Taking the Blinders Off, Part 2

Susan Schroeder is a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). This is the second part of a three-part article, originally published in the July/August 2016 issue of Dollars & Sense magazine.

Susan Schroeder

Instability in Capitalist Economies

A market economy is not completely unpredictable—it does have gravitational tendencies, such as a tendency towards a falling rate of profit. Those tendencies are created by the day-to-day activities of firms and consumers, and are further shaped by the contexts in which they are embedded, such as institutional configurations and social norms.

What is the source, then, of instability in capitalist economies? It emanates from firms’ quest for profit. Capitalism runs on profit. To enhance their profits, firms adopt production techniques that lower their per-unit production costs. As this occurs, each firm’s structure of production changes relative to industry norms. Firms that use lower proportions of labor relative to other inputs are deemed to be more efficient and will earn a better rate of return on their capital than firms that do not adapt.  Firms also switch from one industry to another, or enter new industries, in a quest for higher returns. Firms must change in these ways in order to survive, and thrive, in a competitive market economy.

Changes to productive conditions within an industry and capital flows between industries, however, are major sources of instability. The mechanization of the production process, for example, increases the presence of capital relative to labor. This process is also facilitated by mergers and acquisitions. As each firm changes its production process, the average conditions of production for each industry change. Capital flows between industries will also affect the industry averages as weaker firms exit.  Firms can never be exactly sure how they compare against the industry average at any point in time. The best they can do is try to lower the unit cost of output faster than their competitors. Moreover, economists have demonstrated that these activities create a third source of instability—a tendency towards a falling profit rate for the entire economy.

Debt exacerbates this instability. Firms use debt, supplementing their own retained profits, to finance investment that improves their structures of production. However, improvement comes at the expense of the increasing weight of debt service. As firms become increasingly fragile, collectively, the economy becomes less resilient, and more vulnerable to a debt-deflation process.

Read the rest of this entry »

Taking the Blinders Off, Part 1

Susan Schroeder is a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). This is the first part of a three-part article, originally published in the July/August 2016 issue of Dollars & Sense magazine.

How private credit rating agencies reinforce global economic instability—and what we can do about it.

Susan Schroeder

The role that credit rating agencies played in the global financial crisis is no secret. One memorable scene in The Big Short depicted an employee of Standard & Poor’s (S&P)—one of the “big three” rating agencies, with Moody’s and Fitch—as being blinded by conflict of interest in her evaluation of mortgage-backed securities. In a visual gag, she is depicted as having just come from the eye doctor, wearing literal blinders as she is quizzed by the film’s protagonists about how S&P could give the highest ratings—AAA—for securities based on bundled subprime mortgages. “If we don’t give the ratings, they’ll go to Moody’s, right down the block.”

In the wake of the financial crisis, rating agencies have faced growing public concerns about their ability to evaluate credit risk. Investors who lost large sums on investments involving structured financial products, such as mortgage-backed securities (MBSs), have sued the rating agencies. The agencies had assessed MBSs as having very low levels of risk prior to the crisis. But this is not the first instance when the products of the ratings industry have come under suspicion. In the Penn Central crisis of the 1970s, the financial instrument involved was commercial paper. In the Latin American debt crisis of the 1980s, it was sovereign debt. In the early 2000s, at Enron and Parmalat, it was corporate bonds. In the most recent financial crisis, it was collateralized debt obligations and, in some countries, sovereign debt as well.

The role of credit in an economy is a double-edged sword. During a business-cycle upswing, credit facilitates investment and economic growth. As a cycle matures, credit becomes a burden and debt servicing becomes more problematic. If firms are forced to sell assets en masse to obtain the means to service debts, the economy is exposed to “debt deflation”—a fall in the level of prices, contraction in the profits and net worth of firms, and a reduction in output and employment. Changes in credit ratings over the course of a cycle have a tendency to exacerbate both the upswings and downswings.

How should credit risk be evaluated in the context of an ever-changing macroeconomic environment? One way is to assume a market economy is inherently stable and self-regulating. Credit risk is evaluated in the context of recent experience, with that context occasionally revisited for possible revision.  Another way is to assume the economy is inherently unstable and not self-correcting. This is something that economists John Maynard Keynes and Hyman Minsky understood well, but that mainstream economists now treat as heretical. Although assuming instability seems more plausible, assuming stability makes it easier to use quantitative techniques and computing power. When rating agencies are processing information on thousands of credit issuers, speed matters. But it comes at the cost of accuracy and ability to foresee crises.

A public credit rating agency could support the development of better credit risk-assessment by using Minsky’s “Financial Instability Hypothesis” to create more sensitive methods of detecting changes in the overall economy, particularly instability generated by risk-taking behavior of individual firms and investors. By more accurately evaluating changes in the macroeconomic context, such an agency could do a better job of assessing firms’ levels of risk, and thereby reduce the danger they pose to the broader economy.

Why Can’t Private Credit Rating Agencies Solve the Problem?

Credit ratings are a form of credit risk-assessment—an opinion about the ability of a borrower to service its debt. These opinions, however, have the ability to destabilize financial markets and economies like no other. The three largest credit-rating agencies—Moody’s, Standard & Poor’s, and Fitch—dominate the global market for this service. Taken together, their global market share, in terms of the value of all rated securities, is more than 95%. They issue opinions on the liabilities of governments, non-financial corporations, financial firms like insurance companies and banks, and even universities. They are separate from credit reference or consumer reporting agencies, sometimes referred to as “credit bureaus,” which issue assessments about individual consumers.

Credit ratings are supposed to address the imbalance (or, in economic lingo, “asymmetry”) of information that exists between borrowers and lenders. Borrowers are thought to hold the most complete information about changes in their ability to service debt, whereas lenders only become aware of this after a time lag. Ratings may shorten the lag, even if they do not eliminate it. Credit risk-assessments are conducted in a way that borrowers and financial instruments can be compared and ranked according to their relative riskiness.  This way, the ratings refine the process by which different firms’ cost of raising capital is established and improve market efficiency and liquidity. At least that’s how it’s supposed to work.

Flaws in the rating methods arise from conflicts of interest, lack of transparency, and changes that coincide with and amplify the business cycle (“pro-cyclicality”). For instance, the agencies’ very business model, in which issuers pay the agencies for assessments of creditworthiness (known as the “issuer-pays” model) generates conflicts of interest. Such conflicts are thought to have contributed to the overly rosy ratings of structured products prior to the financial crisis (e.g., the highest, or “AAA,” ratings for residential mortgage-backed securities), as the agent from S&P in The Big Short made clear. The lack of information about the agencies’ methods and processes made it hard for investors to scrutinize their decisions. The pro-cyclicality of rating changes is striking, as credit risk-assessments are intended to be “through-the-cycle” or impervious to cyclical behavior of the economy. Why is this?

A key flaw with many credit-assessment methods is that the assumptions they make to process data from thousands of borrowers—to make their own quantitative techniques work—are the same assumptions that envision a market economy as inherently stable. For instance, assessment methods often employ traditional statistics that rely on the notion of stable relationships between possible outcomes and their probability of occurrence. That is, the purchase of a security is seen as similar to placing a bet at a roulette table. All the different possible outcomes, and their relative probabilities, are fixed. In real life, the probability distributions describing the riskiness of different securities are not necessarily stable if the broader market economy is inherently unstable. And, given the recent global financial crisis, not many people would be easily convinced that market economies are inherently stable.

Triple Crisis welcomes your comments. Please share your thoughts below.

Triple Crisis is published by

Looking for Food in All the Wrong Places

Timothy A. Wise

I spent another week in Mozambique looking for ProSAVANA, the much-touted, much-reviled Japanese-Brazilian-Mozambican agriculture project that has spectacularly failed to turn Mozambique’s savannah-lands in the Nacala Corridor into a giant soybean plantation modeled on Brazil’s Cerrado region. I was there doing follow-up research for a book.

I hadn’t found much evidence of ProSAVANA two years ago (see my previous articles here and here) and I didn’t find much now. Government officials wouldn’t talk about it. Japanese development cooperation representatives spoke only of pathetically small extension services to a few small-scale farmers. Private investors were scarce. Civil society groups debated whether it is worth cooperating in the wholesale redesign of the program.

I wondered why anyone would bother. Like many of the grand schemes hatched in the wake of the 2007-2008 food price spikes, this one was a bust, by any measure. Still, ProSAVANA remains the Mozambican government’s agricultural development strategy for the region. While farmers defend their hard-won land rights, it seems they will have to look elsewhere for agricultural development.

Read the rest of this entry »

The UK Vote to Leave European Union

Economically Negative, Politically Devastating

Philip Arestis and Malcolm Sawyer

On June 23, 2016, the UK voted by 52 per cent to 48 per cent, on a relatively high turnout of 72 per cent, to leave the European Union (EU). The UK and its EU partners will now have to enter into negotiations, which are likely to take at least two years in view of Article 50 of the Lisbon Treaty, the so-called ‘formal exit clause.” The economic impacts of UK exit from the EU will depend to a considerable extent on the outcome of those negotiations.

The coalition for “remain” ran in political terms from moderate Conservatives, through Liberal Democrats, Labour Party, and Greens. The supporters of “remain” generally covered large corporations and trade unions, universities and scientists, those in the arts and the media, and Premier League soccer teams. The “leave” campaign had more support from small businesses (though by no means universal), nationalists, and free marketers. And crucially received large electoral support from working class voters, particularly those located in the old industrial areas.

In “narrow” economic terms, the effects of Brexit are likely to be negative but not to a catastrophic extent. These come from trade effects—the UK would leave the “single market,” trade relations between UK and the EU would be somewhat more difficult, with some tariffs in place instead of tariff-free. The estimates from a wide range of official organisations (HM Treasury, IMF, OECD for example) and research organisations (National Institute for Economic and Social Research, Institute for Fiscal Studies, London School of Economics, for example) had put output and employment losses from Brexit which over time could amount to the order of 4 to 5 per cent of GDP. There would also be negative effects that would emerge from the City of London weakening in view of a number of the financial sector companies emigrating elsewhere in the EU; and volatile financial markets in more general terms.

Read the rest of this entry »

Economics without Scarcity

Sara Hsu

Economists have often been characterized as a dry, calculating bunch, focusing on the allocation of scarce resources with carefully drawn supply and demand curves.  The reason for this is that economics has, in Neoclassical theory and particularly within the writings of Lionel Robbins, emphasized choices and competition under conditions of scarcity.  Mainstream economic theory, rooted in Neoclassical thought, has continued in this vein, with a focus on market efficiency as the rule.  So, why do I have a problem with it?

Mainstream theory embodies decades of debate and rigorous application, but its focus on choice under scarcity has centered the study of economics on products, not people.  The assumption that people are there to either consume or produce products moves away from any requirements for basic human well-being, as emphasized by Amartya Sen in his own criticism of Neoclassical economics, supposes that consumers and producers always want to buy or sell more goods, and fails to focus on aspects of nature (such as forests or coral reefs) as more than resources, such as entities with a right to exist without subjugation to the human race.

These assumptions are flawed and not universally held.

Read the rest of this entry »

An Historical Perspective on Brexit

Capitalist Internationalism, Reactionary Nationalism, and Socialist Internationalism

Alejandro Reuss

The June referendum vote in the United Kingdom, narrowly in favor of departure from the European Union (or “Brexit,” a portmanteau of “Britain” and “exit”), has thrown the future of the U.K. and its constituent nations into turmoil. The votes in England and Wales favored Brexit by modest margins. In contrast, the votes in Scotland and Northern Ireland favored remaining in the EU; in Scotland, overwhelmingly so. Already, the leaders of the Scottish government have described as “very likely” a new referendum on independence from the U.K. (which, if victorious, would likely result in the country seeking to remain in the EU). It remains to be seen, meanwhile, whether Brexit is just the first in a domino tumble of exits from the union.

There has been a great deal of analysis, in the days since the vote, on the motives animating pro-Brexit voters. Many commentators have looked to underlying economic discontents, from the economic crisis of the 1970s and the death spiral of British industry and mining, to the age of neoliberal economic policy since the advent of Thatcher, to the global Great Recession and searing austerity under the current government. It is unmistakable, though, that the politics of Brexit, and the campaign led by the right-wing UK Independence Party (UKIP), are heavily laden with anti-immigrant sentiment. (In polls, over half of “leave” voters identified immigration into Britain as a “very important” issue, compared to just 14% of “remain” voters.) Right-wing, anti-immigrant leaders elsewhere in Europe, like Geert Wilders in the Netherlands and Marine Le Pen in France, have hailed Brexit as an example and called for referendums, in the near future, on their own countries’ EU membership. Commentators are reading the rise of nationalism in Europe as a frightening echo of the events—leading up to the world wars—that shattered the last great age of capitalist globalization.

Just over a century ago, leaders and theorists of European Marxian socialism engaged in a pitched debate about the international integration of capital and the possibility that this would attenuate the conflicts between rival imperialist powers. The German Marxist theorist Karl Kautsky was a leading exponent of this theory of “ultra-imperialism.” The Russian Marxists and Bolshevik leaders Lenin and Bukharin argued, against Kautsky, that the contradictions between rival imperialisms were too great to be reconciled anytime soon, whatever the far-off future might hold. They had a point, since the debate was taking place as the First World War raged. Ultimately, of course, the 20th century would see two World Wars erupt in the heart of Europe.

Kautsky saw ultra-imperialism as a possible result of capitalism’s tendency toward international economic integration, along with the ruling classes’ conscious desire to avoid future ruinous conflicts. He did not, however, openly advocate this as a system—in fact, he wrote “of course we must struggle against [ultra-imperialism] as energetically as we do against imperialism.” The politics of post-World War II social democracy were a different story. Leading figures in Western Europe’s mainstream social democratic parties embraced European political and economic integration as a way to avert a replay of the disasters of the first half of the 20th century. (Some were, surely, also motivated by the aim of strengthening Western Europe vis-a-vis the United States. And some had dreams for a united Europe that were genuinely social democratic—though not anti-capitalist.) In the most recent period, the “Third Way” figures who came to dominate the mainstream social democratic parties (like “New Labour” in the U.K.) signed on to the neoliberal project and to the selling of it as a triumph of globalism and cosmopolitanism over nationalism and parochialism. Now that this corporate-dominated and finance-dominated globalization has fallen into a disastrous crisis, a nationalist revanchism—embodied in nativist and “economic nationalist” movements—is capturing the backlash.

It is now a central challenge for the left, in Europe and around the world, to rescue internationalist politics from the disaster of capitalist globalization. The answer to surging nationalism is not to be found in the dream of a peaceful internationally integrated capitalism. There needs to be a radical left alternative that rejects nationalism and racism, that rejects the false equation of capitalist globalization with internationalism, and that fights for a new internationalism founded in workers’ solidarity.

Sources: Melissa Etehad, “This map shows Britain’s striking geographical divide over Brexit, Washington Post, June 24, 2016; Elisabeth O’Leary, New Scotland independence referendum ‘highly likely’: Sturgeon, June 24, 2016; Zack Beauchamp, Brexit is terrifying—and no, not because of the economics, Vox World, June 24, 2016; Mary Pascaline, Brexit Sparks Calls For More EU Exits, World Leaders React To EU Referendum Result, International Business Times, June 24, 2016 ; Amanda Taub, Making Sense of ‘Brexit’ in 4 Charts, The Interpreter blog, New York Times, June 23, 2016 ; Luke Reader, Why Brexit Won, History News Network, June 26, 2016 (historynewsnetwork.org); Karl Kautsky, Ultra-Imperialism, (September 2014); Nikolai Bukharin, Imperialism and World Economy(1917).

Triple Crisis welcomes your comments. Please share your thoughts below.

Triple Crisis is published by

Alone Now: From Hope to Brexit Despair

John Weeks

A Tale of Two Summers

The summer of 2015 brought a spectacularly bright ray of progressive hope to the United Kingdom: the increasingly obvious likelihood that a socialist would soon lead the near-moribund Labour Party. After almost 20 years of Thatcher-lite neoliberal policies, the grassroots membership voted overwhelmingly for Jeremy Corbyn to take leadership of the Labour Party.

The progressive victory proved short-lived. Less than year later, the far Right would achieve its greatest victory in British electoral history, winning the IN/OUT referendum on the European Union through a campaign of flagrant xenophobia and racism. Attempts to portray the referendum result as a rejection of globalization, an opening for “progressive nationalists,” or a recapturing of democracy lost to Brussels confront an extremely inconvenient fact: the most reactionary UK political party drove the OUT campaign with a message of fear of foreigners and especially of Muslims (see UKIP poster).

That the overwhelming majority in Scotland, the most social democratic region of the United Kingdom,  favors  remaining in the European Union,  further indicates the reactionary politics of so-called Brexit. As the consistently progressive and anti-racist UK journalist Gary Younge wrote,

[The Leave campaign] unleashed a range of demons it could not tame and then refused to face them honestly, preferring to wade to the finish line through a toxic swamp of postcolonial nostalgia, xenophobia and general disaffection

What OUT Did Not Mean

The post-referendum misrepresentations rival and reflect the lies peddled during the campaign. First and foremost, the suggestion that the British Isles would enjoy more “sovereignty” outside of the European Union  is nonsense. The grain of truth in that campaign assertion is that capitalists operating in Britain will enjoy less regulation, because UK consumer protection, guarantees of workers rights, and restrictions on environmental degradation are far stronger in EU law than British law.

Second, the infamous and eponymous “Brussels bureaucrats” exert almost no influence, much less control, over British economic policy. The British government refused to join into the package of fiscal rules that are the most pernicious element of the EU Treaties (Britain has a formal “opt-out”, as does Denmark). The savage policies enforced on Greece and to a lesser extent Ireland, Italy, Portugal, and Spain would be impossible to implement in Britain, because they derive from membership in the eurozone (the British government also negotiated an “opt-out” from the requirement that if it meets specified criteria a country must join the eurozone).

Third, for better or for worse with the exception of Scotland the referendum outcome will not encourage separatism in the European Union. On the contrary, the boost of right wing parties will lead to them overwhelming the few substantial separatist movements on the continent, most obviously in Spain.

Fourth, I am very skeptical that British withdrawal will prompt “reform” of EU governance of any type (see the hopeful article by German parliamentarian Norbert Röttgen, no doubt sincere but fanciful). The German government’s power over EU decisions varies between strong and hegemonic. That power and the austerity policies it has forced upon the continent very much serve the interests of German industry and banks.

Domestic austerity keeps wages and thus export costs down; austerity for the rest of the eurozone enforces the servicing of public debt held by German banks. More likely than German led reform is German enforced consolidation of a smaller European Union around appallingly reactionary domestic policies and a mercantilist trade strategy.

What the Referendum Did Mean for the British Isles

Above all the referendum outcome means strengthening right-wing political parties and ideology on the continent and in the British Isles. This fallout from a campaign of overt xenophobia and thinly disguised racism should surprise no one.

Progressive forces in the British Isles have suffered a triple blow. First, the strong OUT vote in England (53%) and stronger IN vote for Scotland (62%) lay the basis for a second Scottish independence referendum. In 2014 the independence referendum lost 45% to 55%.

However, Scotland’s First Minister Nicola Sturgeon, perhaps the canniest politician of the British Isles, may read the Brexit result as a harbinger of success for a second referendum. Should a majority of Scottish voters choose independence it would prove virtually impossible for the parliament in London to prevent a breakup of the United Kingdom.

The consequence for progressives of a “Great Britain” made up of England, Wales and Northern Ireland would be dire. The likelihood is extremely low of the Labour Party winning a majority of the parliamentary seats in England. In Wales, the Labour Party holds most of the seats, but they are few in number—only 40 of 650 (with 59 in Scotland).

For decades, the Labour Party could hope for Wales and Scotland to cover its losses in England and Northern Ireland, but Scottish independence would mean either a near-permanent Conservative majority in “Britain” or a Labour Party re-conversion to neoliberalism to court voters in the South of England.

The second blow arrived quickly: an attempt by the center-right of the Labour party to depose Jeremy Corbyn from the leadership. Since the moment of Corbyn’s election as head of the party the so-called Blairites have conspired to undermine his leadership. Their objection to Corbyn is political: he fights for a re-invigoration of social democracy based on trade union support, and the Blairites seek to maintain neoliberalism in the interest of capital.

Those Labour Party MPs who led the coup have more in common with the Conservative Party than with Corbyn. They favor renewal of the country’s nuclear weapons, reduction of the fiscal deficit through expenditure cuts, and support for the financial sector. Right-of-centre Labour abhors the policies that won Corbyn the leadership: commitment to terminate nuclear weapons, end austerity, and tight regulation of  “the City”.

As I write this article, the Parliamentary Labour Party is in the process of voting overwhelmingly to pressure Corbyn to resign. Because of his grassroots support and the rules for electing Labour leaders, the vote, likely to be more than two-to-one against Corbyn, cannot in itself depose him. But at best Labour’s first social democrat leader in decades will be severely weakened.

This intra-party challenge to Corbyn follows directly from Brexit. Perhaps even more serious is that the OUT victory has unleashed a wave of overt racism. Only four days after the referendum, the soon-to-be-replaced Prime Minister David Cameron found it necessary to denounce what he called “despicable” acts against foreigners throughout England (watch speech on the BBC). Aditya Chakrabortty, Guardian journalist, pointed out the irony: Cameron ran a pro-EU campaign with a promise to reduce migration and now is forced to denounce the xenophobic results of that promise.

Independence of Scotland leaving a neoliberal rump Kingdom, near-fatal weakening of a progressive leader, and a rising wave of racism—these are the fruits of victory for the pro-Brexit forces.

What the Referendum Did Mean on the Continent

If anyone hoped that Brexit would strengthen progressive forces on the continent those hopes quickly evaporated. Quite the contrary has occurred with alarming rapidity.

On the Sunday after the UK referendum Spain held its second general election in less than a year. In December 2015 Europe’s largest progressive coalition, Podemos, came close to an electoral break-through. It won 20% of the vote in its first entry onto the national scene, less than two percentage points short of replacing the Socialists as the leading opposition party. The inability of any grouping to form a government resulted in a second election, held last Sunday.

Polls suggested that the broadened coalition, Unidos Podemos, would leap past the Socialists to second place nationally, laying the basis for a new Spanish government committed to end austerity. In the event the Right gained. Seats won by Unidos Podemos came from the Socialists, a swap within the left of center. After substantial losses in December 2015, the right-wing Peoples’ Party gained fifteen seats and will continue its hold on government.

Elsewhere in Europe the Brexit vote emboldened the ultra-right. In France Marine Le Pen, leader of the neo-fascist National Front, immediately promised an OUT referendum. In the Netherlands, the virulently anti-Muslim politician Geert Wilders called for a referendum on EU membership. Were this to occur, it would follow closely on the Dutch electorate’s defeat of a referendum for closer links between the European Union and Ukraine in which Wilders played a prominent role.

The Reality of the UK Far Right

A majority of working class and poor white English men and women voted to leave the European Union. To consider that vote as progressive because of its class origin represents the equivalent of taking a favorable view of Donald Trump because he harvests the votes of white working class Americans.

Gary Younge, quoted above, succinctly summarized Brexit:

Not everyone, or even most, of the people who voted leave were driven by racism. But the leave campaign imbued racists with a confidence they have not enjoyed for many decades and poured arsenic into the water supply of our national conversation.

It may be that this surge of the Right and weakening of progressive movements will prove a passing moment, soon to be replaced by a blossoming of Brexit-provoked grassroots democracy and social democracy throughout the British Isles and the European continent.

But don’t plan on it, because there is no indication of it.

Triple Crisis welcomes your comments. Please share your thoughts below.

Triple Crisis is published by

Unfounded Debt Fears Block Economic Recovery

Anis Chowdhury and Jomo Kwame Sundaram

Debt anxieties are not new, often fanned by political competition. But so is a double dip recession due to premature deficit reduction. For example, to seek re-election, President Roosevelt backed down from his New Deal in 1937, promising that “a balanced budget [was] on the way”. In 1938, he slashed government spending, and unemployment shot up to 19 per cent.

Deficits and debt

Many countries had huge public debts when World War II ended. Despite such anxieties and calls for drastic spending cuts, governments continued to spend. Had they caved in, Europe would not have been rebuilt so soon. As governments continued with massive expenditure to rebuild their countries, economies grew and the debt burden diminished rapidly with rapid economic growth. Clearly, debt is sustainable if government expenditure enhances both growth and productivity.

When the debate about deficits and public debt was raging during the Great Depression, Evsey Domar, growth theory pioneer, noted, “Opponents of deficit financing often disregard … completely, or imply, without any proof, that income will not rise as fast as the debt … There is something inherently odd about any economy with a continuous stream of investment expenditures and a stationary national income.”

After the 2008-2009 financial meltdown brought many OECD economies to a standstill, there was a brief revival of fiscal activism. Many OECD governments initially responded with large fiscal stimulus packages, while bailing out influential financial institutions. Major developing countries also put in place well designed fiscal stimulus packages including public infrastructure investment and better social protection.

Hence, there were sudden increases in debt/GDP ratios, mainly due to large financial bail-out packages and some fiscal activism. But with the first hints of “green shoots” of recovery from mid-2009, fiscal hawks stepped up their calls for winding back, sounding dire warnings about ballooning deficits. They argued that rapid fiscal consolidation would boost confidence, particularly in the finance sector, creating an expansionary impulse.

Thus, the affected countries undertook rapid fiscal consolidation measures with large cuts in public expenditure, especially in the areas of health, education, social security and infrastructure. Yet, their debt-GDP ratios continue to rise as they struggle to reignite growth. Meanwhile, the IMF has admitted that its initial fiscal consolidation advice was based on erroneous ad-hoc calculations.

Overwhelming recent research findings, including from the IMF, indicate that discretionary counter-cyclical fiscal policy in recessionary periods augments and catalyses aggregate demand, encourages private investment and enhances productivity growth, instead of raising interest rates and crowding-out private spending.

Optimal debt-GDP ratio?

The fixation with a particular debt-GDP ratio lacks any sound basis. The 60 per cent debt-to-GDP ratio, used by the European Commission and the IMF as the upper threshold for fiscal sustainability by 2030, was simply the median pre-crisis ratio for developed countries and the median debt-GDP ratio of EU countries at the time of the Maastricht Treaty. Similarly, the 3 per cent budget deficit rule of the EU happened to be the median budget deficit ratio at the time of the Treaty. None of these ostensible bench-marks imply optimality in any meaningful, economic sense.

Public debt in Japan soared to well over 200 per cent of GDP over two and a half decades of deflation. Yet, interest rates have remained low for many decades. In 1988, Belgium had the highest public debt, and Italy’s debt rose above 100 per cent of GDP during this period. Neither of them experienced spiraling inflation or very high interest rates as ‘austerity hawks’ claim will happen when government fiscal deficits rise. Meanwhile, studies of public finance in the United States do not find any significant relationship between debt-to-GDP ratios and inflation or interest rates during 1946-2008.

However, real interest rates may be adversely impacted by whether the debt is denominated in domestic or foreign currencies. In other words, a sovereign country should have the option to monetize debt. The problem arises when that option does not exist, as with countries in the Euro zone. This is clear from the contrasting experiences of Spain and the UK during the recent rapid public debt build-up.

The UK public debt-GDP ratio was 17 percentage points higher than the Spanish Government debt (89 versus 72 per cent) in 2011. Yet, the yield on Spanish government bonds rose strongly relative to the UK’s from early 2010, suggesting that international bond markets costed Spanish risk much more than UK government bonds.

As a member of a monetary union, Spain does not have control over the currency in which its debt is issued, while UK public debt is mostly in its own currency, as in the US and Japan. Therefore, much of the problem in the Euro zone is not really about high public debt or deficits. Rather, it is rooted in the currency union that limits its members’ policy space with regard to money creation and exchange rate policy. Hence, the only way they can improve what is seen as competitiveness is by cutting wages!

Then and now

Since 2014, even the IMF has changed its stance. In its October 2014 World Economic Outlook, it advised that “debt-financed projects could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment”.

There is, of course, one difference between now and the 1930s. The finance sector and rating agencies are much more influential and powerful now than then. Democratically elected governments have become hostage to money-market investors who shift money from one place to another in search of quick profits.

Governments should not be driven by superficial diagnoses of complex economic issues by rating agencies. The record of rating agencies before the 2008 global economic crisis was abysmal, and the US Congress has seriously debated whether they should be prosecuted. Trying to win their confidence is futile, and trying to anticipate them is hazardous, but they nevertheless hold finance ministries and central banks to ransom.

Originally published by Inter Press Service.

Triple Crisis welcomes your comments. Please share your thoughts below.

Triple Crisis is published by

What We’re Writing, What We’re Reading

What We’re Writing

Bofeng Cai, Xin Bo, Lixiao Zhang, James K. Boyce, Yanshen Zhang, Yu Leif, Gearing carbon trading towards environmental co-benefits in China

Martin Khor, A toast to the right to development

Sunita Narain, Redefining gender issues and conservation

Matias Vernengo, On the Recent Productivity Slowdown (at the Rick Smith Show) (audio)

Tim Wise, Rules, Rights, and Resistance: The Battle Over TPP and TTIP – Session 3: Health and Food (video)

What We’re Reading

Stop Austeridad, Ending austerity policies to open a new time in Europe

Prabhat Patnaik, The Phenomenon of Negative Interest Rates

Robert Pollin, The Green Growth Plan to Climate Stabilization

Triple Crisis welcomes your comments. Please share your thoughts below.

Triple Crisis is published by

Enforcement of Puerto Rico’s Colonial Debt Pushes Out Young Workers

“Compromise” protects vulture funds, not Puerto Rico

José A. Laguarta Ramírez

At least 23 of the 49 people killed in the mass shooting that took place at Pulse nightclub in Orlando on June 12 were born in Puerto Rico. While the horrendous hate crime targeted LGBT people of all ethnicities, the large proportion of island-born casualties is not surprising, as the central Florida city has become a preferred destination of Puerto Rican migrants over the past two decades. Steadily growing since the onset of the island’s current “fiscal” crisis in 2006, yearly out-migration from Puerto Rico now surpasses that of the 1950s. The island’s total population has begun to decline for the first time in its history.

Nearly a third of the island-born victims of the Orlando massacre were 25 or younger, most of them students employed in services or retail. This is the population group that will be hit hardest when the ironically named Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) comes into effect. Among its other “promises” for working-class Puerto Ricans, PROMESA will cut the minimum wage in Puerto Rico for those under 25, from the current federally mandated $7.25 to $4.25 per hour, and scale back the federal nutritional assistance program on the island. Purportedly aimed at “job-creation,” these measures will likely intensify the outflow of able-bodied “low-skilled” workers. Ongoing out-migration has already decimated the number of available healthcare and other professionals on the island. Puerto Rico’s 2013 median household income of $19,183 was barely half that of Mississippi, the poorest U.S. state (at $37,479), despite a cost of living that rivals that of most major cities in the United States. Inequality on the island is also greater than in any of the states.

The U.S. House of Representatives approved PROMESA on the evening of June 9, following a strong endorsement by President Barack Obama. The bill, which would also impose an unelected and unaccountable federal oversight board and allow court-supervised restructuring of part of the island’s $73 billion debt, now awaits consideration by the Senate. Its advocates hope the president can sign PROMESA into law before July 1, when $1.9 billion’s worth of Puerto Rico general obligation bonds will come due. Unlike those issued by public utility corporations and certain autonomous agencies, general obligation bonds, under Puerto Rico’s colonial constitution, must be repaid before any further public spending for the following fiscal year is authorized. Puerto Rico’s government has partially defaulted three times within the past year, but not on general obligation bonds. Puerto Rico is not the only place, under the global regime of austerity capitalism to face predatory creditors and the imposition of unelected rulers —as illustrated by cases like Argentina, Greece, and post-industrial U.S. cities such as Flint, Mich.— but its century-old colonial status has made it particularly vulnerable and defenseless.

Read the rest of this entry »