Arguing the case for an easing of austerity

Writing in today's Irish Times, Patrick Honohan, the governor of the Central Bank, defends austerity with a reference to the 1945 experiences of the great British economist, John Maynard Keynes. The parallels he draws are, indeed, fascinating: because Keynes didn't get what he wanted, we should, apparently, continue on the path set for us by the Troika. I'm not sure about this.

Then, as now, a bankrupt country (the UK) was trying to negotiate a loan (another one) from a rich state (the US).

Keynes thought he could get favourable terms from his American friends because it was both ethical and logical.

The British thought that their earlier sacrifice of blood and treasure deserved some kind of recognition; if they had crumbled before the US had entered the war, the world would have looked very different in 1945.

They also thought it obvious that to impose penal terms on a totally bankrupt country was illogical. It made more sense, argued Keynes, to foster some semblance of economic growth rather than to impose further austerity. Yes, the parallels are obvious.

Keynes lost the argument. Not because he was naive (as Patrick Honohan suggests) but because the Americans had an agenda that was served by the further relative impoverishment of Britain. They also made mistakes, something that was recognised in 1947 when they changed course and showered Europe with dollars in the shape of the Marshall Plan, something that Keynes had predicted.

Harry Truman in 1945 abruptly cancelled the favourable "Lend Lease" financing of the UK: this, as much as anything, was the biggest contributor to Britain's post-war problems. Writing in his memoirs, Truman later said of that decision that he wished that he had read everything that he signed.

Earlier, in 1944, Keynes had lost his first battle with the US treasury: their plan, which he opposed, for the creation of the IMF and the World Bank had been negotiated by Harry White who was later exposed as a Russian spy.

Keynes knew very well that the US was interested only in shaping the world to serve its own interests. His appeals to both history and logic fell on deaf ears; trying to explain to anyone that they are idiots rarely ends well.

As Paul Krugman has found today, being right counts for nothing: nobody likes someone who is very clever and mocks the idiocies of conventional wisdom.

Arrogant, certainly, but not naive. Keynes wrote that “they mean us no harm but their minds are so small, their prospects so restricted, their knowledge so inadequate, their obstinacy so boundless and their legal pedantries so infuriating”. This could easily be said today of the Troika.

The lesson from Keynes is that you don’t have much of a chance in one-sided negotiations. When you are broke and credit is available from one source only, you have to accept the terms you are offered. Like the the US and Britain in 1945, the Troika and the debtor countries of the the EU today have different agendas.

Austerity is preached because this is the only time entities like the ECB believe governments can be made to bend to their will. Once economic growth resumes and budget deficits start to shrink, the Troika’s power will also shrivel.

And, of course, left to their own devices, democratically elected governments cannot be trusted.

So, this crisis cannot be allowed to go to waste. When the Troika is the only game in town it doesn’t really matter if their minds are small or their knowledge inadequate: we have to do their bidding. Once we have more than one potential creditor, we have choices.

The Troika’s agenda is not necessarily the same as the bond markets’. I have written before about adopting ADOG (austerity dependent on growth). If – and I admit it is a big if – we could credibly commit to restoring sustainability to the public finances only when growth has actually occurred, the bond markets should give us a break (unlike the Troika).

It’s a big if because more austerity really is needed. The issue is when.

Keynes had argued in 1919 that the austerity imposed on defeated Germany would lead to total disaster. He was far less apocalyptic in 1945 but equally correct. My guess is that he would see further problems and policy reversals ahead.

Being right doesn’t necessarily mean you win the argument with a bone headed adversary. Just because Keynes didn’t achieve less austerity back then is no reason not to debate the issue going forward.