Unlocking the “Debtors’ Prison” - A Book Review

Despite rising stock market prices and more friendly newspaper headlines, the economic picture in the West remains grim.

The current rate of job creation is not only insufficient to replace the jobs lost in the crisis – it can’t even keep up with labor force growth. At the recent pace of job creation, and with the correspondingly perverse embrace of austerity, we not only fall further behind, but also become further locked into the debtor’s prison.

That’s why Robert Kuttner’s new book, Debtors’ Prison; The Politics of Austerity Versus Possibility, is an important contribution to the economic conversation.

In light of the recent sustained attack on fiscal austerity and the work of Reinhart and Rogoff, the timing of Kuttner’s book is very opportune. But Kuttner has long been an early and eloquent critic of the austerity policies now currently used in the United Kingdom, Greece, Spain, Portugal, and Italy. As each of those economies suffered immense blows after the financial meltdown in 2008, Kuttner has been a leading voice in exposing the flaws underlying the arguments of the fiscal austerity champions.

Yet the single-minded obsession on deficit reduction as a potential cure-all to end our current economic misery still dominates the policy conversation. Meanwhile, policy makers are ignoring the key variable that could solve the crisis – employment.

It is through employment that people are able to fully participate in society, both because employment itself is a social activity and because the income earned allows one to enjoy the minimum economic and social benefits considered by many to be human rights. Without paying jobs, individuals are unable to partake in a large number of social activities and, in this context, service their debts.

Drawing on the successful experience of FDR’s New Deal, Kuttner both offers a clear set of growth policies to get us out of our collective “debtors’ prison”, whilst also recognizing that debt forgiveness has to be part of any long-term sustainable solution, because there are simply times when debts cannot be paid no matter how much creditors – whether they be creditor nations such as Germany, or creditor banks holding piles of toxic mortgage paper, such as JP Morgan – squeeze.

Kuttner marshals his historical arguments carefully, exploring a long history of successful debt workouts (from Treasury Secretary Alexander Hamilton’s paying off Continental Congress war bonds at one cent on the dollar to the Brady Bonds in the 1980s), whilst highlighting that the protracted pressure to repay 100 cents on the dollar in the context of a steadily contracting creates massive additional social and economic damage, as it did in Weimar Germany and has in 21^st century Greece and Spain.

And to anticipate the cries of “moral hazard” Kuttner makes a point that was recognized as early as the time of Daniel Defoe in late 18th century Britain, when debtors’ prisons were overflowing “not only with sundry speculators and deadbeats but with solid businessmen whose enterprises had been ruined by the era’s economic dislocations.” Kuttner notes that the subsequent bankruptcy reform act therefore differentiated between honest bankrupts who were victims of financial circumstances beyond their control and perpetrators of fraud, who were to be treated as criminals.

Contrast that with today’s horrible double standards: corporations make ample use of Chapter 11 bankruptcies to facilitate the destruction of negotiated labor union contracts and pension fund agreements that are in effect debts to their workers and retirees. And banks have been extensively bailed out through a variety of alphabet soup labeled programs such as TARP, TALF, and a host of hidden subsidies that largely remain unseen by the broader public. And yet where are the regulations and the prosecutions that provide the main deterrence against fraudulent activity on Wall Street?

Most importantly, this double standard creates a devastating “Gresham’s” dynamic, which tends to drive honest dealings out of the market. The cost of dishonesty lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.

It wasn’t always like this.

True, in 19^th century Britain and in the US prior to the Great Depression, Finance Capitalism was predominant. That was an era characterized by a small government, little regulation of banking and finance (or anything else), and growing income and wealth inequalities. As a consequence, the economy was much more financially unstable and recorded numerous, frequent, and prolonged economic contractions.

But from 1931, the size of government spending progressively grew and, with the New Deal, a new stage of capitalism progressively emerged that more heavily involved the federal government in macroeconomic and regulatory affairs. Partly due to this involvement, the distribution of income and wealth narrowed and real income grew across all income categories.

Given that their income was rising steadily relative to the cost of living, Kuttner notes that households were able to increase and maintain their standard of living without recourse to debt. A broad range of households benefited from the prosperity. The Golden Age of Managerial Capitalism was a dynamic period of great economic achievements: the US economy recorded a high growth rate averaging 5 percent from the early 1950s. The growth of real GDP per capita was also at its highest level with an average growth rate of 0.91 percent from 1950 to 1973 during periods of expansion.

Government spending was one of the sources of economic growth but most of the economic expansion came from a mix of domestic private investment and consumption – between 55 percent and 60 percent of economic growth came from the growth of private domestic consumption alone.

The more stable business environment was accompanied by a rapid improvement in the standard of living of the population and a general decrease in poverty. Thanks to strong unions, limited international labor competition, and the geopolitical setup, individuals were able to capture some of the benefits of higher labor productivity by demanding better working conditions, paid vacations, better benefits, on-the-job training and many other elements that improved the quality of life of workers in and out of their job environment. A big government contributed significantly to this improvement through its commitment—albeit limited—to full employment and its involvement in the economic development of the country.

Finally, banking and finance were at the service of the rest of the economy and, while consumerism was strong, bankers did not entice households and companies to use a lot of leverage to improve their economic wellbeing. Bankers’ profitability rested on a careful examination of the creditworthiness of borrowers and the establishment of long-term recurring relationships rather than the aggressive expansion of their market by increasing debt loads.

Kuttner also makes another key analytical distinction overlooked by most of the champions of fiscal austerity, including Rogoff and Reinhart, which is the distinction between private and public debt. Lumping together government and private debt is meaningless and simply heightens the bogus hysteria surrounding government fiscal policy activism.

Government debt is a net private asset, while private debts must net to zero. Private saving, however accomplished, increases the future consumption possibilities for the household sector at the expense of current consumption. Saving is foregone consumption that in normal times (barring huge financial crashes) will enhance future consumption.

In this context, because the household sector is revenue-constrained, it has to sacrifice consumption possibilities now to improve them later. It can increase consumption now beyond income via increasing its indebtedness or selling assets (past saving) but the budget constraint has to be obeyed at all times. But, of-course, this sort of reasoning doesn’t apply to the government. A budget surplus does not create a cache of money that can be spent later. Government spends by crediting a reserve account. That balance doesn’t “come from anywhere”, as, for example, gold coins would have had to come from somewhere. By the same token payments to government (such as via taxation) reduce reserve balances. Those payments do not “go anywhere” but are merely accounted for.

These might seem like fine distinctions but if they are not clearly understood then, as Kuttner illustrates, one gets a toxic policy mix that actually exacerbates the underlying problems, rather than solving them.

Today, private debts, not publicly profligate governments, are strangling the recovery. The symptoms are well known: “young people weighted down with college loans, homeowners whose mortgages are worth more than the value of the house, consumers who turn to credit cards when wages lag behind the cost of living or medical bills overwhelm savings.” Yet, as Kuttner notes, the national discussion is all about reducing public debts, and this single mindedness exacerbates the private debt problems by removing another vital source of income support from the economy.

When the government intervenes with bailouts, Wall Street stands with hat in hand. No one wants to bear the actual discipline of markets if that means losses. And yet, as Kuttner notes, there is a moral imperative associated with “deadbeat” households, who are always supposed to repay their debts, if they are to remain in society’s good graces.

Concerns about government deficits and the government debt have served as a very useful way of masking the real issue, the unwillingness of austerity hawks to allow the government to work for the good of the population, something that a democratic government is supposed to do. This is why Kuttner’s excellent work focuses not only on the need for debt relief but also on the need for public spending to compensate for the shortfall of private purchasing power.

It was the massive spending from the New Deal and World War II that finally cured the Great Depression. Today’s counterpart, as Kuttner notes, would be both debt relief and a public investment program aimed at improving the country’s decaying infrastructure, eliminating the euro zone’s Depression-like levels of unemployment, and investing in sustainable green energy programs. Taken together, these initiatives would help us eliminate the scourge of unemployment.

Kuttner’s work helps to restore the public good to its central place in the economic conversation.

These important insights make Debtors’ Prison a book that should be read thoroughly by all policy makers in Washington, Brussels, Tokyo, Beijing, and Berlin, especially as a welcome antidote to champions of austerity who have dominated the political conversation for too long. Let’s hope his message breaks through. Otherwise too many will continue to be locked in the modern version of debtors’ prison while our leaders throw away the key.

Buy Debtor’s Prison: The Politics of Austerity Versus Possibility