Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I note the calls for more discussion on the trap that the ‘left’ has made for itself by buying into the globalisation/political capture myth. As I have noted previously, I am currently researching a new book on this topic which might appear in 2016 but more likely early 2017, such is the delays in publishing. My current research is focusing on the 1960s and 1970s. I am exploring the deep infighting within the French state between the ‘Keynesians’ in the planning ministry and the ‘Monetarists’ in the finance ministry, which shaped the way the French ‘left’ dealt with issues of monetary integration and the like. I am also tracing the evolution of ‘left’ macroeconomic thinking, or rather, the absence of it, in the late 1960s as the Bretton Woods fixed exchange rate system collapsed and fiat currency freedom was taken up by governments around the world. In 1973, after several years of work, American sociologist James O’Connor published his book “The Fiscal Crisis of the State”, which was considered by many on the ‘left’ to explain why the Keynesian policy era had failed. This book and the derivative literature that followed it was extremely influential among ‘left’ scholars and effectively negated their capacity to challenge, what by the mid-1970s, was becoming the Monetarist resurgence. We can trace back the failure of the ‘left’ to fight against austerity to this period. This is just part of the work I am doing on this topic at present.
The rot was setting in during the early 1970s, which is surprising because it was the period when the Bretton Woods fixed exchange rate regime had just collapsed and despite some vain attempts to salvage it (Smithsonian Agreement etc), the writing was on the wall.
Fixed exchange rate regimes are difficult to maintain and so compromise the policy independence of currency-issuing nations that they should never be a model for any progressive political movement.
James O’Connor outlines the argument in this way:
Every economic and social class and group wants government to spend more and more money on more and more things. But no one wants to pay new taxes or higher taxes on all taxes. Indeed, nearly everyone wants lower taxes, and many groups of agitated successfully for tax relief. Society’s demands on local and state budgets seemingly are unlimited, but people’s willingness and capacity to pay for these demands appear to be narrowly limited. And at the federal level expenditures have increased significantly faster than the growth of total production …
We have termed this tendency for government expenditures to outrace revenues that “fiscal crisis of the state.”
O’Connor was offering what he called the “sociological foundations if state finances” to distinguish his work from what he called the “theoretical bankrupcty … with the mainstream of Western economic thought”.
He wanted to get beyond what he called, quoting Joseph Schumpeter, a “collection of hard, naked effects” that typically describes the way traditional economists discuss fiscal matters, to situate such discussions within the “realm of sociology”.
It should be noted here, that his characterisation of mainstream Western economic thought was referring to the dominant Keynesian approach to public finance of the day, which he said rested on the “premise”:
… that the government budget should and can be increased or lowered to compensate for reduced or increased private spending. Many orthodox economists believe that the volume of federal spending (if not its composition) is determined by and inversely related to the volume of private spending.
He described this “approach” as being “at best simplistic”. He considered that “Particular expenditures and programs and the budget as a whole are explicable only in terms of power relationships within the private economy”.
In other words, his theoretical framework was “drawn from Marxist economics and adapted to the problem of budgetary analysis”.
To begin with, he is “first premise is that the capitalistic state must try to fulfil two basic and often mutually contradictory functions – accumulation and legitimization“.
He explained this in terms of the state having to:
1. “maintain or create the conditions in which profitable capital accumulation is possible”.
2. “Maintain or create the conditions for social harmony”.
If “a capitalist state … openly uses its coercive forces to help one class accumulate capital at the expense of other classes” it will quickly lose its “legitimacy and hence undermines the basis of its loyalty and support”.
But “A state that ignores the necessity of assisting the process of capital accumulation risks drying up the source of its own power, the economy’s surplus production capacity and the taxes drawn from this surplus …”
In other words, the state is in a contradictory location where it is forced to keep private “profits high and growing” yet at the same time, provide some redistributive function (in terms of the surplus), to ensure that workers in some wise sharing the prosperity that the capitalist production process has created.
So the state has to provide “social capital” which includes “social investment” that “increase the productivity of a given amount of labourpower” and “increase the rate of profit” (for example, various forms of public infrastructure), and, “social consumption”, which “consists of projects and services at lower the reproduction costs of labor” and “increase the rate of profit”.
On the other hand, state expenditures are also incurred as “social expenses … which are required to maintain social harmony”. He uses the example of the “welfare system, which is designed chiefly to keep social peace among unemployed workers”.
He recognises that these categories are not rock solid and that “nearly every state expenditure has” a “twofold character”. For example, state expenditure on education can involve “social capital”, where “teachers and equipment … reproduce and expand work-force technical skill levels”, and, “social expenses”, such as the “salaries of campus policeman”.
He believed it essential to go below the level of numbers in the fiscal statements, where for example, “national income accounts lump the various categories of state spending together”, and analyse fiscal matters in terms of these two broad. contradictory functions of the state in a capitalist system – accumulation and legitimization.
There was a huge literature at the time, produced by Marxist scholars, discussing the forms and nature of the legitimisation function that governments were forced to take to maintain economic growth without rebellion. That literature is interesting in its own right but tangential to my topic today.
So while the state is required to socialise various costs of production that would otherwise be borne by the private sector, it allows the capitalists to take the profits. But at the same time it has to do meet the increasing demands of the population for better services and protections. Both functions require the government, according to O’Connor, to relentlessly expand its expenditure shares.
We have to see the work in the context of its time. For example, how do we explain the constant support by the corporate sector for reducing the size of the state? It might be argued, that the component that directly benefits the corporate sector has been preserved while attacks have been made on the “social expenses” categories.
But then why do people continue to support governments that hack into the Welfare State and introduce legislation that deliberately undermines their income security?
O’Connor thus transcended the ideas of Marx and Keynes, who saw crises in the economy as a systemic failure to produce sufficient spending to underpin the current rate of capital formation and resulting output, O’Connor placed the source of the capitalist crises directly within these contradictory aims of the state.
To emphasise his point, O’Connor quoted from testimony given by the Chairperson of the US Federal Reserve Bank (Arthur F. Burns) to the Joint Economic Committee hearings on July 26, 1972:
We stand at a crossroads in our fiscal arrangements. Many of our citizens are alarmed by the increasing share of their incomes that is taken away by Federal, Stated, and local taxes … The propensity to spend more than we are prepared to finance through taxes is becoming deep-seated and ominous. An early end to Federal deficits is not now in sight. Numerous Federal programs have a he growth of expenditures built into them, and there are proposals presently before the Congress that would raise expenditures by vast amounts in coming years.
You can read that Statement – HERE
This statement, for O’Connor encapsulated the “fiscal crisis of the state”.
It is also interesting, that while he adopted what might now be conceived as being ‘orthodox’ views on public finance, he also saw government spending as being a positive and essential ingredient of growth in a capitalist system and believed that more welfare spending was necessary to support that growth.
… The growth of the state sector is indispensable to the expansion of private industry, particularly monopoly industries … [but] … the growth of monopoly capital generates increased expansion of social expenses. In sum, the greater the growth of social capital, the greater the growth of the monopoly sector. And the greater the growth of the monopoly sector, the greater the state’s expenditures on social expenses of production.
That would appear to be diametrically opposed to modern austerity theory, which believes that government spending reduces economic growth and the deeper the cuts they can be made to the outlays on income support (welfare) the better.
The crisis he envisages is that the capacity to tax lags behind the ever-increasing state expenditures, which mean that fiscal deficits rise.
Further, there is a constant battle over the composition of state spending, which often compromises the state further and leads to even greater growth in public expenditure.
While the accumulation of social capital indirectly increases total production and society’s surplus and thus in principle appears to underwrite the expansion of social expenses, large monopoly-sector corporations and unions strongly resist the appropriation of this surplus for new social capital or social expense outlays.
In addition, “the fiscal crisis is exacerbated by the private appropriation of state power for particularistic ends. A host of “special interest” – corporations, industries, regional and other business interests – make claims on the budget for various kinds of social investment … Organised labour and workers generally make various claims the different kinds of social consumption, and the unemployed and poor … stake their claims for expanded social expenses. Few if any claims are coordinated by the market. Most are processed by the political system and are won and lost as a result of political struggle”.
This leads to “waste, duplication, and overlapping of state projects and services”.
Remember that O’Connor was writing during the 1960s Vietnam war period where economists continually talked about the trade-off between ‘guns and butter’, that is the choice between maintaining public spending to prosecute the war effort and the growing demands of an emerging middle class America for public spending on education, health, transport, and income support.
But, and this is one of the points of the blog, O’Connor was locked into the mindset, which is presented in any modern mainstream (here I am using the term as neo-liberal) macroeconomics textbook, that the national government faces a financial constraint on its expenditure.
In the Introduction to the 2009 reprint of his book by Transaction Publishers, we read that:
The state has three ways to finance increased budgetary outlays: create state enterprises that produce social expenditures; issue debt and borrowing against future tax revenues; raise taxes and introduce new taxes. None of these mechanisms are satisfactory. Neither the development of state enterprise nor the growth of state debt liberates the state from fiscal concerns. Similarly, tax finance is a form of economic exploitations and thus a problem for class analysis.
Consistent with his Marxist leanings, O’Connor believed that the government would increasingly place the tax burden on the working class, which would heighten the class conflict inherent in American capitalism. He also recognised that the working class was being subjected to ‘divide and conquer’ strategies by capital, which undermined their capacity to organise effectively and defend their shares of national income.
But, even though his focus on the distribution conflicts by class of his alleged crisis are worthy in themselves, he effectively adopted the mainstream macroeconomic notion that a currency-issuing government is financially constrained.
While that was true during the Bretton Woods fixed exchange-rate system, where governments had to contrain their expenditures to meet the central bank requirements to sustain the currency parity, it was certainly not true after 1971, when President Nixon, effectively ended the gold convertibility and floated the US dollar.
It appears that O’Connor didn’t grasp the significance of what happened in August 1971 and proceeded as if nothing significant had changed.
In fact, the body of teaching in undergraduate macroeconomics courses that students are subjected to today also reflects a failure by the authors of those textbooks to appreciate what actually happened in August 1971. The chapters on public finance in those textbooks and the articulation of the so-called fiscal constraints that governments face are irrelevant in the modern fiat currency monetary systems.
O’Connor, in the introduction to the 2009 reprint of the book by Transaction Publishers, was aware of the contextual place of his work in history. He said that:
… the book was a study of one particular historical conjuncture of the U.S. economy and society, and the U.S. state on state budget. Yet one can find many “fiscal-crisis type” phenomena in other countries in the same year and also in today’s globalist era.
So he wasn’t entirely given up the relevance of his thesis beyond the particular events of the late 1960s in America.
The point of introducing O’Connor’s work is not to argue whether the events have proven him wrong or not. In many ways, his analysis was prescient. Yet, in other ways, he failed to predict the future very well at all.
The main point of the blog is that by adopting the mainstream view that a currency-issuing government (in the era of fiat currencies) was financially constrained and could not run continuous fiscal deficits he failed to create a new theory of the state fiscal relations that would underpin a coherent and powerful ‘left’ narrative.
At the time, his work and related work by other ‘left’ writers, was very powerful and, seemingly, scared the bejesus out of those on the ‘left’, who may or may not have been attracted, at least in part, to the mechanics of ‘Keynesian’ economics and the obvious empirical fact that it had been used successfully for several decades in the Post World War 2 period, to sustain rising real incomes for workers, full employment and income-support safety nets of various levels of generosity across the advanced world.
In the period following the publication of the Fiscal Crisis of the State a myriad of left-wing and socialist orientated articles, academic papers, books emerged which reflected the fact that the authors had begun to absorb the underlying message – that currency-issuing governments were financially constrained.
At that point, these intellectuals started steering the progressive agenda down the wrong road. The essential ideas that we find in Abba Lerner’s work on Functional Finance were lost to this group of scholars.
It didn’t take too much imagination to understand that once the ‘left’ stopped questioning whether governments faced financial constraints or not, their capacity to articulate a broad, wide-ranging progressive policy agenda became deeply compromised.
The same holds today of course. I often have conversations with The Greens at various levels, who hold themselves out as the progressive force in Australian politics. The conversations come to a dead-end when they tell me in one form or another that the Government cannot ‘afford’ or cannot ‘pay’ for full employment or some such, or needs to ‘tax more fairly’ to ensure the rich pay for the spending.
At that point, I know that their social and environmental plans are ‘dust’ because they would accept voluntary financial constraints on government spending that would limit the scope of the federal government to achieve the desirable ends they articulate.
But in the early 1970s, just as governments were becoming financially unconstrained and floating their exchange rates, which freed their central banks from engaging in official foreign exchange market intervention, the intellectual (Marxist) ‘left’ was becoming besotted with notions that the deep crisis was to be found in the lack of taxing capacity of governments.
The situation became worse when the ‘left’ started incorporating the increasing global nature of finance and production-supply chains into their analysis. They wrongly assumed that these trends further undermined the capacity of states to spend and maintain full employment.
The ‘fiscal crisis of the state’ and ‘globalisation’ were held out as the two major impediments to state sovereignty. Nothing could have been further from the truth. But the ‘left’ bought it and in the 1970s, the neo-liberal resurgence as Monetarism, then privatisation and austerity, became virtually unchallenged and the ‘left’ disappeared up its own post-modern whatever.
Academic journals became overwhelmed with all sorts of post modern deconstructions of this and that, while the main game, the macroeconomics debate was lost – in a no contest. James O’Connor had taught the ‘left’ that the government was financially constrained and could not run continuous deficits because it would run out of money.
In the European context, the unchallenged domination of the Monetarists was an important reason why France and Germany were able to come together and advance the move towards monetary union.
In 1972, the Governor of the Danish Central Bank said (source is in my current Eurozone book, page 5):
I will begin to believe in European economic and monetary union when someone explains how you control nine horses that are all running at different speeds within the same harness.
What eventually allowed the ‘nine horses’ to be harnessed together was not a diminution in Franco-German national and cultural rivalry but rather a growing homogenisation of the economic debate.
The surge in Monetarist thought within macroeconomics in the 1970s, first within the academy, then in policy making and central banking domains, quickly morphed into an insular Groupthink, which trapped policy makers in the thrall of the self regulating, free market myth.
The accompanying ‘confirmation bias’, which arises when people or groups only accept information that ratifies their prior beliefs and reject contrary facts, overwhelmed the debate about monetary integration that was being conducted along ‘Keynesian’ lines at the time – that is, the recognition that there had to be a federal fiscal capacity in order for the union to be effective.
The introduction of the Monetarist inspired Barre Plan in 1976, by French Prime Minister Raymond Barre, under President Valéry Giscard d’Estaing, showed how far the French had shifted from their Gaullist ‘Keynesian’ days.
Across Europe, unemployment became a policy tool aimed at maintaining price stability rather than a policy target, as it had been during the Keynesian era up until the mid 1970s. Unemployment rose sharply as national governments, infested with Monetarist thought, began their long-lived love affair with austerity.
The ‘left’ was disappearing into its post modern haze by this time.
As I discuss in my Eurozone book, and I will write more on this as my research on the deep divisions between the ‘Keynesians’ in the planning department and the ‘Monetarists’ in the French finance department in the 1970s advances, the French people realised the Barre austerity plan was a disaster.
Barre coined the term d’austérité and was the first Monetarist government – Thatcher came second
After indulging in the early Monetarist experiments under Giscard d’Estaing and Barre, the political fallout associated with the sharply rising unemployment demonstrated the poverty of that policy framework and led to Mitterrand’s election.
His government immediately set about doing what a sovereign government should do: use fiscal and monetary policy to expand employment, reduce unemployment and expand the social wage.
But the French were still intent on remaining in the European Monetary System (EMS) – that is, they were besotted with the belief that fixed exchange rates protected them from the ravages of global capital.
That was a popular ‘left’ narrative – it was fatally wrong but dominated leftist thinking.
Mitterand wanted everything: political popularity associated with the lower unemployment and improved living conditions, a straitjacket on perceived German pretensions to European power, and continued German subsidies to the Common Agricultural Policy (CAP).
On the one hand, domestic policy sovereignty was crucial if it was to lower unemployment and this predicated against participating in the EMS.
On the other hand, the desire to undermine German influence and to find a way to subsidise their farmers under the CAP forced them to engage in the European dialogue. They were caught betwixt!
By the third currency realignment in March 1983, the French were at the crossroads and the incompatibility of these competing ambitions was obvious.
At that point, the French socialists in power had a choice. They could retain its policy sovereignty and pursue its legitimate domestic objectives by floating the franc or remain within the EMS and subjugate its domestic policy freedom to the dictates of the Bundesbank.
Unfortunately, for the French and for Europe in general, they chose the neo-liberal path, however culturally alien this was to them.
The works of James O’Connor and the derivative studies were influential in this regard in conditioning the ‘left’ into believing that global capital compromised the ever decreasing fiscal capacity of the state.
Accordingly, the French government fell lock step into the increasingly dominant Monetarist policy approach that involved using rising unemployment as a policy tool to discipline the inflation process.
That political reality was too stark for the public to accept and necessitated a smokescreen being erected to disassociate the rising unemployment from macroeconomic policy choices.
The rising unemployment was reconstructed by the political and bureaucratic spin doctors as a ‘structural’ problem reflecting a failure of individuals to be self reliant and assiduous in job search and skill development.
A bevy of securely employed and highly paid economists pumped out a massive number of ‘research’ papers, which served to give authority and legitimacy to this ideologically tainted and empirically bereft view.
Most of this ‘authority’ lacked credibility, but then mainstream economics has never really been concerned with its theoretical inconsistencies or lack of empirical traction.
The shift in French policy in March 1983, the so-called ‘tournant de la rigueur’ (turn to austerity), took France back to the ‘fight inflation first’ policies of Giscard d’Estaing in the late 1970s and ended the few years of social advance in France.
The shift in language, from ‘d’austérité’ (as coined by Raymond Barre) to the softer ‘la rigeur’ was just window dressing.
The socialists were abandoning their principles to become part of the neo-liberal political convergence that captured social democratic parties in most advanced nations during this period.
The sudden shift in policy in March 1983 should also be seen in the context of the longstanding intellectual battle between the planners and the Finance Ministry economists as to the pros and cons of the free market and the growing obsession among economists in the Banque de France with the primacy of price stability in economic policy making.
In 1983, Jacques Delors, as the Economics, Finance, and Budget Minister (1983 to 1984), strengthened the neo-liberal program that Barre had begun. The reduction in domestic inflation that resulted from the ‘scorched earth’ approach was celebrated as the first serious sign towards a convergence reality, while the sharp rises in unemployment were brushed under the carpet and forgotten.
Various bureaucrats, supported by free market orientated academics worked overtime to convince everyone that the unemployment was not a result of a lack of jobs created by excessively restrictive fiscal and monetary policy, but rather a sign that people were not searching for work hard enough and were lulled into a welfare dependent lassitude.
The war on the victims of this folly in macroeconomic policy gathered pace through the 1980s and culminated in the 1994 release of the OECD Jobs Study, which became the bible for those intent on ignoring the fact that the unemployed cannot search for jobs that are not there.
The ‘non-fiscal crisis of the state’ had, in fact, become, an outright state-led attack on the unemployed justified by the belief that austerity was the only alternative available to governments.
The French socialists turned austerity into an art form.
And now the hard left in Greece is doing worse.
I think the literature that emerged from the Marxist scholars like James O’Connor in the early 1970s was not only substantially wrong it is presentation of macroeconomic theory (particularly in terms of its characterisation of the fiscal opportunities available to the fiat currency issuing governments) but was so influential among the practical ‘left’ – trade unions and other activists – that it provoked the downhill path of progressive opposition.
Neo-liberalism in its macroeconomic manifestation faced little opposition. Sure enough progressives attacked the retrenchment of welfare states, the privatisation schemes, the outsourcing and all the rest of it.
But when it came down to a hard argument against the claims that the ‘state had run out of money’, the ‘left’ had little to say.
The acceptance of key Syriza officials of continued austerity and continued membership of the Recession Cult (aka the Eurozone) really starts back in the early 1970s.
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