Chapter Four: The causes and consequences of austerity

Abstract

The struggle not just to define but also to preserve American power is no modern phenomenon: questions of intervention and projection have dominated the nation's politics from the days of the Founding Fathers. Then, as now, the old centres of power were shifting. Nor is economic stress an unfamiliar factor for policymakers. As another presidential election looms, America's role in global affairs and security has emerged as one of the campaign's great battle lines.

But in 2012, domestic political and economic problems are compounded by the ongoing financial crisis in Europe, which, together with the overstretch and fatigue from two wars, has sapped the strength of America's chief allies. While it may urge its NATO partners to shoulder more of the security burden, the US finds them less willing and occasionally unable to share the strain. This Adelphi examines the myriad challenges America must confront if it is to uphold and spread its values and interests.

Notes

Robert Kagan, ‘Not Fade Away: The Myth of American Decline’, The New Republic, 11 January 2012, http://www.tnr.com/article/politics/magazine/99521/americaworld-power-declinism.

See Paul Krugman, ‘A Dark Age of Macroeconomics’, New York Times, 27 January 2009, http://krugman.blogs.nytimes.com/2009/01/27/adark-age-of-macroeconomicswonkish/.

‘In the long run,’ Keynes continued, ‘we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us that when the storm is long past the sea is flat again.’ Keynes, ‘A Tract on Monetary Reform’ (1923), cited in Robert Skidelsky, Keynes: The Return of the Master (London: Allen Lane, 2009), back cover.

The National Bureau for Economic Research (NBER) provides the economic profession's official count of business cycles. They list 11 such cycles since 1945. See http://www.nber.org/cycles.html. Only the first ten of these were conventional boom-and-bust cycles. The eleventh was worse.

The basic psychology described here is best analysed by Hyman Minsky who derived his ‘financial stability hypothesis’ reading of Keynes. Charles Kindleberger has popularised this argument through his classic work on financial crises – which has recently been updated to include the most recent crisis by Robert Aliber. See Hyman P. Minsky, Stabilizing an Unstable Economy (New Haven, CT: Yale University Press, 1986); Charles P. Kindleberger and Robert Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises, Sixth Edition (London: Palgrave Macmillan, 2011). See also George A. Akerlof and Robert J. Schiller, Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton, NJ: Princeton University Press, 2009).

See Martin Wolf, Fixing Global Finance: How to Curb Financial Crises in the 21st Century (New Haven, CT: Yale University Press, 2009); and Robert J. Schiller, The Subprime Solution: How Today's Financial Crisis Happened and What to Do about It (Princeton, NJ: Princeton University Press, 2008).

Perhaps the best illustration of this is provided by Michael Lewis, The Big Short: Inside the Doomsday Machine (New York: W.W. Norton & Company, 2011).

These percentages are calculated using data from the annual macroeconomic database of the European Commission, at http://ec.europa.eu/economy_finance/ameco/user/serie/SelectSerie.cfm.

See ‘Trends in the Distribution of Household Income between 1979 and 2007’ (Washington DC: Congressional Budget Office, 2011).

Lewis, The Big Short.

See Schiller, The Subprime Solution. See also Arnold Kling, Unchecked and Unbalanced (Lanham, MD: Rowman & Littlefield, 2009).

See Hank Paulson, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System (New York: Hachette, 2010), pp. 208–22.

Two recent industry histories – for Lehman Brothers and AIG – give a sense of the scale of the crisis. See Mark T. Williams, Uncontrolled Risk (New York: McGraw-Hill, 2010); Roddy Boyd, Fatal Risk (New York: John Wiley & Sons, 2011).

The Bureau of Labor Statistics produces a range of indicators to capture the dimensions of what is known technically as ‘labour underutilisation’, to avoid confusion with the more precise economic definition given to the term unemployment. The figure we quote is for October 2011 and is seasonally adjusted. See http://www.bls.gov/news.release/empsit.t15.htm.

See Erik Jones, ‘Reconsidering the Role of Ideas in Times of Crisis’, in Leila Simona Talani (ed.), The Global Crash: Towards a New Global Financial Regime? (London: Palgrave Macmillan, 2010), pp. 52–72.

The details for the Geithner plan can be found on the Obama administration's financial stability website at http://www.treasury.gov/press-center/press-releases/Pages/tg65.aspx.

See David J. Lynch, ‘Economists Agree: Stimulus Created Nearly 3 Million Jobs’, USA Today, 30 August 2010, http://www.usatoday.com/money/economy/2010-08-30stimulus30_CV_N.htm; ‘Varney Contradicts Private Analysts, Economists with Claim that Stimulus Failed’, Media Matters, 7 June 2010, http://mediamatters.org/research/201006070015.

See Ezra Klein, ‘Could this Time Have Been Different?’, Washington Post, 25 August 2011, http://www.washingtonpost.com/blogs/ezra-klein/post/could-this-timehave-been-different/2011/08/25/gIQAiJo0VL_blog.html; and Paul Krugman, ‘Stimulus Arithmetic (Wonkish but Important)’, New York Times, 6 January 2009, http://krugman.blogs.nytimes.com/2009/01/06/stimulusarithmetic-wonkish-but-important/.

See Jean-Marc Lucas, ‘US State and Local Government Finances: From Recession to Austerity’ (Paris: BNP Paribas, April 2011), http://economic-research.bnpparibas.com/applis/www/recheco.nsf/ConjonctureByDateEN/50295B95134B87D7C125786F00439852/$File/C1104_A1.pdf.

Republican presidential candidates addressed the issue of tax during a debate at Iowa State University, Arnes, Iowa, 12 August 2011, http://foxnewsinsider.com/2011/08/12/full-transcript-complete-text-ofthe-iowa-republican-debate-on-foxnews-channel/. During the debate, Byron York of the Washington Examiner asked the candidates: ‘Is there any ratio of cuts to taxes that you would accept? Three to one? Four to one? Or even ten to one?’ Rick Santorum answered, ‘No. The answer is no, because that's not the problem.’ Fox News's Bret Baier then said: ‘Well, I'm going to ask a question to everyone here on the stage. Say you had a deal, a real spending cuts deal, ten to one, as — as Byron said, spending cuts to tax increases. Speaker [referring to Newt Gingrich], you're already shaking your head. But who on this stage would walk away from that deal? Can you raise your hand if you feel so strongly about not raising taxes, you'd walk away on the ten to one deal?’ All the candidates (Rick Santorum, Herman Cain, Ron Paul, Michelle Bachman, Tim Pawlenty, Jim Huntsman, Newt Gingrich and notably Mitt Romney) raised their hands.

See Jonathan D. Ostry et al., ‘Fiscal Space’, IMF Staff Position Note, SPN/10/11 (Washington DC: International Monetary Fund, 1 September 2010).

J. Bradford DeLong and Lawrence H. Summers, ‘Fiscal Policy in a Depressed Economy’, 20 March 2012, http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2012_spring_bpea_papers/2012_spring_BPEA_delongsummers.pdf.

See Erik Jones, ‘Merkel's Folly’, Survival, vol. 52, no. 3, June–July 2010, pp. 21–38.

Erik Jones, ‘Italy's Sovereign Debt Crisis’, Survival, vol. 54, no. 1, February–March 2012, pp. 83–110.

Christine Lagarde, ‘Global Risks Are Rising, But There Is a Path to Recovery: Remarks at Jackson Hole’, Jackson Hole, Wyoming, 27 August 2011, http://www.imf.org/external/np/speeches/2011/082711.htm.

Martin Wolf, ‘A Fragile Europe Must Change Fast’, Financial Times, 23 May 2012, p. 13. On the case for eurobonds, see Jones, ‘Merkel's Folly’, p. 34.

The line of argument developed in this subsection builds on two essays by Erik Jones: ‘Shifting the Focus: The New Political Economy of Global Macroeconomic Imbalances’, SAIS Review, vol. 29, no. 2, Summer–Fall 2009, pp. 61–73; and ‘Macroeconomic Imbalances and the Sovereign Debt Crisis’, in Kurt Huebner (ed.), Europe, Canada, and the Comprehensive Trade Agreement (London: Routledge, 2011), pp. 289–305.

Riccardo Hausmann and Federico Sturzenegger, Global Imbalances or Bad Account? The Missing Dark Matter in the Wealth of Nations, CID Working Paper No. 124 (Cambridge, MA: Center for International Development, Harvard University, January 2006 – revised September 2006).

Herbert Stein, Chairman of the Council of Economic Advisers under Presidents Nixon and Ford, articulated this eponymous principle: ‘If something cannot go on forever, it will stop.’

Stephen M. Walt, ‘The End of the American Era’, The National Interest, November–December 2011, pp. 6–16.

See ‘USA Debt Downgrade’, Reuters, 6 August 2011, http://www.reuters.com/article/2011/08/06/us-usa-debt-downgrade-idUSTRE7746VF20110806.

Valery Giscard D'Estaigne, quoted in Pierre Olivier Gourinchas and Helene Rey, ‘From World Banker to World Venture Capitalist: U.S. External Adjustment and the Exorbitant Privilege’, in Richard H. Clarida (ed.), G7 Current Account Imbalances: Sustainability and Adjustment (Chicago, IL: National Bureau of Economic Research and University of Chicago Press, 2007), pp. 11–66, http://socrates.berkeley.edu/~pog/academic/gourinchas_rey_exorbitant.pdf.

Kennedy, The Rise and Fall of Great Powers.

David P. Calleo, The Imperious Economy (Cambridge, MA: Harvard University Press, 1982).

David P. Calleo, ‘Obama's Dilemma: Enraged Opponents or Disappointed Followers’, p. 7, http://bcjournal.org/wp-content/uploads/2010/05/calleo-from-bcjiamag_final-2.pdf.

For a good overview of China's position from a variety of different perspectives, see Morris Goldstein and Nicholas R. Lardy (eds), Debating China's Exchange Rate Policy (Washington DC: Peterson Institute for International Economics, 2008).

See Joanne Gowa, Closing the Gold Window: Domestic Politics and the End of Bretton Woods (Ithaca, NY: Cornell University Press, 1983); Arnold Kling, Unchecked and Unbalanced (Lanham, MD: Rowman & Littlefield, 2010).

Robert Skidelsky, ‘The Economic Crisis and the International Order’, Plenary Speech, the IISS Global Strategic Review, 13 September 2009, Geneva, http://www.iiss.org/conferences/global-strategicreview/global-strategic-review-2009/plenary-sessions-and-speeches-2009/lord-robert-skidelsky/.

Ibid.

Wolf, Fixing Global Finance, pp. 58-59.

Skidelsky, ‘The Economic Crisis and the International Order’.

Bill Emmott, ‘The world economy is Osama's biggest victim’, The Times, 5 September 2011, http://www.billemmott.com/article.php?id=333.