourg Germany Hungary Malta Bulgaria Sweden DEBT SITUATION IN THE EU Government gross debt as % of GDP 200 180 160 140 120 100 80 60 40 20 0 -5.0 15.0 10.0 5.0 0.0 % of workforce Greece Spain Cyprus Ireland Lithuania Portugal Croatia Bulgaria Italy Latvia Slovenia Estonia EU Total Denmark Netherlands Slovakia Hungary France United Kingdom Sweden Czech Republic Luxembourg Finland Belgium Poland Romania Austria Malta Germany % of workforce Change in Unemployment 25.0 20.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 Spain Greece Cyprus Croatia Italy Ireland Portugal Bulgaria Lithuania Slovakia Latvia Slovenia Hungary Estonia Czech Republic EU Total United Kingdom Poland Denmark France Belgium Sweden Romania Netherlands Finland Luxembourg Austria Malta Germany CHANGE IN UNEMPLOYMENT EU Change in Unemployment under 25 CHANGE IN GDP EU GROWTH IN THE EU 2007 - 2013 25% 20% 15% % change from 2007 10% 5% 0% -5% -10% -15% -20% -25% -30% ROMANIA 30 25 20 15 10 5 30.0 160.0 25.0 140.0 20.0 120.0 15.0 100.0 10.0 80.0 5.0 60.0 40.0 0.0 0 Source: Eurostat All Under 25 Source: Eurostat 20.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 35 Romania GDP (2000 = 100) Unenmployment Romania 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 40 Romanian Government Debt as % of GDP SUMMARY • Austerity measures were introduced at a tremendous cost to the general population, in order to get government debt under control. • In spite of the enormous suffering, the stated objective of reducing debt did not happen. • In the UK, which has been held up as an example of that austerity does work, the economy only improved after austerity measures were suspended! • Quack medicine! Aggravates the sickness while having lots of negative side effects. WHY AUSTERITY DOES NOT WORK UNDERSTANDING THE ECONOMY • Different competing views on how economy works • • • • • Classical Economics Monetarists Keynesians “Other Cannon” Marxist • Different views gives different understanding RECESSION: THE TRIGGER OF AUSTERITY • While government deficit spending, overextension of banks may go on for many years, they only become an issue when a recession strikes. • Recession often triggered by the burst of speculative bubbles. • During a recession • Productive resources in the form of people, machinery and raw materials are idle. • The financial system, which is necessary for a modern economy to function, freezes up. CAUSES OF RECESSION AND CRISIS • Monetarist view: Temporary, random shocks. • Keynesian view: Fall in aggregate demand. • Marxist view: Fall in the rate of profit. MONETARIST VIEW • As long as money supply is kept stable, inflation and output will be stable as well. (MV=Py) • Recessions and unemployment occur due to temporary, random shocks, that affect markets. During this time the demand for money increase, and result in a drop in output. • Monetarists recommend in such situation and strong increase in the supply of money. • Although they believe monetary policy is more effective than fiscal policy, they have never called for a reduction in government spending at the start of a recession! • Milton Friedman recommended dramatic expansion of Japanese money supply to get out of stagnation. The thought of austerity never occurred to him. KEYNESIAN VIEW • Demand drives the economy. • When aggregate demand drops, the economy is thrown into recession. • This can happen when: • Purchasing power drops for common people. • The government cuts back on spending. • Investment slows down. • The government’s role in a crisis: • Spend more to stimulate the economy. This will have a multiplier effect to revive the economy. MARXIST VIEW • Marx considers that the periodic crises of capitalism is triggered the by falling rate of profits. • Due to competition between companies, there is a constant pressure on profits, the so called tendency of profits to fall. • When profits have been reduced to unsustainable limits, a recession takes places, that forces many companies into bankruptcy with the wholesale destruction of productive resources and inventories. • This reduces competition and profits are restored. • This is an inevitable outcome of the capitalist mode of production, and cannot be done away with except in socialised, planned economy. • As to the present crisis, Marxists disagree: • Some consider it a classical example of the periodic crisis of capitalism (e.g. Mick Brooks, Capitalist Crisis: Theory and Practice, (London, 2012)) • Some consider it a new phenomena of financial : structural accounts of the crisis 2007-9) crisis not analysed by Marx (e.g. Costas Lapavitsas, Financialisation and capitalist accumulation • Austerity programs during recession is from a Marxist view seen as having the workers bail out the capitalists, and is hence not supported. THE TENDENCY OF THE RATE OF PROFIT TO FALL • Labour theory of value: All value comes from Human Labour. They alone produce surplus value. • Machines do not add any value. • Due to competition, better and faster machines are always developed. • Industries more capital intensive (Marx: Increase in Organic Composition of Capital) • Fewer workers needed to produce same things. • As value only comes from human labour, and the exploitation of workers is more or less constant between industries, the surplus value per product reduces, and hence the profits decline. MARX AND FINANCE CAPITAL • Marx also analysed what he calls finance capital, but does not consider it the cause of crisis. • Capital formation: • Production: M-C-M’ • Finance: M-M’ • Finance capital causes assets bubbles. • When expectations of future earnings increase, then the value of the underlying assets increases, e.g., the value of stocks go up. • When it becomes clear that the value of future earnings are unrealistic or false, the value of the asset goes down. If the assets were highly overvalued, then the bubble bursts. • Marx calls these over valued assets “Fictitious Capital.” • According to Marx, Fictitious Capital can be a contributing cause, but not the main cause, of crisis. • In general, Marx had an astonishingly clear understanding of the financial system that seems well before his time. While the system has got more sophisticated, in general it still works the way Marx described. DIFFERENT THEORIES SAME CONCLUSION: AUSTERITY MAKES THINGS WORSE • Neither Monetarist, Keynesians nor Marxists theories recommend austerity measures to fight recession! • Indeed, no economic school of thought has even made an argument that austerity measures will revive the economy. • The supporters of austerity this time invented a theory that went like this: • Cutting the government deficits would increase expectations of future growth, and would increase demand today! • This went against all existing economy theories, and, as we have seen, did not work! THE DIFFERENCE BETWEEN STATES AND FAMILIES • Families • Cutting expenses has no effect on income • The family is too small to effect the whole economy • Governments • • • • • Government spending in Western Countries 20%-30% of GDP US If government cut spending 5%, it immediately cuts 1-1.5% of GDP! This has a ripple off effect on individuals and companies that will earn less. As they earn less, they pay less in taxes. Government revenue shrinks, which necessitates even higher cuts. DEBT/AUSTERITY SPIRAL WHO LENDS OUT THE MONEY? • In the economy, we have public wealth and private wealth. • We cannot borrow from the future! Whatever money is borrowed is borrowed from someone who has it now. • If the government borrows money, who does it borrow from? • From the private sector! COUNTRIES ARE RICH BUT STATES ARE POOR • Public debt, about one time national income, equals national wealth. Net public wealth: ZERO. • Private wealth, which equals total national wealth, equals 4 to 6 times national income. • Therefore, most countries are not broke, they are rich. • It is the states that are poor. • Had the states Private and public capital in Europe 800% Germany Public and private capital (% national income) 700% France 600% 500% United Kingdom Private capital 400% 300% 200% Public capital 100% 0% -100% -200% 1870 1890 1910 1930 1950 1970 1990 2010 WHY ARE STATES POOR? • Since 1970’s, a long set of policies have been geared to transfer wealth from the low and middle income groups to the rich. • In addition, all public assets were also transferred to the rich. • Policies include: • • • • Regressive income tax. Reduction in taxation for speculation. Reduction in wages at fixed prices which increased profits. Bailing out the rich. • This was financed by • Increased borrowing. • Depletion of government assets. • Cut in education, welfare, and other public services. INEQUALITY HIGH AND INCREASING • Private assets are roughly 5-6 times National Income, so the countries are not really poor. It is only that private people own most of it. • Out of this, the richest 1% own 35%, or two times the national income, and the next 9% richest own another 35%. • The poorest half of the population own only 5%. • If we took half of the wealth of the richest 1% it would pay back all public debt, and they would still have more than three times more wealth than the bottom 50% combined! Structure of Inequality: Share of Total Wealth Poorest 50% 5% Medium wealth 25% Richest 1% 35% Next richest 9% 35% Structure of Inequality: Relative Wealth of Various Groups Poorest 50% Medium wealth Next 9% Richest 1% 50% Share of top decile in total income (incl. capital gains) Share of top decile in national income INCOME INEQUALITY IN THE UNITED STATES, 1910 -2010 45% 40% 35% 30% 25% 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Sources and series: see piketty.pse.ens.fr/capital21c. INEQUALITY OF INCOME USA 2010 WEALTH INEQUALITY IN THE U.S., 1810 -2010 Share of top decile or percentile in total wealth 100% Top 10% wealth chare 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 . Sources and series: see piketty.pse.ens.fr/capital21c. INEQUALITY OF WEALTH USA 2010 WEALTH INEQUALITY IN SWEDEN, 1810-2010 100% Top 10% wealth share Share of top decie or percentile in total wealth 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010 Sources and series: see piketty.pse.ens.fr/capital21c. INEQUALITY OF WEALTH SWEDEN INEQUALITY WILL CONTINUE TO RISE • Unless steps are taken to change policies, inequality will keep on rising. • Even with the reintroduction of a progressive income tax it will take hundreds of years to remove inequalities in wealth. INEQUALITY AND THE ECONOMY • The poor and the middle class consume their income. This money goes back to the economy. • The rich invest their money. While some of the investments are productive, most are speculative and do not benefit the real economy. • The greater the divide between rich and poor, the more resources are wasted in hoarding, financial services and speculation. • Also: • Inequality leads to increased borrowing by common people. • When the bubble bursts, they are forced to try to repay their debts, thus lowering demand. • This makes a direct link between inequality and recession. SPECULATION AND INVESTMENTS • Productive investments create wealth: • Create something new • Examples • Building factory • Writing software • Growing food • Speculation redistributes wealth: • Buy something in the hope that the price will go up • Examples • Buying stocks • Buying real estate • Speculate in derivative products (e.g., CDS, CDO, DCD, trackers, futures contracts, options) • Financial services redistribute wealth • Does not create anything new • Extracts a commission to facility loans and speculation SIZE OF SPECULATIVE ECONOMY • Global GDP: USD 75 trillion • Global annual world trade: 19 trillion • Global annual foreign exchange turnover: USD 1,900 trillion • Global market capitalisation: USD 63.4 trillion • Notional value of outstanding derivatives: USD 1,200 trillion SPECULATION AND FINANCIAL SERVICES • Speculators are like gamblers in the casino – they sometime win and sometime lose. • Financial firms and banks are like the bank of the casino – they always win regardless of who else wins or loses. • Financial services and banks drain wealth from the real economy. • 40% of corporate profits in the United States are siphoned off by financial service firms. CONCLUSIONS • No backing for austerity programs by any economic school. • The real problem is that the state has too little resources compared to the private sector. • In the private sector, inequality is extreme and rising. • Due to inequality, consumption by the poor is curtailed and wasteful speculation among the rich is rife. • Austerity is not the solution. Any solution must entail a transfer of resources from areas that waste them to those who will use them productively. • In other words, resources has to be moved from the rich, who use them for speculation, to the common people and the state, who employs them productively.