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Europe: economics final exam summary
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LECTURE 7 – The Crisis of the 1970’s: From Keynesianism to NeoliberalismThe Post-2016 Electoral Revolutions
We are living in a new era of politics, in which traditional alignments of right and left have
suddenly broken down. In Europe, in the US, in Chile suddenly the labour party and the
democrats cannot count on working class votes. Even traditional conservative parties are
having difficulty holding on to voters, who move towards “fringe” parties, sometimes with
Far-Right overtones. What is going on?
Traditional newspapers, edited by ‘metropolitan elites’, are very quick to call this ‘simple
racism’ against immigrants, but the average voter on the street was fine with significant
immigration, until the 2008 economic crisis… it was a ‘golden age’ of multiculturalism… right
through about 2015 even… so what has changed?
Many W. Europeans are increasingly anti-E. European immigrants: this clearly isn’t racism
either.
So maybe economics has something to do with it?
Mass migrations from Syria and North Africa, following massive instability there, precipitated
it, but, these merely tipped decades long policies, which have done increasing economic
damage to the middle classes of Europe the US and elsewhere
End of History
From the 1990’s, parties on both sides have agreed that there was an End to History,
meaning that we are all heading towards global democracy, but also towards a globalization
of business. The EU was created as a globalist’s dream. NAFTA, TTIP, WTO are all products of
this enthusiasm in the 90’s. Bretton Woods was originally set up to avoid the autarky of the
30’s.
By the 1980’s conservative economists were seeing Bretton woods as a mandate towards
globalization, meaning neoliberalism. They were arguing that Free Trade is the ultimate
political and economic goals, using WTO, World Bank, IMF, that will create a global trading
regime.
This means the free movement of labour, goods, services and capital. This according to the
economists will create the greatest efficiency.
However, the lowering of national borders, especially re: immigration, led to a rapid
movement of people from poor to rich countries. The Middle classes in rich countries, which
had spent decades toiling away to create a solid lifestyle for themselves, found that their
social services and their wages were being chipped away at (higher taxes, lower wages)
Neoliberal economists thought this was great: they don’t like government spending anyway
Neoliberal economists like immigration because it keeps wages low, which allows for cheap
labour making business more competitive.
So Conservative elites were elated at the flows of cheap labour coming in.
Meanwhile Liberal elites were elated that people from all over the world were moving in
next door, and they could have one giant block party with multiculturalism all over the place.
They tend to overlook the problems, and see things with rose coloured glasses about how
wonderful it will all be ‘imagine all the people/living live in peace’.
,Meanwhile, the middle classes—the majority of voters, were seeing wages stagnate after
2007, job opportunities fall apart, full time jobs were being shed, and pensions dismantled;
home ownership became increasingly out of reach, and student debt was increased.
With massive immigration, social services are strained, because poor people
disproportionately use social services. Also, the price of rent and housing goes up (again,
great for elites who own a lot of property), but for post-high school couples, this makes
home ownership increasingly difficult.
With no one to turn to, because both are wedded to Globalization and essentially to
Neoliberal economics, the Middle classes are turning to ‘outsiders’ such as Trump, Johnson,
and sometimes even to Nationalist parties, because these are the only ones who seem to
address the issue of controlling immigration, helping the welfare state back on its feet, re-
creating jobs in-country etc..
Trump was elected in large part because he talked about protectionism. Most economists
think he’s crazy, but is he? Have we had too little protectionism? Have we had too much
globalization? Should we sacrifice our middle class lifestyles for the sake of some ‘greater
good’ while the .1 percent are capturing far more of the wealth than previously?
No party is addressing the most pressing issue, the fact that the middle class is losing their
lifestyle through too much neoliberalism.
Before you need to know what Neoliberalism is you need to know Keynesianism.
The Big Switch
The issue today is the Crisis of the 1970s. It was a watershed in European Economic history,
because it was the decade which sparked the change from a predominantly Keynesian
Policy, in which both conservatives and liberals all assumed that Keynesianism was
normative, to a predominantly Neoliberal policy, in which both sides of the political aisle
thought it was normative to move towards globalization and reducing government spending.
How did they conclude that it was old fashioned? How did they decide? Have they done too
much neoliberalism?
Golden Age of Capitalism
The very high growth rates of the 1950s and 60s have led some to call this period the ‘golden
age’ of capitalism. It was a time of unprecedented (and unrepeatable) technological
opportunities. Society became ‘electrified’; meaning that consumers switched their homes
to rely on electric appliances. These labour saving devices had several effects. They boosted
manufacturing sales throughout the period.
They provided employment for many people working in these sectors. They heraled the end
of classism because people did not need servants (middle class had servants in the 20’s)
As wages increased, servants became more expensive and even upper middle class wives
began to do more housework (30’s, 40’s, 50’s
Europe moved towards a one class society, the middle class. By the 1960’s the new devices
freed women to join the workforce. The pill also revolutionized the ability to stay single for
much longer and marriage was increasingly delayed. Women started being admitted to
university with major crest in the 70’s.
,The Hippie Culture was a middle class culture. Getting along, being one big family. This also
started the age of family vacations and pay checks started being structured around
vacations.
Why did Europe being the one class society by the 1960’s?
Neoclassical economics say that it was just GDP growth.
Piketty on the other hand that states that the growth meaning return on labour was greater
than the rate of return on capital.
Keynesians say it was because of the New Deal and the Welfare State. Or because of war
destruction or communist competition.
It was probably a combination of these factors.
Why did the period of Keynesianism come to an end?
By the later 1960s, there are signs of a general economic slowdown. In Europe, plants are at
capacity and there are no new markets. The US experiences a stock market crash in late
1968 and, the USD begins sliding against European currencies. It is the global reserve, and
since European currencies are pinned to the USD, if Europeans stay in the Bretton Woods
system, they will have to ‘Import inflation’
• What does this mean?
Nixon Shock
So in 1971, Germany decided to leave the Bretton Woods system, the alternative was to
devalue the DM. The Deutschmark began to appreciate against the USD and soon the US
also left Bretton Woods, meaning they allowed the dollar to float somewhat against gold and
other currencies. This is called the ‘Nixon Shock’, the USD devalued. This was a spark which
caused inflation, also, with currencies allowed to float, the tendency was to increase the
money supply, and this happened across Europe.
Types of Economic Shock
Shocks can be positive or negative.
Supply shocks refers to the raise of production or input costs.
Demand Shocks refers to consumers or businesses suddenly shifting their spending patterns.
Financial shocks refers to the credit crunch, stock market crash, liquidity crisis and
devaluation.
Policy Shocks are through fiscal or monetary policy.
Technology Shocks refer to rapid change of productivity.
Monetary Fluctuation
There were various attempts to try and keep global currencies aligned. There was a
Smithsonian Agreement in Dec. 1971, which was already attempting to keep currencies
within a band of 2.25% away from the USD. By 1972, this was seen as unworkable, and the
six + three members of the EEC decided to align their currencies in a more narrow ‘Snake in
the Tunnel’ , meaning currency values would fluctuate within a narrower band;
, By 1973, the USD was allowed to float even more freely, and the Snake had to be
abandoned. The recession of 74-5, delayed further action, until a 2 nd recession in the later
1970s resulted in a new European Monetary System being arranged in 1979…
Crisis of the 1970’s
So although few analysts really focus on the destabilizing of the Bretton Woods currency
regime as a major factor precipitating the crisis of the 1970s, it was, I believe, perhaps the
most serious factor which led to the craziness about to ensure.
The Crisis in the 70’s at its base was about the economic opportunity again declining.
Currency instability was bad, but then came the exogenous negative supply shock broght by
the Yom Kippur War. In 1973 Israel defeated several enigborng states and occupies them. In
retaliation, the newly formed Organization of Petroleum Exporting Countries (OPEC) acted as
a cartel and decided to squeeze the global petroleum production. The effect was dramatic
and unprecedented.
Prior to this, the colonial powers controlled this oil supply, but now, the newly independent
middle eastern countries were free to dictate policy and they did not like Israel. With the
price of oil increased, the price of almost every other good was affected. Transport is
fundamental to most prices thus, supply curves across the board shifted to the left and
prices increased. Firms began to lay people off, and unemployment began to increase.
Keynesian Response?
In a standard response since 1945 the governments increased spending. This stimulates
demand and people spend more and this will get the state out of the slum. This is Demand
Side Economics.
Now the potential downside of this policy is that spending by the government will increase
inflation. Governments tend to ‘print money’ or increase the money supply during
downturns, as part of their policy of ‘giving away’ money and in any event, more spending
always creates a positive inflationary pressure. Usually however, during an economic
downturn, inflation is already low and decreasing, this is because when people spend less,
there is a downward pressure on prices.
The Keynesian response is predicated on the assumption that inflation will already be low.
The problem here, is that, due to the exogenous shock, inflation was high at the beginning
of the downturn and yet the economy was shedding jobs. This goes against the theory
encapsulated in the famous ‘Phillips Curve’, which holds that economies either have inflation
or unemployment, and when one fights one, one creates the other.
The result of all of this, was that when governments tried to ‘spend their way’ out of the
recession of 1974-5, this didn’t work, and in fact it created alarming rates of inflation, which
were 6 percent or more in some economies.
Why is high inflation alarming?
It eats away at the value of savings. It also causes nominal interest rates to have to be very
high and to top it all off, unemployment remained stubbornly high.
Also: fighting inflation involves a lot of unemployment, and the higher it gets, the
more painful it is to bring it down. Governments historically hate having to fight high
inflation, so they try and keep it as low as possible.
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