Greece, 2010: Tens of thousands of striking Greek workers took to the streets, some throwing stones at police, in a defiant show of protest against austerity measures aimed at averting the debt-plagued country’s economic collapse. (Photo: underclassrising.net)

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Economist, professor at Brown University and author of Austerity: The History of a Dangerous Idea, Mark Blyth talks with Truthout about the historical origins of austerity as an economic idea, how previous attempts to enforce austerity policies were catastrophic, and the worldwide economic crisis today.

Michael Nevradakis: To get us started, share with us a few words about the history of the idea of economic austerity and the theories that this idea is based upon.

Mark Blyth: You have to go back quite a way to get to the roots of this. You almost have to go back to the origins of capitalism itself. Go back to the time of John Locke and the English Revolution back in the 17th century; what you have is a bunch of people who have decided that the divine right of kings isn’t good enough anymore, and they want to redistribute property amongst themselves.

So liberalism has always had a love-hate relationship with the state. It doesn’t trust it, but at the same time, it needs it, and, most importantly, it has to pay for it, which is a question of taxes.

In order to do that, the paradox is that you kind of have to take over the state. So you fight the civil war in order to run the state in order to make markets – and the dirty little secret of liberalism is that markets don’t spring forth from the ground. They are often times made in conjunction with, or made possible by, the state.

But then there’s a problem, because a state that’s strong enough to defend you against the people who will take the property that you get when markets generate that surplus, because it tends to generate rather unequal distributions, that state’s also strong enough – as the Americans fear and why they have the Second Amendment – to come after you and take your property from you. So liberalism has always had a love-hate relationship with the state. It doesn’t trust it, but at the same time, it needs it, and, most importantly, it has to pay for it, which is a question of taxes.

So it’s out of an ambivalence towards the state and the need to fund it that the idea for austerity comes out, in the following sense: Whenever the economy gets into trouble, if something has to be cut – rather than the excesses that caused the bubble, for example in property, that’s to blame – it’s the state spending that led to it, so we cut back on spending every time.

There’s this perception being pushed by the supporters of austerity policies that we were all living beyond our means, particularly those of us in Southern Europe, that spending is wasteful, that we must “tighten our belts.” But you take a different view, and you place the blame for the economic crisis on the banks, primarily. Why is this the case?

Well, it’s not bank-bashing for the sake of it; banks are relatively useful things. It’s just that when they become leverage machines – that is to say, for every dollar they have in reserves, they have $30 or $40 or $50 out there in loans, and they fund themselves overnight to lend 30 euros – they become very, very leveraged and very vulnerable.

So when the funding dries up, suddenly you’re billions of dollars on the hook for loans that you have no way of keeping hold of, and you turn around to the state and say, “We need bailouts, because if we go down, everybody goes with us.” That’s an extortion racket. That’s what we think happened in America, but it actually happened in Europe as well; it just took a more slow-motion form from 2009 through 2012.

To talk about Greece for a moment, much has been made of the fact that the Greek government, in 2010, revealed that its deficit was bigger than had previously been advertised, and that certainly rattled the markets. But what really bothered the markets was the decision by the European Central Bank back in May 2009 to say publicly that they were not going to stand by all European sovereign debt. That said, there’s no backstop for the bank run, if there’s a bank run, through the bond market; and that means that the markets started to price Greek debts and other debts differentially from German debt, and that’s where the problem started.

Now the problem – and we see it in the Eurozone now – is when everyone tries to cut at once, all that happens is that growth disappears, and the amount of debt actually increases rather than decreases.

If we go back to Greece again and the notion of an “orgy of pubic spending,” if you look at Greek public spending through the 2000s, it’s really on track and quite average in comparison to everyone else’s. Over a five-year period between 2001 and 2006, it’s pretty much flat. As for the orgy of public spending leading to all of those public sector jobs, which were useless, I believe that the figure was 14,000 jobs over a two-year period, which is no different from the United Kingdom when you scale it up. So there’s a lot of nonsense being talked here as political cover for the fact that what we’ve done is bail out some of the richest people in European society and put the cost on some of the poorest.

Economic austerity is not a new concept, and over the past century, we’ve seen it implemented in numerous instances around the world. Could you share with us a brief history of these economic austerity policies as they have been implemented in the past 100 years and what the outcome typically was?

Certainly. I’ll go back to where we began, with the notion that you have this love-hate relationship with the state. Well the problem starts to come in the 19th century, when the state gets bigger and the state gets bigger because you have the reformist liberals, particularly in the United Kingdom, but also elsewhere, and you have a conservative version of this in Germany with Bismarck and others.

They say that the state needs to kind of soak up the excesses of the market in order to protect the market from revolution, and that’s why we have welfare states and other such devices.

Now the problem with these things is they’re very expensive, and periodically, markets fall into crises, and then those who have wealth and income at that point in time have a choice: They can either smooth the transition by spending, that is to say, when income is collapsing, you generate more income, which tends to mean taxing the top. Or, alternatively, you cut it for those at the bottom, to reduce government spending. It’s two ways of attacking a deficit and debt problem.

Now the problem – and we see it in the Eurozone now – is when everyone tries to cut at once, all that happens is that growth disappears, and the amount of debt actually increases rather than decreases. And we’ve seen this historically almost everywhere.

My favorite example of this was in the 1920s in Japan. Coming out of World War I on the victor’s side, the Japanese thought that the golden age was ahead of them. They were the new industrialized economy; they were export-driven; they copied their main institutions from Germany, just as the Eurozone is meant to do today. And then, the world went into a gigantic slump. Rather than try and compensate for this, the Japanese government went on an austerity binge that took 30 percent of GDP out of the economy in three years.

It was called the Showa Depression; it was deeper than the Great Depression, and the idea was by reducing costs so much – it’s the same story in Southern Europe today – you will become more competitive. But the problem was the world economy began this long slide into the Great Depression, and you couldn’t be competitive enough.

And the more you were cutting, the more you were reducing domestic demand, and eventually there was nothing left to cut except the military budget. And eventually, the Japanese military, after years and years of cuts, had enough, so they assassinated the political class, took over the country, and went on an imperial expansion binge in China and the rest of Southeast Asia.

So austerity is not just a bad economic policy, but [is present] in some of the crucial turning points of some of the ugliest moments of European and world history.

With such a history, why do you believe the European Union and the International Monetary Fund chose this route for Europe when the crisis over there began a few years ago?

Because no one wants to stand up in a democracy and say we need to bail out the richest people in society from their own errors, and if we don’t do it, we’ll all be worse off, because essentially they have us. And that’s really what’s going on. We talk a lot about the 1%. Let’s broaden that a little bit: It’s true the 1% globally, as a new Oxfam report showed, own basically 40 percent of everything. Now across the OECD, including countries like Greece, if you talk about the top 30 percent, you’re talking about 90 percent of wealth and income. And, when the banks lever up, and when they give us loans, and when we can buy new cars and all this, we love it, and we love the mortgages and all this other stuff.

Because that’s what a central bank is for. You’re meant to bail, fail and then send the culprits to jail.

And you have to remember that our assets are the bank’s liabilities, and our liabilities are the bank’s assets, so we’re all in this together. So the top 30 percent see the banks failing, and we’re quite happy then when the government steps in and bails out these banks, because they’re bailing out your mortgage and your pension, and they’re bailing out your assets and your investments, along with the 1%. They may have billions, but you still care about yours. So you’re quite happy when it gets bailed, but the cost of that is a massive increase in government debt. Well, who are the people who ultimately pay for that when you cut spending? Those who receive government services or salaries. So they are the ones who get their salaries cut by 30 percent; meanwhile, you’ve had your pension “bailed.” I like to call this a “class-specific put option” because that describes exactly what it is.

In your opinion, what should have been done differently back in 2009 or 2010 in Europe?

Do what the Americans did, which is admit that you have a banking crisis. The Europeans still have a slow-motion banking crisis. The Spanish banking system is not just illiquid; it’s insolvent.

If it hadn’t been for the so-called long-term refinance of operations, which was $2 trillion of liquidity pumped into the European banking system, it would as a whole be insolvent. There’s a report that came out at the end of last year that estimated that of the assets in the European banking system, 50 percent of them would be basically underwater or worthless if it wasn’t for public money supporting the entire system.

So you’ve got a banking problem; you address the banking problem. You don’t address a government problem. You don’t turn around and say the problem is the Greeks don’t work enough, when in fact they work 600 hours a year more on average than the Germans. And you don’t create a politics of division between north and south.

So how do you solve a banking problem? First of all, you force the banks to take their losses. And that means that you have to confront some of the most powerful people in society and tell them that they need to actually bear the costs of the risks that they’ve taken.

Now how do you do that without taking down the whole system? You do it by developing the capacities of the European Central Bank. They say that they cannot bail out banks; they say that they won’t bail out sovereigns. Well unfortunately they missed the memo, because that’s what a central bank is for. You’re meant to bail, fail and then send the culprits to jail.

So far all we’ve done is bail, and everyone’s gotten away with it that matters. However, in the American case, what they were able to do by identifying it as a banking crisis was to take the assets off the books of the banks and allow them to de-lever. That is, the footprint of the assets becomes smaller. This eases their funding constraints and allows them to recapitalize.

So the American banking system is back to where it was in terms of size, which is 60 percent of GDP, but is much healthier and is lending again, which is why America is growing.

The European banking system is twice as leveraged and three times the size of the American system. There are countries in Europe whose assets to their banks to GDP are 450 percent: I speak of no less than the United Kingdom. One bank in Germany, Deutsche Bank, is 86 percent of German GDP and runs an operating leverage of over 40 to 1! These are behemoths; they dwarf the sovereigns that are putatively responsible for them. And now that they’re in the Euro and don’t have their own printing press, they can’t bail their own banks, so it falls back to the ECB, and the ECB said, “Ee don’t do this,” and that’s where the whole crisis started.

Once Mario Draghi came in, the ECB said they’ll do whatever it takes . . . It’s called being a central bank. Because of that, and not because of cuts, and not because of austerity, because of that promise and the liquidity that was granted in the LTROs (Long-Term Refinancing Operations), the yields are down, Europe has breathing space. But, it is addicted to cutting for the sake of cutting, and that’s why it can’t grow, and that’s why it’s not going to grow.

And that leads right to my next question: We keep hearing about there being a Eurozone recovery, we hear many politicians in the European Union that are talking about how things are improving, and they are crediting, of course, the austerity policies with this supposed success. What is your response to that?

If I was hit by a car, and I managed to stand up and walk away, I wouldn’t thank the road for being there, and that’s essentially what they’re doing. They’re confusing cause and effect. What’s actually happened is a banking crisis. What has resolved the banking crisis is action by the central bank; nothing more, nothing less.

The countries that cut, Greece amongst them, have lost nearly 30 percent of GDP. Ireland is celebrating its return to the bond market. Its unemployment rate is still 12 percent, and there’s practically no one in the country under the age of 25; they’ve all moved. Quite how they’re going to pay back the debt they’ve accumulated when cuts alone are generating more debt is a mystery to everyone.

Now why are they saying this? Because they’re politically invested in it, because some of them believe it; sometimes it’s ideological; sometimes it’s naked self-interest. It’s not as simple as “they’re all in the pockets of the banks;” it’s simpler; it’s a slightly different story which goes like this:

We recognize that collectively, the European banking system is multiples the size of GDP of the national economies. We recognize that European governance institutions are completely inadequate for dealing with this task. We recognize that Germany alone is too small to bail this problem, even if it wanted to. If it tried, it would fail. So we’re kind of stuck. So what do we do?

We squeeze; we add liquidity, and we tell everybody one more time . . . because we don’t have any other policies. The alternative would be to admit that they have a banking crisis. The alternative would be to develop some kind of common fiscal policies. But given that’s in the hands of the Germans, who basically want to turn everyone into a mirror-image of themselves, for everyone to run an export surplus all at once, which is mathematically, let alone practically impossible, that’s not going to happen anytime soon.

The Greek translation of Mark Blyth’s book, Austerity: The History of a Dangerous Idea, will soon circulate in Greece, published by Pandora’s Books under license from the Oxford University Press.