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Mainstream, VOL LIII No 33 New Delhi August 8, 2015

Origins, Nature and Solution of the European Crisis

Saturday 8 August 2015


by Nirupam Sen

Europe in Question — and what to do about it” by Stuart Holland; published by Spokesman, UK; 2015; 301 pages; price: GBP 15.

At present, Stuart Holland teaches economics in Portugal and Hungary. What distinguishes Stuart Holland from most economists is that he is both a brilliant theorist and has been a brilliant practitioner, both in the UK and in Europe. For long he was a Labour MP and the Shadow Minister for International Development in the British House of Commons. In the 1990s he advised Jacques Delors, the then President of the European Commission, and drafted the Delors White Paper which, had it been imple-mented, would have saved Europe from its present crisis.

A special mention may be made of his two most recent books that complement the book under review: The European Imperative and Towards a New Bretton Woods. The former Greek Finance Minister, Yanis Varoufakis, compares Stuart Holland to Keynes—to the Keynes of the Economic Consequences of the Peace on the evils of the Versailles settlement: nobody in power listened to Keynes and the result was the rise of Hitler and the Second World War. But, Stuart Holland also supplements and goes beyond Keynes’ General Theory, developing it in the light of the evolution of the European and the world economy since Keynes’ days. He also has something of Keynes’ literary quality, which makes this book absorbing from beginning to end.

The book is beautifully structured. First he clears the economic conceptual decks of rubbish. Then he surveys the evolution of the European economy—the wrong roads taken and the right roads not taken in spite of concrete proposals being available. Then, he examines the New Deal. Finally, he concludes with clear proposals, both for the global economy and specifically for the European economy. The concluding Annex is called “A Modest Proposal for Resolving the Eurozone Crisis”, drafted by Yanis Varoufakis, Stuart Holland and James Galbraith. The proposal was not accepted. Varoufakis resigned, climbed onto his motorcycle and went home. Greece accepted terms that the referendum had specifically rejected. An even more profound crisis is likely to engulf Greece in the short run, and the European Union in the longer run. It was never part of the Syriza programme to quit the Euro. The European Troika knew this and therefore the referendum result had little impact on their inflexible negotiating position. Only a radical socialist leadership and a radical socialist party could have organised and prepared the people for the immense hardships of leaving the Euro and instituting the Drachma and going through a period of stabilising it.

Stuart Holland’s comments on the macro-economic concepts are both illuminating and relevant, not just for Europe but for the world, including especially for us in India. Hence, this book would enrich the economic understanding of not only those interested in Europe but also of those interested in India. He shows the error of ‘structural reforms’ and ‘flexible labour markets’. There are a range of goods and services that are not subject to international competition but are local: hospitals, dispensaries, schools, urban transport and other social and civic services. Maintaining Keynes’ effective demand is important, but equally so is meeting latent social demand for wellbeing and welfare, such as greater labour intensity in health and education (more doctors for every clinic and hospital; more teachers for every classroom and school). He similarly corrects the popular under-standing of Adam Smith, who said that functional economies depend on functional societies. This means recognising the salience of social and human, rather than merely market values. Holland reminds us that Adam Smith only once uses the ‘invisible hand’ metaphor, and that too after 400 pages into his Wealth of Nations, and defends free trade ‘only in a parenthesis within a sub-clause of a chapter’, which is devoted to defending the right of a nation to in fact protect trade if foreign economic dominance is likely to destroy its manufacturing capacity. Adam Smith, thus, clearly needs to be rescued from his misinterpreters and misusers. Stuart Holland unambiguously shows that it is not reducing labour costs but Schumpetarian product innovation that has lifted economies, and this has been led by public investment, including the internet, Google’s algorithm and nanotechnology.

Another economist gravely misrepresented is Leon Walras. He specifically attacked those who misinterpreted him as the father of pure theory and equilibrium outcomes and, as Stuart Holland points out, emphasised that public utilities and public transport should be publicly owned and run on a non-profit basis. More presciently, he stated that banks and financial institutions should be cooperatives or mutual societies because, in private hands, they would speculate, destroy people’s savings and cause crises. Stuart Holland punctures ‘rational expec-tations’ and ‘efficient market’ theories, because they ignore Pareto’s argument, that there is no case for projecting past market trends into future outcomes. By ignoring this insight, men closed their minds to the looming subprime crisis and the crash of 2008. The real way to mitigate and deal with such crises in future, according to Stuart Holland, is not the unavailing reform of entrenched Bretton Woods institutions, but for ‘the G-20 to nominate the governing body of a World Development Organi-sation’—a bold and imaginative proposal, inspired by post-war European experience, where recovery was not through the IMF and World Bank, but through a non-hegemonic institution’, the Organisation for European Economic Cooperation. Some European institutions today have become disruptive of democracy; Stuart Holland advocates political and economic decentralisation, within countries themselves, to realise the democracy of Rousseau’s General Will. It is at that level that the General Will is embodied in democratic practice. He, thereby, rescues Rousseau from the misrepresentations and totalitarian imputations of Popper and Talmon. He refers with approval to Rousseau’s insight that the majority cannot safeguard the rights of the minority and, even when it freely votes, it can only ‘choose the better of two bad alternatives’ and, in between, ‘remain as unfree as before’.

When touching on macroeconomic concepts and issues, Stuart Holland offers a trenchant critique of Thomas Piketty. I may say, however, that this is not too difficult because of the contradiction between the richness of Piketty’s empirical research and a few specific insights, and the poverty of his theoretical framework, neo-classical economics, rejected even by many mainstream economists today. In 1944 Keynes had achieved fixed exchange rates. In 1971, when the USA devalued the dollar, this regime perished and, with it, an economic era. Middle East oil revenues, denominated in dollars, depreciated. The OPEC was formed. The oil shock inflation of 1973 was the result. Deflationary policies inevitably followed. The abolition of fixed exchange rates and, therefore, the liberalisation of financial capital, made the outcome infinitely worse. In the Keynesian era, when growth had trebled, foreign exchange was controlled and finance ‘caged’ nationally. Now the demon of finance had broken out of its cage. It is not high taxation of personal wealth and income, stressed by Piketty, that was responsible for this growth and welfare, but the Keynsian Marshall Plan and the Keynesian public investment-led ‘clustering’ of innovation, as war time technologies were translated into civilian use.

So also, it is not Piketty’s lowering of taxation on personal income and wealth but the dynamics of financial liberalisation and foreign investments, including speculative investments, of finance capital, which restored inequality to pre-World War I levels and created an increasingly ‘patrimonial’ society. Behind this is Piketty’s law that the ratio of return on capital is greater than the rate of economic growth, so that wealth accumulates faster than income to labour, thus sharpening inequality. As Stuart Holland points out, Keynes long before had argued that capital accumulates faster than income. Keynes had not only related this to income inequality, but pointed out the fallacy of the ‘treasury view’ that the rate of growth can be increased through austerity and savings by demonstrating that savings may remain uninvested or under-invested, whereas increa-sing the wages of ordinary people (thereby reducing income inequality) would have a positive economic impact. Ironically, the ‘Treasury view’, demolished by Keynes, is today the ruling dogma in the major EU countries. Stuart Holland feels that Piketty’s recommendation on global income and wealth tax is technically unrealisable, besides being politically unacceptable. On the other hand, major European countries have supported a Financial Transaction Tax. This has been known to us as the Tobin tax—‘throwing sand into the wheels of finance capital’. One of the aims of the proposal on the G-20 and a World Development Organisation is to recycle global surpluses to sustain a global recovery.

The Yanis Varoufakis-Stuart Holland-James Galbraith’s Modest Proposal builds on Roosevelt’s New Deal and the 1993 Delors White Paper. Roosevelt was not a Keynesian, because Keynes’ General Theory was published only shortly after he was elected President. In fact, Roosevelt began by cutting spending. It is interesting that the only woman in his Cabinet, Frances Perkins, discovered, independently of Keynes, that public works would stimulate demand and lead to economic recovery—a remarkable fact of economic history brought to light in this book. Stuart Holland shows how the Industrial Recovery Act of 1933 enabled the USA to directly undertake public investment projects. In contrast to unemployment increasing by fifty per cent in Greece and Spain, since the onset of the Eurozone crisis, it took Roosevelt 37 days, since his inauguration, to set up the Civilian Conservation Corps which employed three million people from 1933-1941. In contrast to the EU Troika’s emphasis on structural reforms and flexible labour markets (short hand for restricting trade union rights), Roosevelt’s National Labour Relations Act of 1935 reinforced workers’ right to join and form trade unions, and made it obligatory for employers to recognise and participate in collective barga-ining—to increase wages and effective demand. Rather than refusing to lend money to needy EU member countries to combat poverty, the US Reconstruction Finance Cooperation lent money to state and local governments to do so. Instead of cutting public investment, on the fraudulent ground that this would increase competitiveness (as the EU is doing), the US Work Progress Administration, from 1935, funded a range of infrastructure projects. It employed 8.5 million people. Instead of encouraging fascist movements (a 2013 poll found that 46 per cent of those polled supported Marine LePen’s neo-fascist National Front in France), Roosevelt’s New Deal strengthened democracy.

The Jacques Delors White Paper of 1993 made a powerful case for a European New Deal (though without saying so). Its necessity flows from the dynamics of European capitalism, and from the original design of the EU itself. Gunnar Myrdal, in his Economic Theory and Underdeveloped Regions, had demonstrated that strong points within an economy would attract both labour and capital, and these would inversely ‘backwash’ other regions. Myrdal himself frankly acknowledges his debt to Marx who, in Capital, had famously analysed the dynamics of wealth accumulating at one pole and poverty and misery at the other. This is precisely what has happened in the EU (and globally). The sentiment, though not the macroeconomic concept, had been anticipated by the poet Oliver Goldsmith in his famous line on ‘where wealth accumulates and men decay’. As early as 1960, in his Yale lectures (published as Beyond the Welfare State), Myrdal had prophetically recognised that Scandinavian and other welfare states would be undermined by globalisation. Clearly, therefore, countermea-sures were necessary—hence the Delors White Paper.

Stuart Holland says that the New Deal for Europe, proposed by Delors’ White Paper, was not accepted because neither Roosevelt’s New Deal nor the case for a New Deal in Europe were cited in these words, and many EU heads of government were not briefed on the US’ New Deal precedent legitimising recovery bonds; it was not widely understood that borrowing from the European Investment Bank (EIB) would not be counted against national debt; it was not recognised that Eurobonds for investment did not need a common fiscal policy or fiscal transfers since they would be serviced form project revenues, as indeed had been the case with EIB borrowing since 1958; it was not realised that these bonds would not need any treaty revisions, new institutions or national guarantees; it was not remembered that the original aim of the European Investment Fund (EIF) was that it should allocate some bond issues to finance a European Venture Capital Fund. While these reasons may be partly responsible, they do not seem to be wholly responsible. I feel that the Delors White Paper did not gain acceptance then for the same reason that the Varoufakis-Holland-Galbraith proposal did not gain acceptance now—not because a lack of understanding stood in the way but because the interests of finance capital, of German and allied EU banks, stood in the way. Potential acceptance came up against, not a wall of willful ignorance, but a wall of vested interests. It is this, rather than a misreading of their own history (Stuart Holland points out that it is not the hyperinflation of the 1920s that led to Hitler’s rise but the deflation and austerity of the 1930s, practised by Bruning’s government, which fueled unemployment and Nazism) that is responsible for German attitudes today.

The Varoufakis-Holland-Galbraith proposal is modest only in the sense that it requires no treaty or institutional change. It is imaginative, clear, concise, comprehensive, elegant and eminently practical. Its acceptance required a political shift towards a social-democratic future for Europe. It addresses the centrifugal force tearing apart the core and periphery economies of Europe. It recognises that there are four sub-crises in the Eurozone crisis: a banking crisis, a public debt crisis, a crisis of underinvestment and a social crisis. Europe with a central bank but without a supra-national government, and governments without central banks were uniquely unprepared for the 2008 crisis. This crisis showed that the European principle of separable public debt could not work. The European Stability Fund and the European Stability Mechanism (ESM) did not contain the crisis because they could not jettison this principle. Lack of investment destroyed living standards and competitiveness: deficit countries were especially hard hit by the 2008 crisis and least able to bear the cost of adjustment. Years of austerity have devastated the lives of ordinary people.

The proposal addresses each of these four sub-crises: 1) The authors propose that banks in need of recapitalisation from the ESM should be managed by the ESM directly, instead of national governments borrowing on their behalf. The ESM would then restructure, recapitalize and resolve failing banks. This can be done without first setting up a banking union, which the EU has been vainly trying to do. 2) The authors propose that the ECB offer member states the opportunity of a debt conversion for the Maastricht Compliant Debt (each member state under this treaty is permitted to issue sovereign debt of up to 60 per cent), while the national shares of the converted debt continue to be serviced separately by each member state. The ECB ‘would orchestrate a conversion servicing loan for the MCD, for the purpose of redeeming these bonds upon maturity’. 3) The authors’ third proposal is the centerpiece of the programme—they propose an Investment-led Recovery and Convergence Programme, financed by bonds issued jointly by EIB and EIF. These would not count as national debt (such bonds have been issued without national guarantees and not counted as national debt since 1958) ‘anymore than US Treasury borrowing counts on the debt of California or Delaware’. These joint bonds would be serviced directly by the revenue generated by the projects they fund. Shifting savings into investments through bonds was how Roosevelt funded US recovery from the Great Depression. 4) Their fourth proposal is an Emergency Social Solidarity Programme by means of a European Food Stamp Programme (modelled on the US) and a European Minimum Energy Programme. The stated economic proposals are not radical; the unstated political ambition is radical, in the current circumstances. A practical proposal becomes utopian because finance capital will not allow its acceptance or implementation. A single example will show what the EU is up against. Man-made climate change is being supported by convincing scientific evidence, and the immediate urgency, of mitigation and adaptation measures, is now beyond dispute—these require considerable resources. The ultimate proof of the power of banks is that while enormous resources were mobilised to save banks they are not available to save the human race. A thoroughly rational proposal has hit the wall of a completely irrational system. It is natural that such a system can only offer the choice of an impossible federalism or a suicidal austerity. Paradoxically, therefore, the title of his latest brilliant book, Europe in Question—and what to do about it, looks forward to the title of his second book published forty years ago, The Socialist Challenge, though in Germany rather than the UK.

A noted diplomat (now retired), the reviewer was India’s Permanent Representative to the UN in New York.