Monday, May 27, 2013

Austerity's rationale courtesy of 18th century Scotland

The Scots have given us great thinkers in political economy. In the modern era, we had John Kenneth Galbraith, whose ancestry was Scottish, and more recently Mark Blyth, a professor of political economy at Brown University has taken to the airwaves to promote his book, "Austerity: The History of a Dangerous Idea".

Blyth goes back to the Scottish Enlightenment to show that in the current debate concerning austerity we remain in thrall to the ideas of Adam Smith and David Hume, in this article (excerpted below)"

Both Hume and Smith had good reason to fear debt, both public and private. British national debt grew from 5 percent of GDP in 1700 to 25 percent of GDP in 1761, rising to 34 percent of GDP in 1814 at the height of the Napoleonic wars. Hume’s opinion was sharpened by the bankruptcy of the Bank of France (thanks to the paper money scheme of fellow-Scot John Law), while Smith’s faith even in private credit was shaken by the bankruptcy of the Ayr Bank a few years before the publication of The Wealth of Nations.

However, both Hume and Smith were quite wrong about debt. Hume predicted the collapse of the British economy through debt financing by the late 1700s – just as the U.K. was about to go through a century of expansion and growth. Smith similarly predicted the growth of “enormous debts which at present oppress, and will in the long-run probably ruin, all the great states of Europe.” But the U.K. paid back its debts after 1815, with public debt falling to 6.6 percent of GDP by 1866 and remaining low until the next great war of 1914. In 1945, government spending amounted to 70 percent of the U.K.’s economy. But the debt fell once again as the economy grew and the debt was retired after the Second World War.

...the logic of government crowding-out private investment both pointed to seems to make sense (so long as we assume perfectly efficient markets and positive interest rates). And it’s in part because economists’ inherent distrust of the state and all its works persists. But it may also be because Smith and Hume do have a point, one that Keynes would agree with.

Keynes famously said that ‘the boom, not the slump, is the time for austerity.’ Yet in the boom, when money is plentiful, there is no incentive for a minister, as Hume had it, to raise taxes and pay back the debt. Rather, we hope that growth will do the job for us, or we delegate the task out to the central bank, which as Smith reminds us, is owned by the same merchant interest. So we never do austerity in the boom. We give ourselves another round of tax cuts instead such that the bias towards debt that our Scots forebears noted continues, even in the good times. [emphasis added]

Reference:
Blyth, Mark. "Austerity’s Scottish Ghosts Haunt the Modern Economic Mind." The Daily Beast. . http://www.thedailybeast.com/articles/2013/05/12/austerity-s-scottish-ghosts-haunt-the-modern-economic-mind.html (accessed May 27, 2013).