Another instalment in the new draft chapter on Expansionary Austerity, which I’m writing for the paperback edition of Zombie Economics. Comments and criticism much appreciated
Despite the advocacy of Keynes, the Treasury View prevailed. When the majority of the Labour government elected in 1929 rejected the austerity policies proposed by Treasury, the government split. The Prime Minister, Ramsay MacDonald and Chancellor of the Exchequer, abandoned Labour and joined the Conservatives in a ‘National Government’, which held office throughout the 1930s.
The effects of austerity were disastrous. The unemployment rate in Britain. Unemployment rates were above 20 per cent throughout the 1930s, and even higher in the ‘depressed areas’ of the North.
But with the Labour party divided and discredited, and the Liberal Party in terminal decline, there was no alternative. MacDonald was soon pushed aside, along with the remaining pretensions of the National Government to any concern about the poor and unemployed. The Conservatives would remain in office for another decade, before finally being swept aside by a resurgent Labour Party in 1945.
If the effects of austerity were bad in Britain, they were disastrous in Germany and Japan. By 1929, Germany seemed finally on the path to recovery after the destruction wrought by what was then called the Great War of 1914-18, the punitive treaty of Versailles and the hyperinflation of the early 1920s. The extremists of the Communist and Nazi parties had been marginalized, and a moderately left-of-centre coalition, led by the Social Democratic party, held power.
The Depression hit the government hard, and provoked a demand for austerity policies, most notably a cut in unemployment benefits. The finance minister, Rudolf Hilferding was a leading Marxist theoretician, but in matters of macroeconomic management Marxist orthodoxy coincided with the Treasury view. Hilferding argued that, while crises and depressions would inevitably bring about the downfall of capitalism in due course, in the meantime, there was nothing to do but to follow the dictates of capitalist sound money.
As in Britain, the government split and fell, and was replaced by a conservative government led by Heinrich Bruning. Bruning pushed austerity policies even harder, steadily losing public support and driving the growth of the extreme parties, most notably the Nazis. By the time he fell from office in 1932, Hitler was unstoppable.
Much the same story played out in Japan. As the Depression intensified, the civilian governments imposed austerity measures that produced a sharp deterioriation in living standards. After a period of chaos, with growing political violence and assassinations, the military took over government, using the time-honored policy of international aggression to cement domestic support. The invasion of Manchuria in 1931 was the first in a series leading up to the Pearl Harbor attacks of 1941, and Japan’s entry into World War II.
The policy of austerity did not triumph everywhere. In some countries, including Sweden and New Zealand, social democratic or labour governments came to power in the early years of the Depression, with a commitment to radical reform and a willingness to use the power of the state to promote economic recovery. The Social Democratic idea of the ‘Folkhemmet’ (People’s Home) formed the basis of a consensus that dominated Swedish (and, more generally, Scandinavian) politics for decades, before being eroded by the forces of market liberalism after the crises of the 1970s and 1980s. Similarly, in New Zealand, the Labour government of Michael Joseph Savage transformed the country. Savage’s picture was a staple decoration of working class homes in New Zealand during his lirgetime, and fifty years after his death he remains the nation’s most admired political leader.
The most important alternative to the politics of austerity, however, was Franklin D Roosevelt’s New Deal. By the time Roosevelt took office in 1933, the Great Depression was nearly four years old, and the banking system was on the verge of collapse. The idea that the economy would return to full employment through market process of adjustment was ad discredited as it had ever been.
Roosevelt was not a Keynesian. In fact, he came to office promising to restore budget balance. He was, however an instinctive activist who was unwilling to sit by and do nothing when a third of the workforce was unemployed. His National Industrial Recovery Act (NIRA), had two main components. The first, the National Recovery Administration incorporated some positive elements such as union rights, but these were placed in the context of an attempt to overcome deflation through the encouragement of cartels. Fortunately, perhaps, the Supreme Court ruled key parts the NRA unconstitutional in 1935.
The other part of Roosevelt’s program, the Public Works Administration was more in line with the prescriptions of Keynesian fiscal stimulus, as was the Works Progress Administration created in 1935.
The stimulus associated with the New Deal was inadequate to deal with the shock of the Depression, and was intermittent,. Faced with criticism about budget deficits, Roosevelt undertook a major reversal in 1937 which almost precipitated a new Depression.
It was not until the outbreak of World War II in 1939 that fiscal policy was directed to the goal of mobilising all available resources. The resulting upsurge in economic activity, and the contrast with the Depression years, killed the idea of expansionary austerity, seemingly once and for all.