The Legacy of the Crash

by Terrence Casey

  Furthermore, although partisan allegiances and the preferences of actors may permit the adoption of particular policies they do not assure it. There are constraints. In his account of Labour’s later years in power, Andrew Rawnsley suggests that the Treasury was institutionally fearful of expansionary policies (Rawnsley, 2010, pp. 601–2). Its concerns appear to have been shared by the Bank of England. Indeed, in early 2009, the Bank’s Governor, Mervyn King, warned publicly against a further fiscal boost (Fidler et al., 2009). In other words, although ideas and policy-makers are important in shaping the process of policy change, ‘whether or not this happens still depends largely on whether key elites deem these ideas to be normatively acceptable and whether they can transport them through institutional channels into influential policy-making arenas’ (Campbell, 2001, p. 162).

  Budget deficits and debt

  Other accounts have pointed to the size, structure and character of the government budget deficit and long-term debt levels in the US and the UK and the discourses that framed perceptions of them. In some respects, the UK faced greater fiscal strains than the US as the projected UK budget deficits were higher as a proportion of GDP. This having been said, the UK’s longer-term national debt levels were comparatively modest. As Michael Devereux and Clemens Fuest conclude in an Oxford University Centre for Business Taxation briefing paper written in November 2008, UK government debt was, at 38 percent of GDP, relatively low by both historical and international standards. Japanese debt, they observed, represented more than 150 percent of its GDP (Devereux and Fuest, 2008, p. 2). Indeed, if budget deficits and debt levels are taken together, the UK and the US were in broadly similar positions. By the beginning of 2011, both were categorized by Bill Gross of the PIMCO Investment Outlook as ‘red zone’ countries within the ‘ring of fire’ in terms of budget deficit levels and public sector debt (as proportions of GDP). In such ‘red zone’ countries (in contrast with fiscally healthier nations such as Germany, Canada, Denmark and Australia), deficits and debt threatened to crowd out private investment and thereby constrain growth (Gross, 2011).

  Even if government budget deficits are considered alone, the UK and the US were not in fundamentally dissimilar positions. Both faced significant structural budget deficits, in other words a budget deficit that is present throughout the business cycle and can be distinguished from the cyclical deficit which arises during periods of downturn.5 These arose from tax cuts, rising expenditure levels, increasing ‘entitlements’ outlays brought about by aging populations, as well as the long-term impact of slow growth and a prolonged recession (Chote et al., 2009, p. 2).

  Underlying variables and institutional arrangements

  A larger part of the answer lies in a country’s underlying economic variables and institutional arrangements. Both shape opportunities and constraints. They set the capacities of governments, mold the strategies adopted by political or economic actors, determine the distribution of power between those actors, and establish frameworks within which actors understand and represent their interests (Pontusson, 1995, p. 119).

  Although perhaps neglected in some institutionalist accounts, underlying economic variables (or ‘economic-structural variables’) are of particular importance. As Jonas Pontusson notes, ‘underlying structures shape the configuration and operation of political and economic operations’ (Pontusson, 1995, p. 120). They include factor endowments, the distribution of income and wealth, the extent to which the economy is open (measured through the contribution of exports and imports to GDP), the occupational structure, the sectoral composition of industry, productivity rates, and despite some institutionalized features, the defining characteristics of many commodity and labor markets. Institutions are in contrast structured, rule-based and tied to mechanisms for the enforcement of such rules (ibid., p. 126). The following sections consider the ways in which such economic variables and institutional arrangements in both the US and the UK affected the use of discretionary fiscal policy.

  Underlying economic variables

  Underlying economic variables (or what might perhaps be termed the ‘national economic architecture’) shape the extent to which a national economy has ‘automatic stabilizers’ – non-discretionary and counter-cyclical tax revenues and forms of government provision that shift in size in response to the business cycle and thereby curb the excesses of the cycle. Although some accounts tie the economic impact of such stabilizers to overall state size, they are instead related to the size of public sector, the extent to which the tax regime has a counter-cyclical character, and the proportion of government spending that is devoted to social provision. Indeed, cross-country analyses published by the OECD suggest that because of the stabilizing role played by extended state provision in some countries there is an inverse correlation between the size and scale of social provision and the relative size of the discretionary fiscal packages that were adopted (OECD, 2009a, p. 117).

  Nonetheless, the extent to which the relative size of automatic stabilizers explains the policy differences between the US and UK is open to question. As Christopher Howard has noted, estimates of government social provision as a share of GDP often neglect the distribution of social benefits in the US through tax expenditures (Howard, 2003).6 Furthermore, insofar as overall changes in fiscal outcomes between 2007 and 2009 in the UK and the US provide evidence of stabilizers being brought into play, there were broadly similar drops in net fiscal balances. There was a 9.9 percent fall in the UK and an 8.4 percent drop in the US (Bénétrix and Lane, 2010, p. 31).

  It may be more fruitful, therefore, to consider the part played by other underlying economic variables. They include, as Pontusson notes, a country’s relative economic openness. Indeed, a national economy’s exposure to international trade has significant consequences for the policy-making process. Economic management will be constrained, or be of more limited efficacy, in a relatively open economy within which a large proportion of GDP is derived from internationally traded goods and services. In particular, the value of projected multipliers for expansionary forms of fiscal policy will be lower in more open economies. A lower value multiplier might therefore be expected to inhibit or deter the use of discretionary fiscal policy whereas, conversely, higher value multipliers might encourage and facilitate fiscal expansion. Because of its size as a market and advanced industrial capacity, the US has a relatively closed economy. Whereas UK exports generally constitute over a quarter of GDP (28 percent in 2009), US exports amounted to just over a tenth (11 percent in 2009) (World Bank, 2010). Furthermore, during periods of downturn or at the beginning of an upswing, policy-makers in more open economies may well attach greater credence to the prospects of an export-led recovery. In the UK, there were still memories of the significant part played by exports in leading the economy out of the recession of the early 1990s. The steady depreciation of the pound sterling during the autumn of 2008 added further credibility to the hopes of those who thought in these terms. Underlying economic variables (and the value of projected multipliers) also incorporate the relationship between consumption and saving (as well as debt repayment) and anticipated shifts in the character of that relationship during periods of downturn and recessions. In the long run, the relationship owes much to cultural and social variables as well as ‘real economy’ indicators. At first sight, the level of debt owed by households and firms in the US and the UK was broadly comparable. It has been estimated at about 200–230 percent of GDP (The Economist, 24 June 2010). In both countries, it was said, households and firms would seek to rebuild reserves, restrain their spending levels because the assets they were holding had lost value, or would be unable to secure credit.

  There were those, most notably John B. Taylor of Stanford University, who questioned the multipliers that some projected and have subsequently asserted that the stimulus policy pursued by the Obama administration had ‘very little impact and not much to show for it except a legacy of higher debt’ (Chan, 2010). Taylor and his co-authors suggested that th
e estimated multipliers and job projections underpinning ARRA were six times higher than those customarily used in new Keynesian modeling (Cogan et al., 2009, p. 22). Nonetheless, at least at the time ARRA was put forward, many of the Act’s components appeared to offer significant multiplier values. Christina Romer and Jared Bernstein (and others such as Mark Zandi of Moody’s Analytics who gave evidence before the House of Representatives Budget Committee) suggested that infrastructural spending would have a multiplier of 1.57 (Harding, 2010). Those elements within ARRA targeted at lower-income groups (such as an increase in food stamps) had higher projected multipliers.7

  The character of the industrial structure (which in turn shapes the nature of business interests) should also be considered. The new and high technology sectors are proportionately larger in the US and thereby have greater weight within the business bloc. In 2007, the high-tech sector accounted for almost 10 percent (just over $1.4 trillion) of US GDP (Ministry of Technology, Trade and Economic Development and the Ministry of Advanced Education and Labour Market Development (British Columbia), 2008, p. 13). This had political consequences. The growing structural weight of new and high technology changed the center of political gravity within the US business bloc. As the 2008 elections approached, there were hopes that an Obama administration and a Democratic Congress would offer a boost to the new technology sector through public investment in broadband expansion, renewable energy, and the extended application of information technology in, for example, health care. Writing in New Left Review, Mike Davis has described a process of realignment whereby the new technology sector aligned itself with Obama’s bid to secure the presidency:

  The near constant presence of Google CEO Eric Schmidt at Obama’s side (and inside his transition team) has been a carefully chosen symbol of the knot that has been tied between Silicon Valley and the presidency. The dowry included the overwhelming majority of presidential campaign contributions from executives and employees of Cisco, Apple, Oracle, Hewlett-Packard, Yahoo and eBay … The unprecedented unity of tech firms behind Obama both helped to define and was defined by his campaign (Davis, 2009, pp. 36–7).

  Just as the new technology sector contributed to a partial reshaping of US politics, the character of the industrial structure has configured political processes in the UK. Indeed, the weight of financial capital has a long history. As Sidney Pollard argued, the pound sterling’s return to the gold standard at pre-war parity in April 1925 reflected the relative strength of finance (or at least ‘the section concerned with international finance, both long-term and short-term’) and the corresponding weakness and subordination – as a class fraction – of industrial capital (Pollard, 1970, p. 13). Ed Miliband, who was elected as the Labour Party’s leader after the 2010 election defeat, is among those who have noted that the financial sector still has disproportionate weight. One estimate suggests that financial services account for about 10 percent of UK GDP while, despite the visibility of Wall Street, the corresponding figure for the US is 7.5 percent (TheCityUK, 2011, p. 1). Against such a background, the calls of the ‘bond vigilantes’ for fiscal rectitude had resonance.

  The structural differences between the US and the UK go some way towards explaining the contrasting attitudes towards fiscal expansion. In the US, the larger peak business groups backed both the Bush and the Obama stimulus. The US Chamber of Commerce said that the 2008 stimulus would ‘spur business investment, consumer spending, increase productivity and put the U.S. economy back on track for long-term growth’ (US Chamber of Commerce, 2008). A year later, Labor Secretary Hilda Solis publicly thanked the National Association of Manufacturers and said that its backing for ARRA ‘was key to its passage on Capitol Hill’ (quoted in The Hill’s Blog Briefing Room, 2009).

  In the UK, the peak business organizations were far less sanguine about calls for fiscal expansion. Towards the end of November 2008, just ahead of the Pre-Budget Report, the Confederation of British Industry (CBI) issued a press release calling for ‘a fiscal boost’ but then reined it in. The specific forms of fiscal boost that the CBI proposed were largely confined to modest business tax cuts, incentives to small and medium-sized enterprises to recruit apprentices, and a ‘time-limited fiscal stimulus focused on employment through a temporary reduction in employer National Insurance Contributions’ (Confederation of British Industry, 2008). Alongside this, the CBI also stressed the importance of the deficit and national debt:

  But given the poor state of public finances, any fiscal stimulus package will need to go hand-in-hand with a credible framework for getting back on track. This would prevent future generations being burdened with huge levels of debt (ibid.).

  Underlying variables also incorporate a government’s borrowing capacity. Although, as noted above, there were similarities between the US and the UK in terms of overall deficit and debt levels, they had different capacities. Having said this, fears were widely expressed in both countries. Much was said about the sovereign debt crises in some Mediterranean countries. In the UK, the issue became a rallying point for the Conservatives’ efforts to win back the reins of power.

  In the US, in the wake of the ARRA’s passage, questions were asked about the bond sales necessary to fund the stimulus and the term ‘bond vigilantes’ began to be heard. The term was used to describe ‘investors who pull the plug on governments they perceive as unable or unwilling to pay their debts’ (Krugman, 2010). There were claims that should this happen, the US’s credit ratings would be downgraded, upward pressure would be placed on interest rates, and there would be a process of ‘crowding out’ that would constrict growth in the private sector. Writing in the UK’s Daily Telegraph at the beginning of 2010, Ambrose Evans-Pritchard cited reports suggesting that the US deficit and debt had reached a point where the US’s AAA rating would be in serious jeopardy unless far-reaching budget-cutting measures were adopted within three to five years (Evans-Pritchard, 2010). Willem Buiter, a former member of the Bank of England’s Monetary Policy Committee, suggested that there were, in the longer term, likely to be acute pressures leading to a loss of confidence and a flight from the dollar, causing ‘the dollar in a couple of years to look more like an emerging market currency than like the US dollar of old’ (Buiter, 2009).

  Nonetheless, although the UK had in some respects greater latitude than individual euro-zone countries insofar as the pound could float downwards (and most of the UK’s public debt was denominated in sterling and with a long maturity), the US had important structural advantages arising from its global position. As Alan Cafruny and Magnus Ryner have noted, whereas France found in the early 1980s that reflationary efforts could in a regime structured around floating exchange rates, trigger a speculative run on the national currency, the importance of the dollar as the world’s leading reserve currency, the denomination of securities and other assets in dollars, as well as ‘deep capitalization’ in the US itself gave the US immense structural power. It could shape the preferences of both debtors and creditors (Cafruny and Ryner, 2007, p. 25).8 As John Grahl concludes, ‘From the point of view of macroeconomic policy, this kind of scale does not so much limit as practically eliminate external financial constraints on the United States’ (John Grahl, quoted in ibid., p. 28).

  Institutional arrangements and the political process

  Underlying economic variables, particularly a national economy’s relative openness, the value of projected multipliers, the sectoral composition of a country’s output, and borrowing capacities, opened the way for fiscal policy variations. Nonetheless, while such variables created ‘fiscal space’ allowing expansionary forms of budgetary policy in the US, they were largely permissive in character and do not explain the outcomes in themselves. Other variables should therefore be considered; in particular, the institutional arrangements that govern political processes. Just as underlying economic variables mold institutional arrangements, such arrangements shape, facilitate but at the same time constrain the initiatives undertaken by political actors.

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nbsp; The federal character of the American state is particularly significant. Because the states spend and collect a relatively high proportion of total government expenditure and revenue, their actions have far-reaching fiscal and economic consequences. The 50 states are bound by their own laws, constitutions and budgetary procedures. Nearly all have balanced budget clauses in their constitutions or are constrained by statute.9 As a consequence, ceteris paribus, state budgets have a pro-cyclical character. In a severe downturn such as that in 2008–09, the pro-cyclical pressures are severe. As the Center on Budget and Policy Priorities reported in July 2010:

  States already have faced and addressed extraordinarily large shortfalls as they developed and implemented spending plans…Every state save Vermont has some sort of balanced-budget law. So the shortfalls for 2009 and 2010 and most of the shortfalls for 2011 have already been closed through a combination of spending cuts, withdrawals from reserves, revenue increases, and use of federal stimulus dollars (McNichol et al., 2010).

  Left unaddressed, state efforts to balance their budgets would have imposed a significant deflationary pull. This was in large part because expenditure by the individual states represented almost half of overall government spending in the US (44.9 percent in 2006). Local government expenditure in the UK was in relative terms, far more limited. Indeed, it spent only 28.4 percent of overall government spending in the UK (OECD, 2009a). Fear of a deflationary pull and the lobbying capacities of the states added to pressures for the ‘bailout’ which rescued many forms of state provision and constituted a significant part of ARRA. Fear of a deflationary pull and the lobbying capacities of the states added to pressures for the ‘bailout’ which rescued many forms of state provision and constituted a significant part of ARRA.