Paul Krugman keeps writing piece after piece lamenting how stupid politicians are to be heaping austerity policies onto already depressed economies and then wondering why the outcome is ever more depression. He heaps scorn on discredited theories of “expansionary austerity” or that excessive public borrowing might “crowd out” private investment pointing out that all the macro-economic evidence is to the contrary.

Absent from his analyses, however, is any theory as to why political leaders (and many of their economic advisers) might be following such counter-intuitive policies, other than the implied or explicit notion that these people must be really stupid. I want to begin the process of offering a more rigorous theory here, and it is in two parts:

Part 1 is a variant of our old friend competitive devaluations: In the days of floating currencies many countries sought to improve their short run competitive position by allowing or encouraging their currency to devalue relative to their trading partners. In the longer run of course, this resulted in inflation which tended to erode this advantage, and it only works in the short term if your country manages to devalue more than your trading partners.

Of course in a currency union this is no longer possible relative to your fellow currency members, and so the only way to improve your relative competitive position is to deflate your economy more than your “partners”. This leads to two problems: Deflation is much more economically damaging than external currency devaluation, and if every country in a currency Union deflates at the same time, they achieve no competitive advantage relative to each other, but manage to massively deflate the currency area as a whole. Indeed one country’s deflationary policies exacerbate deflation in their neighbours. This is what is currently happening in the Eurozone with record unemployment and forward economic indicators sufficiently bad to strike terror into the hearts of anyone likely to be looking for a job in the future – itself a cause of further depression.

But part 2 of the explanation is perhaps more insidious still, and it is to Marx rather than Keynes that we have to look for inspiration: What if the current depression is also being caused by an inter-generational and class war – currently really only being effectively fought and won by the older and wealthier classes? Not all older people are wealthier, I know, but there are inter-generational as well as class aspects to this divide. Follow me below the fold if you feel this hypothesis merits further exploration and elucidation.
There are a number of things that are striking about the current political responses to the crises in Europe:

  1. The almost complete dominance of conservative parties in most European countries and in the European Parliament and Commission.
  2. The rise to political dominance of the “Troika”, made up of the European Commission, Central Bank and the IMF, the first two of which are the least democratic of the four main EU institutions, and the IMF which has no direct European mandate at all.  Indeed the Troika has no constitutional or institutional standing within the EU whatsoever.
  3. The almost complete abandonment of class analysis by “socialist” parties in the wake of the fall of the Soviet Union, the re-unification of Germany, and the expansion of the EU into eastern Europe.
  4. The almost complete imposition of the burden of adjustment on the relatively poor, the growing numbers of the unemployed, and those dependent on state services rather than private provision for basic needs like healthcare, housing, education, and employment.

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Speaking as a relatively older and wealthier person in a country that has borne one of the most brutal brunts of adjustment in the EU – namely Ireland – I am continually struck by how relative little I am being personally hit by government cutbacks: My children have grown up, so cutbacks in child benefits do not effect me. I built my house 30 years ago, so I was never caught up in the property boom and negative equity bust.

The Irish economy was also in recession when I first entered the job market in the late 1970’s, but I had many relatively good years since then to build up pension entitlements and a retirement nest egg and fund for a rainy day. Those investments naturally took a hit in 2008/9, but have been recovering strongly ever since.

When I compare all that to those younger people currently trying to find a job or make a career I note that they have been hit far harder by pay reductions, tax increases, public service reductions, unemployment increases and negative equity. Mine is truly perhaps the first generation in recent times whose children will be worse off than we are.

And yet when we look at how the Government parties are performing in the polls, we see the larger conservative party, Fine Gael, doing relatively well, and the notionally more left wing party, Labour, imploding. Hardly surprising when the propertied classes, at least those who bought or inherited their houses and farms and businesses many years ago are generally still doing relatively well, whilst those who have to start off with relatively little now are truly struggling. Marginal tax rates at higher income levels have hardly increased at all, and we still have no wealth tax.

The new property tax currently being introduced is still very low compared to other northern European countries, and is being levied on virtually all properties, regardless of income. It will marginally cost the owners of mansions more, but not in any way as to effect a significant redistribution of wealth, as opposed to income. Inheritance taxes remain very “liberal”and capital gains taxes (on unearned income) are actually lower than income tax.

In some ways many older and wealthier people are actually better off now in absolute terms, and certainly so in relative terms. If I wanted to buy an apartment in Dublin today, I could do so at a discount of c. 60% on the peak price. The relative prices of many modern conveniences and luxuries – computers, electronic goods, clothes, fashion, luxury foods and personal services like restaurants and hairdressing are probably cheaper now relative to income than they have ever been – if you have the money to actually buy them. And this is one of the paradoxes of austerity and deflation: It may make life very hard for the poor, the sick and the unemployed, but it can actually make life cheaper for the relatively wealthy. Eating out in Dublin is certainly more affordable than in the Celtic Tiger years.

So the dirty little secret of austerity and deflation is that if you are already a little better off with even a small stockpile of cash or assets, you can actually do rather well out of it, certainly as compared to the vast majority of your compatriots. The roads are less crowded because fewer people have cars. Virtually every hotel in the country is running remarkably cheap special offers – for those who have the time and money to get away. Even with 14% unemployment, there are still 86% of voters more inclined to support the status quo rather than rock the boat for fear of joining the 14%. Conservative parties are doing well because the relatively well off are still doing rather well, thank you very much.

It cannot be denied that there may also be a larger geopolitical game in play: that the EU as a whole is adjusting to a reduction in its historic competitive advantages relative to the “third world”, and that we cannot compete with Chinese prices for manufactured goods, or even with India for low end software and support services. The gradual exhaustion of non-renewable resources cannot but put pressure on energy prices and living standards generally, even before you factor in the costs of climate change.  In a world of almost unlimited labour supply, the price of labour is always going to be under downward pressure.

But much of what the EU is doing now is of the nature of a self-inflicted wound; an own goal in the international war of trade and competitiveness. Social cohesion and inter-class and inter-generational solidarity used to be part of what helped to define Irish and European societies as distinct from the rather more brutally divided and authoritarian societies elsewhere in the world. What we are doing in Europe is undermining the whole basis of that cohesion and historic competitiveness as a society as a whole. What took many generations to build up is now being willfully destroyed in the space of a few years in the interests of the better off.

And don’t get me started on the really rich top 1% who mainly authored the crash and are now its chief beneficiaries. That was a scam on an international scale without precedent, but it is different from the petty jealousies and differentials which are enabling conservative parties and ideologies to thrive in the face of all economic evidence that these policies are counter-productive as well as socially unjust.

So the answer to Krugman’s incomprehension as to why the EU is pursuing policies which are objectively destructive of its own growth and wealth potential is that it is doing so because many of its older, wealthier, and more influential citizens are still doing very well out of austerity, thank you very much, and especially in relation to their perceived inferiors in society, be they the relatively poor, less experienced, or members of a less favoured minority.