Austerity by Design

Yanis Varoufakis’s lessons for reasserting European social democracy.

J. W. Mason

Image: Ververidis Vasilis/Shutterstock

Adults In The Room: My Battle With Europe’s Deep Establishment

Yanis Varoufakis

Farrar, Straus and Giroux, $28.00 (cloth)

In the spring of 2015, a series of debt negotiations briefly claimed a share of the world’s attention that normally goes only to events where celebrities give each other prizes. Syriza, a scrappy left-wing party, had stormed into office in Greece on a promise to challenge the consortium of international creditors that had effectively ruled the country since its debt crisis broke out in 2010. For years, austerity, deregulation, the rolling back of labor rights and public services, the rule of money over society, had been facts of life. Now suddenly they were live political questions. It was riveting.

Syriza was represented in these negotiations by its finance minister, Yanis Varoufakis. With his shaved head, leather jacket, and motorcycle, he was not just a visual contrast to the gray-suited Eurocrats across the table. His radical but rigorous proposals for a different kind of Europe—one based on meeting human needs rather than rigid financial criteria—offered a daily rebuke to the old refrain “there is no alternative.”

The drama was clear, but the stakes were a little obscure. Why did it matter if Greece stayed in the euro? Orthodox economic theory, after all, gives little role for money or finance. What matters are real wants and real resources, for which money is just a convenient yardstick. University of Chicago economist John Cochrane probably spoke for much of the profession when he asked why it made any more sense to talk about Greece leaving the euro than about Greece leaving the metric system.

Transformed from a critic of the play to one of the main characters in it, Varoufakis is like the protagonist in a postmodern fable.

But money does indeed matter—especially in economic relations between countries, as Varoufakis himself has convincingly shown. In his three books—The Global Minotaur (2011), And the Weak Suffer What They Must (2016), and Adults in the Room (2017)—Varoufakis offers a fascinating lens on the euro system and its masters. While the first two books chart the history of the international monetary system from World War II up to the debt crisis, his last and most recent book is a reflection on his five months as Greek finance minister. Taken together, they read as if Varoufakis is the protagonist in some postmodern fable, in which he is transformed from a critic of the play to one of the main characters in it.

Greece today has 20 percent unemployment—the highest in Europe. It would be higher still if it weren’t for the loss of a tenth of the working-age population to emigration. The most recent IMF projections say that unemployment will remain in the double digits well into the 2040s. Multiple rounds of bailouts and “reform” packages left its GDP a quarter below pre-crisis levels, and the IMF projects it will not regain the lost ground until around 2030.

And yet the Greek government is committed to sending 3.5 percent of national income abroad as tribute to its creditors each year, for the indefinite future. The battle by Varoufakis and his Syriza comrades against this intolerable state of affairs is, even in defeat, a rare spot of genuine heroism in today’s discouraging political landscape. There is plenty to question and criticize. But any political movement that hopes to reassert the values of European social democracy against its current legatees will have much to learn from his example, as well as his books.

National economies are linked by a vast web of money flows—payments for goods and services, of course, but also loans, interest payments, asset purchases, profits on foreign investment, and so on. Since David Hume in the eighteenth century, theorists have looked for automatic mechanisms—changes in prices, or interest rates, or exchange rates—that would bring all these flows of money across borders into balance. If such a mechanism existed, then in discussing the economic relations between countries we could safely ignore money, and imagine a kind of international barter serving the needs of all sides. The central claim of Varoufakis in The Global Minotaur, however, is that there is no such mechanism.

In Varoufakis’s story, money is not just an accounting device; real productive activity is organized—and disorganized—by flows of money. The stable reproduction of an international economy requires flows of money across borders to balance. But when this has happened over any significant period, it has either been through dumb luck or else because some more or less conscious “surplus recycling mechanism” moves money from countries gaining it back to those losing. Otherwise, human labor and other real resources must be sacrificed to bring the money flows into line, or else the imbalance will eventually end with a crisis.

The Eurozone’s crisis can only be understood through the political choices of its central bankers. This is the most important lesson of Adults in the Room.

Since World War II, there have been two main global surplus recycling mechanisms. The first, in the twenty-five or thirty years after World War II, is the Bretton Woods system, or what Varoufakis calls the “global plan.” During this period, the United States ran trade surpluses, but recycled them—plus whatever additional dollars the world needed—through a mix of foreign aid, military spending and foreign investment. During this period, exchange rates were more or less fixed; the first resort for a country losing hard currency was expected to be not devaluation, but capital controls—restrictions on financial flows out of the country. This system worked well, says Varoufakis, as long as the United States accepted responsibility for running it, managing the U.S. economy to maintain a sufficient but not excessive outflow of dollars to the rest of the world.

By the 1970s, this responsibility came to seem like too much of a constraint on achieving domestic policy goals. After a chaotic period of experimentation, the recycling mechanism shifted toward what Varoufakis calls “the global minotaur” and what others, less creatively, sometimes call Bretton Woods II.

Under this system, the pattern of flows was reversed: the United States runs a trade deficit, financed by foreign investment from the rest of the world. Capital controls were now verboten, and exchange rates were supposed to float; countries losing foreign exchange would solve the problem by allowing their currency to depreciate until their exports were competitive enough to earn the hard currency they required.

Perversely, the new recycling mechanism, and the U.S. position within it, benefited from the now-frequent currency crises. Safe assets—meaning dollar assets—were in great demand by anyone who wanted to protect themselves against the vicissitudes of international markets. The United States could comfortably finance its trade deficits with financial inflows from the foreign central banks that desperately needed reserves in the new regime of capital-flow and exchange-rate uncertainty. The United States was, in effect, selling insurance against the instability it had itself created when it abdicated responsibility for the international order.

One way of looking at the financial crisis of 2008 is as a breakdown in the post-Bretton Woods surplus recycling mechanism. Mortgage backed securities had played a key strategic role in the system in which dollars flowed out of the United States to pay for imports, and then back in as investment in the safe financial assets the United States was uniquely able to provide. So when the U.S. mortgage market blew up, so did the international payments system.

Europe at first seemed to better weather the 2008 financial crisis. But it soon suffered a financial breakdown and deep recession even worse than those in the United States. This crisis—and its deep institutional roots in the development of the euro system—is the subject of And the Weak Suffer What They Must?

The euro project, as Varoufakis tells the story, sprouted from the rubble of Bretton Woods. Elsewhere, the flexibility of floating exchange rates was supposed to help countries weather the rougher waters of the new international non-system. But in Europe’s tightly integrated economies, the idea that stable trade flows could coexist with wild swings in exchange rates was a non-starter.

It is rare to get such a frank and seemingly unfiltered account of the private conversations in which power is exercised.

A vast array of cross-border links were “calibrated to function under the assumption that all European currencies moved gradually together.” If Europe was to be tightly integrated in terms of real productive activity—something no one had seriously questioned once plans for a permanently deindustrialized Germany were abandoned shortly after the war—then it needed a tightly integrated monetary system as well. When the global system of fixed exchange rates broke down, a European equivalent had to be built up.

With one difference: the New Dealers who set up “the global plan” at Bretton Woods recognized that someone had to actively manage the international monetary system. Their European successors did not. Obsessed with “the fantasy of apolitical money,” they placed at the center of their new system a central bank with no political oversight, and no responsibility for Europe’s financial system.

The combination of maximally fixed exchange rates with maximally free trade led, inevitably, to the development of large trade imbalances within Europe—imbalances that were amplified by the otherwise desirable convergence of incomes across members of the union. (Despite the focus on competitiveness, faster growth probably played a larger role in southern deficits than did higher costs.)

For the corresponding financial flows from north back to south, the system relied on the private decisions of profit-seeking investors. This meant that when things broke down there was no one at the center focused on getting payments flowing again or maintaining the viability of the weaker partners, only a gaggle of burghers who wanted their money back.

The play-by-play of this breakdown is ably narrated by Varoufakis. The short version is that a number of poorer countries in Europe—Spain, Greece, Ireland, Portugal—enjoyed huge expansions of credit in the first decade of the euro, which financed (among other things) a big run-up in property values. The immediate lenders were the banks in the peripheral countries, but they in turn financed themselves by borrowing from elsewhere in Europe, an arrangement made much easier by the euro system.

Among the lessons in Varoufakis’s story is that real power does not always lie where titles and organizational charts say it should.

The crisis saw an abrupt halt to these cross-border financial flows. The result was a steep decline in lending, in asset values, and soon in real activity. With incomes falling steeply and interest rates rising, the debts incurred by a number of governments—Greece, Portugal, Ireland, but also Spain and even Italy—threatened to become unpayable. The deep cuts in public spending these countries were forced to make in response—along with business-friendly reforms to boost their “competitiveness”—were an economic disaster, plunging millions of people into a new world of deprivation and insecurity.

They were also the euro system working as designed.

Thomas Mayer, the former chief economist of Deutsche Bank, once described the euro as an attempt to create “the modern equivalent of a gold standard.” The goal was to subject the managed economies of postwar social democracy to a hard external constraint, outside the control of national governments. Forced to rely on money that “politicians could not conjure up from thin air,” governments would once again be subject to the judgment of the market. Capital would be fully mobile, national governments would voluntarily surrender the tools once used to manage financial flows, and exchange rate adjustments would no longer be available as even a last ditch resort to cushion trade imbalances.

Governments that wish to maintain a stable position in the international system would instead have to focus on two goals. First, to maintain an acceptable balance on the financial account, they would have to maintain the confidence of the markets; and second, to maintain an acceptable balance on the trade account, they would have to keep wages down and productivity up. The narrowing of policy space for national governments was, arguably, not a bug but a feature—even the central one.

Some version of this analysis is widely shared by both supporters and critics of the euro system. It has an important element of truth. But reality isn’t so simple, for a number of reasons. First, the role of exchange rates in stabilizing trade flows has been greatly exaggerated. It is simply not the case that Greece, for instance, could “pay its own way” before the euro by devaluing its currency, as is sometimes suggested. In fact, despite frequent devaluations Greece ran trade deficits continuously for decades before entering the euro. (As Varoufakis points out, the last time the country had a trade surplus was under German occupation in 1943.)

Second, financial flows often shift for reasons that have nothing to do with the policies of particular governments. The experience of peripheral Europe, like the experience of smaller countries around the world that have accepted free capital mobility, is not the strict but fair discipline of stern foreign investors, but rather of wildly unpredictable floods and droughts of money from alternately credulous and panicky markets, which depend more on financial conditions in the world’s financial centers than anything happening in the receiving countries.

At times Varoufakis’s narrative has the feel of a horror story where the protagonist tries to operate by the rules of normal life, only to gradually discover the conspiracy all around him.

A third difference between the euro system and the gold standard ideal is more subtle. Under the gold standard, as under the dollar standard that most of the world operates on today, central banks are subject to the same constraints as national governments. The Bank of Mexico cannot print dollars, it can only acquire them in the same ways as anyone else in Mexico. The European case is different. Despite the common perception that the European Central Bank is, well, the central bank of Europe, national central banks still exist and perform almost all the routine functions of central banking. (Among other things, they literally print euros.)

The central banks, in turn, make payments to each other through the TARGET2 system. If, say, there are more payments from people and businesses in France to Germany in a given period than from Germany to France, the difference shows up as a credit for the German central bank in the TARGET2 system, and a debit for the French central bank. This system has one critical feature: no one has to approve a central bank borrowing through it, and there are no limits to the balances it can run up. In effect, each central bank in the euro area has an unlimited overdraft facility from all the others.

There were good reasons to design the system this way. Indeed, it is hard to see how one could have a monetary union without some mechanism to ensure that a euro in a bank account in one country can always be used to make a payment of one euro to any other. But from the point of view of creating a disciplining mechanism on states, it is a fatal flaw. With a cooperative central bank, it is impossible for a euro area government to ever run out of euros.

Whatever limits the system puts on public spending, then, do not come automatically, but must be actively imposed by central banks. Under the gold standard, central banks were inside the nation-state, sharing its international constraints. But in the euro system they are outside it, part of the machinery that imposes those constraints. This critical difference means that the euro area’s crisis cannot be understood in terms of bad institutional design; instead, it must be understood in light of the political choices of its central bankers. This is perhaps the most important lesson of Adults in the Room.

In January of 2015, when Varoufakis entered the stage, Greece was already on its third loan negotiations with its official creditors. The first one had swapped the Greek government’s debt to private lenders elsewhere in Europe with debt to other European governments, to the ECB and to the IMF. The money loaned to the Greek government had been used to repay loans that private lenders were unable or unwilling to roll over. It was a bailout—but for banks in Germany, France, and elsewhere, not for Greece. From the point of view of the Greek state, their debts to private lenders had simply been replaced with debts to official lenders.

‘We were dealing with creditors who did not really want their money back.’ The real issue was power.

While the bailouts did not reduce the amount of debt owed by the Greek state, they did change its character. While private lenders are primarily interested in getting their money back, public authorities often have a broader set of interests in the behavior of their debtors. The new loans to Greece were governed by a Memorandum of Understanding (MoU) laying out a set of policy changes the Greek government had to make to receive the money. The loans were to be doled out in installments, with each new payment contingent on the “conditionalities” being satisfied.

This model followed a precedent set by numerous loans to developing countries since the 1970s. In principle, the goal was to not just solve the immediate crisis, but to make the “hard choices” necessary to put the borrower on a sound footing to avoid future payments crises—something that, by hypothesis, local political institutions would not be willing to do on their own. Whatever their intentions, these agreements necessarily involve a substantial transfer of authority from national governments to creditors.

By the time Syriza took office, the Greek state had already agreed to a long list of “reforms”—from banning collective bargaining to loosening restrictions on milk freshness—and had surrendered control over key government functions, including tax collection, to officials appointed from outside. Varoufakis describes the arrangement as “neocolonial,” and with reason. In the nineteenth century, turning over tax collection to European authorities was a penalty imposed on defaulting governments from China to Turkey to Egypt, often as a first step toward outright subjugation. The central issue under dispute in the first month of negotiations was whether the new government would continue to be bound by the agreements signed by the previous one.

The bulk of Adults in the Room is a detailed account of the negotiations between the Greek government and its creditors between February and June of 2015. The creditors were, notionally, three public institutions—the IMF, the European Central Bank, and the governments of the other euro-area states as represented by the European Commission. It was this “troika” that had drafted the MoUs and appointed the officials running the Greek tax authority and other government functions under government control. The legitimacy of this body was immediately challenged by the new Greek government, leading to the famous exchange at the end of the first public meeting between Varoufakis and Dutch Finance Minister Jan Dijsselbloem, who angrily told him “you’ve killed the troika!” before pointedly refusing to shake his hand. (In the end, the accusation proved premature.)

Confusingly, the negotiations themselves took place in the Eurogroup, an informal working group that included all euro-area finance ministers as well as representatives of the three troika bodies. Within these meetings, the dominant figures were Dijsselbloem, as president of the Eurogroup, and perhaps the book’s most fascinating character, German finance minister Wolfgang Schäuble.

Austerity was supposed to be just a means to stabilize payments by Grece to its creditors. But what if the actual goal was austerity, and the crisis and unpayable debt just convenient openings to pursue it?

Varoufakis’s description of his time in the Eurogroup meetings is never less than gripping. He is a master storyteller, and it is very rare to get such a frank and seemingly unfiltered account of the private conversations in which power is exercised. For this narrative alone, the book deserves a place on the short shelf of great political memoirs. The content of the negotiations described by Varoufakis—not to mention his own political role—will look very different in retrospect, depending on whether Europe continues down its current path toward a Hayekian prison of nations, changes course, or blows itself apart. But no matter what happens, this book will be read in fifty years by anyone who wants to understand how elite politics actually works.

Several lessons are clear from Varoufakis’s story. First, real power does not always lie where titles and organizational charts say it should. Neither Schäuble nor Dijsselbloem has, on paper, any more authority over the Greek debt than any of the other fifteen finance ministers. Nonetheless, their control of the proceedings is seldom questioned and never seriously challenged.

In one striking scene, Pierre Moscovici (representing the European Commission) initially agrees to replacing the existing MoU with language he and Varoufakis draft together and promises to get the new text through the Eurogroup. But the moment he presents their new language “in the room,” Dijsselbloem swats it down. And “in a voice that quavered with dejection,” Moscovici meekly assents: “Whatever the Eurogroup president says.”

A second lesson is that the rigidity or flexibility of rules is a decision variable for whoever is in charge of enforcing them—and the more opaque and indirect the decision-making process, the more space for discretion there is. In a dramatic scene near the end, Dijsselbloem announces that the Eurogroup will depart from its til-then ironclad principle of unanimity and issue an official statement over Greece’s veto. When Varoufakis asks how that is allowed, he gets this response from the EU secretariat: “The Eurogroup does not exist in law. . . . and therefore its president is not legally bound.”

Third, arguments are seldom decided, or even debated, on the merits. Varoufakis’s main activity during his months in office seems to be putting together detailed “non-papers” (the EU’s suggestive term for unofficial proposals) on possible resolutions, which the other side simply ignores. As he puts it:

On the assumption that good ideas encourage fruitful dialogue and can break an impasse, my team and I worked very hard to put forward proposals based on . . . sound economic analysis. Once these had been tested on some of the highest authorities in their fields . . . I would take them to Greece’s creditors. Then I would sit back and observe a landscape of blank stares. . . . Their responses, when they came, took no account of anything I had said. I might as well have been singing the Swedish national anthem.

Curiously, no matter how often it is repeated, this experience doesn’t lead him to question his assumption that good ideas are what matter. Even when Schäuble tells him bluntly in a one-on-one meeting that “I am not going to negotiate with you,” Varoufakis goes on gamely trying to make a deal. Right to his last days in office, he is offering new proposals, all vetted by the highest authorities.

At times the narrative has the feel of a horror story where the protagonist tries to operate by the rules of normal life, only to gradually discover the conspiracy all around him. In Berlin, for example, Varoufakis is invited to a dinner by a couple of leading figures in the Social Democratic Party. The Social Democrats are Merkel’s junior coalition partners but, they assure him, they see the insanity of what is being done to Greece and they want to support him in his struggles with their government. The dinner must be a secret of course—no aides, no press—so they can strategize together. Then, at the restaurant, one of the Germans’ phone rings. He hands it to Varoufakis: it is ECB president Mario Draghi, calling to say that assistance for Greece’s banks is being cut off.

The message is threatening enough, but it is doubly chilling that it is delivered through a supposed ally.

What was it all about, then? More precisely: what did the creditors want? What leverage did they use to get it? And, could Greece have done any better?

The negotiations which dominated Varoufakis’s five months in office were ostensibly aimed at a long-term resolution in which the Greek state could continue servicing its debts while getting the resources it needed to foster economic growth and development. But it would be a mistake to see the stakes as being whether the debtor could continue borrowing, or the creditors would get their money back.

For one thing, Greece already had a primary surplus—its revenues were more than enough to fund expenses other than debt service costs. No one on either side contemplated a return to primary deficits. So the funds being doled out or withheld by the creditors were not in any sense financing the activities of the Greek government. Quite literally, the creditors were lending Greece money only so that it could keep paying back those same creditors. In effect, the Greek state was paying a substantial tribute to its creditors each year for the privilege of remaining in debt to them.

Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions go well beyond what we normally think of as the remit of a central bank.

The circularity of this arrangement in financial terms makes it clear that the financial side was never what mattered. As Varoufakis shrewdly notes, “we were dealing with creditors who did not really want their money back.” The real issue was power—the power the debt gave the creditors to dictate the Greek government, and the power they had to punish Greece if it didn’t comply.

Concretely, this meant, on the one hand, acceptance of the existing MoU and everything it implied, including even deeper austerity, fire-sale privatization of everything owned by the public, a permanent end to collective bargaining, and steep cuts in public and private wages; and on the other hand, the ECB’s ability to shut down the Greek banking system.

We will return to the second point—the key strategic role of the ECB. As to the first: why were the European authorities so insistent that Greece surrender control over domestic policy and accept the ultra-liberal program of the MoU? Varoufakis suggests two possible answers.

At some points, he argues that the MoU and the larger austerity agenda were embraced opportunistically by politicians who did not want to admit that the first bailout had handed over public funds to their own banks. Blaming Greek profligacy was the politically easier cover story. “The sole reason that the IMF and EU were asphyxiating us [was] because they did not have what it took to confess the error” of the earlier bailouts, he says. Austerity, in this telling, is not a goal in itself, but merely “a morality play pressed into the service of legitimizing cynical wealth transfers from the have-nots to the haves during times of crisis, in which debtors are sinners who must be made to pay for their misdeeds.”

A second possibility is that austerity and the rolling-back of social democracy were the goals all along, for which the Greek crisis simply provided an opportunity. In this version, Greece was subject to “fiscal waterboarding” not to avoid acknowledging the earlier bailout, but precisely to force compliance with the MoU—and even more, to provide an example for other governments in Europe.

It is clear why Varoufakis prefers the first story: the logic of his position in government required something like it to be true. If austerity were not an accident, a mistake—if the authorities would not in principle be just as happy with an active, egalitarian Greek state—then what was he sitting in all those meetings for? You can’t walk into negotiations unless you believe that a mutually satisfactory agreement is at least possible.

Unfortunately, Varoufakis’s narrative doesn’t cooperate with his analysis here. Just a few pages after the “sole reason” line, he describes a meeting with Pier Carlo Padoan, Italy’s finance minister:

Our discussion was friendly and efficient. I explained my proposals, and he signaled that he understood what I was getting at, expressing not an iota of criticism but no support. To his credit, he explained why: when he had been appointed finance minister a few months earlier, Wolfgang Schäuble had made a point of having a go at him at every available opportunity. . . .

I enquired how he had managed to curb Schäuble’s hostility. Pier Carlo said that he had asked Schäuble to tell him the one thing he could do to win his confidence. That turned out to be ‘labour market reform’—code for weakening workers’ rights, allowing companies to fire them more easily with little or no compensation and to hire people on lower pay with fewer protections. Once Pier Carlo had passed appropriate legislation through Italy’s parliament, at significant political cost to the Renzi government, the German finance minister went easy on him. ‘Why don’t you try something similar?’ he suggested.

“I’ll think about it,” is Varoufakis’ diplomatic reply.

A couple days later, he has his first meeting with the German finance minister himself. Schäuble brushes off Varoufakis’s suggestions for strengthening the Greek tax authorities, insisting instead on “his theory that the ‘overgenerous’ European social model was no longer sustainable and had to be ditched.”

Comparing the costs to Europe of maintaining welfare states with the situation in places like India and China, where no social safety net exists at all, he argued that Europe was losing competitiveness and would stagnate unless social benefits were curtailed en masse. It was as if he was telling me that a start had to be made somewhere and that that somewhere might as well be Greece.

Schäuble’s frank language is revealing, and we owe Varoufakis thanks for bringing it—and many similar statements by other officials—into public view. At the same time, it is a problem for his argument that the only obstacle to a decent deal was the authorities’ need to save face over the earlier bailouts.

The exchange with Schäuble also makes clear how right Varoufakis is to dismiss as a “fundamental misconception” the idea that Europe’s crisis involves “a tussle between Germans and Greeks.” The battle in Europe may be between interests, classes or ideas; but it is not, except superficially, between nations. Whichever way the austerity machinery is pointed at the moment, it can easily be turned somewhere else.

During the debt negotiations, one of the rare moments of disunity on the creditor side is a shouting match between Schäuble and the French finance minister Michel Sapin. Varoufakis, on the other side of the room, asks someone what is going on. “Wolfgang said that he wants the troika in Paris,” is the reply. For German conservatives such as Schäuble, Greece is indeed just somewhere to make a start; the real target is the larger and stronger welfare states of Europe—and ultimately their own working class.

The ostensible purpose of the negotiations was to resolve the crisis and stabilize payments by the Greek government to its creditors; austerity was supposed to be just a means to that end. In that case, if the same financial results could be achieved with a less brutal set of policies, everyone should be ready to sign on. But what if it is the other way round? What if the actual goal was austerity, and the crisis and unpayable debt just convenient openings to pursue it?

One doesn’t have to look far to find this argument being made quite openly. I suspect the real attitude of much of the European elites is well captured in a 2006 Economist editorial, which argued:

The core countries of Europe are not ready to make the economic reforms they so desperately need—and that will change, alas, only after a diabolic economic crisis. . . . The sad truth is that voters are not yet ready to swallow the nasty medicine of change. Reform is always painful. And there are too many cosseted insiders—those with secure jobs, those in the public sector—who see little to gain and much to lose. . . .The real problem, not just for Italy and France but also for Germany, is that, so far, life has continued to be too good for too many people.

If Varoufakis didn’t want to take Schäuble’s word for the real stakes, he might have listened to the various representatives of the troika who repeatedly made clear that “labor reform”—specifically, a permanent ban on collective bargaining—was one of their red lines. Or he might have looked at the ECB’s record as an enforcer of austerity in Ireland, Italy, Portugal and Spain, years before Syriza came into office.

In 2011, when the Italian bond market was in turmoil, the ECB intervened to stabilize it—but only after sending a private letter to then-prime minister Silvio Berlusconi demanding a long list of “structural” reforms, including “full liberalisation of local public services,” particularly “the provision of local services through large scale privatizations,” “reform [of] the collective wage bargaining system . . . to tailor wages and working conditions to firms’ specific needs,” “thorough review of the rules regulating the hiring and dismissal of employees,” and cuts to private as well as public pensions, “making more stringent the eligibility criteria for seniority pensions” and raising the retirement age of women in the private sector. (Strangely, this intervention and the similar demands by the ECB on the governments of Spain, Ireland and Portugal get almost no mention here.)

Privatization, weaker unions, more employer control over hiring and firing, skimpier pensions go well beyond what we normally think of as the remit of a central bank. And since the letter was private (it was published later) it can hardly be seen as a cover story for a bank bailout. The only reason for the ECB to make these demands is if they really wanted them met.

Dozens of poor countries have been forced to sign humiliating agreements with the IMF. What was new here was just that this treatment was being applied to a country in the rich world.

Looking beyond Europe, Varoufakis might have looked at the many structural adjustment programs promulgated by the IMF in countries of the South. Varoufakis is not wrong to liken Greece’s treatment to that of Europe’s colonies and protectorates in the age of gunboat diplomacy. But one needn’t look back to the nineteenth century for precedents. Since the 1980s, dozens of poor countries have been forced to sign humiliating agreements with the IMF, surrendering autonomy over economic policymaking and committing to brutal austerity. What was new here was just that this treatment was being applied to a country in the rich world.

Late in the book, Varoufakis has a meeting with IMF chief Christine Lagarde. Of the leaders on the creditor side, Lagarde comes off as the most sympathetic, and Varoufakis is cautiously optimistic he may be able to win her over. But when he gets his private meeting, what is the first thing she wants to talk about? Pharmacy deregulation! In a country with a quarter of the workforce unemployed, massive poverty, and public services in a state of collapse, that has already seen wall-to-wall deregulation, the most urgent problem she sees is that family-owned drugstores are still too sheltered from competition with international chains.

Stories like these—and the book is full of them—suggest that the creditors were not just looking for a politically palatable way to avoid responsibility for their earlier failures. They were sincere and consistent ideologues, striving to remake Europe in the model of an idealized free-market society. Varoufakis recounts these stories masterfully, yet curiously they never seem to shake his view that a mutually beneficial deal is just around the corner.

If Varoufakis’ account of his opponents’ motives is somewhat unsatisfactory, his account of their means is lucid and compelling. One of the central points is that the European Central Bank is a thoroughly political actor. Its decisions to buy or not buy government debt, to lend or not lend to banks, are always described in terms of statutory rules, but in practice, the rules mean what the ECB wants them to mean.

Perhaps the most dramatic expression of this was Draghi’s 2012 interventions to bring down rates on euro-area governments’ bonds—something the ECB’s charter was understood to explicitly forbid. In Greece, of course, the rules were bent the other way.

‘They want to destroy us.’

Varoufakis gets this exactly right: “In reality, after 2008, any attempt by the ECB to impose its charter rigorously . . . would have ruled out any of the various waivers, reinterpretations and extraordinary shenanigans that have so far prevented the eurozone from collapsing altogether. Far from being apolitical, the ECB’s huge discretionary power over when to enforce its rules and when to circumvent them . . . make it the most political central bank in the world.”

The ECB was also the only one of the three troika institutions with direct coercive power. The other creditors could, of course, refuse to extend new loans. But by 2015, the funds Greece was receiving from its official loans were being used entirely to service their existing debt. So a threat to cut off lending would just mean that if Greece defaulted on its loans, it would have to default on its loans.

The ECB, on the other hand, had the power to withdraw liquidity assistance from Greek banks, forcing them to shut down. Indeed, even the threat that assistance might be withdrawn was enough to provoke a bank run. This was the creditors’ only real stick, but it was a big one.

Dijsselbloem, who uses his first meeting with Varoufakis to deliver an ultimatum (“the current program must be completed or there is nothing else!”), clearly expects that the mere threat of a bank shutdown will end all resistance. As Varoufakis observes, “Experience has taught functionaries operating on behalf of Europe’s deep establishment [that] . . . government ministers, prime ministers, even the president of France, buckle at the first whiff of . . . the ECB’s big guns.”

Was there anything to be done? Could different choices by the Syriza government have allowed them to deliver on their promises? Or were the creditors always going to get their way?

Varoufakis’s answer is unambiguous: Greece should have walked away from the negotiating table at the end of February, when the creditors withdrew an earlier offer to reconsider the policy commitments made by previous Greek governments, and made it clear that the troika would not accept any modifications to the existing MoU.

If Greece had walked away at that point, the ECB and Bank of Greece would certainly have withdrawn liquidity assistance from the Greek banking system, forcing it to shut down—just as they eventually did in June.

But if the confrontation had come in February rather than June, Varoufakis believes, his colleagues would have chosen to fight rather than to surrender. Four months of fruitless negotiation, of “fiscal waterboarding” (letting the state get enough resources for minimal functions but not for any new initiatives), of vilification in the press, and of public and private pressure on individual members, left the Syriza government too demoralized and divided to resist when the ultimatum eventually came.

Varoufakis, to his great credit, takes responsibility for the decision to go on with talks even when it was clear that the other side would accept nothing but continued austerity. In a section entitled “mia maxima culpa,” he doesn’t mince words: “It was a tough call,” he writes, “but I should have made it. . . . I failed to rise to the challenge.”

This book will be read in fifty years by anyone who wants to understand how elite politics actually works.

Suppose the Greek government had refused to continue negotiations after February 24. What would have happened then? The ECB and/or the Bank of Greece would have announced an immediate end to emergency liquidity assistance (ELA) to Greek banks. The pretext would have been that the Greek government debt held by the banks, being rated below investment grade, was not acceptable as collateral, and that a waiver from this requirement could only be granted if an IMF program was in place and Greece was in compliance with it.

Without ELA, the Greek banks would have shut down and available cash would have had to be carefully rationed, just as eventually happened in June. At that point—as did not happen in June—the Syriza government would have activated its “deterrent.” The three key pieces of this were, first, a unilateral write-down or “haircut” of Greek bonds held by the ECB; second, the introduction of a parallel payment system, including both a system of electronic payments and certificates against future tax liabilities that could circulate in the place of cash; and emergency legislation to replace the head of the Bank of Greece, an establishment politician hostile to Syriza who had been appointed in the final days of the previous government.

Varoufakis is convinced that the bond haircut was seen as a serious threat by the ECB—not of course for the financial loss involved, which is trivial and anyway irrelevant for a central bank, but because of the administrative and political headaches it would cause. But given the ECB’s flexible approach to its own rules, it is hard to be convinced on this point.

Much more important is the second piece. If an alternative payments system could allow purchases to be made, workers to get paid, and businesses to buy needed inputs even with the country’s private banks shut down, then the ECB would be largely defanged. With the creditors’ threat to bring economic life to a halt removed from the game, Greece could return to the bargaining table in a much stronger position. And in the worst case, if the creditors still refused to accept anything but the existing package, the parallel payments system would become the basis for a new currency, allowing a gradual transition out of the euro instead of a wrenching leap. Obviously there are many devils in the details, but the logic of what Varoufakis describes seems sound.

The greatest strength of the political establishment in Europe—as of political establishments everywhere—is the perception that their rule is an unchangeable fact, that there is no alternative. The sight of Greece still standing—businesses running, people working and paying bills, public services functioning—after the ECB had done its worst would severely damage this aura of inevitability.

For precisely this reason, a Greek non-capitulation was directly threatening to conservative politicians elsewhere in Europe, especially those facing challenges from the left. As Varoufakis says, “What mattered to them was their authority, and that was being challenged by a leftist government whose success at negotiating a new deal for its country was the creditors’ greatest nightmare, as it might give ideas to other Europeans.”

Spanish finance minister Luis de Guindos directly confirms this at one point, telling Varoufakis that his position in the Eurogroup meetings was dictated by fear that any Syriza success would give ammunition to his government’s opponents in the leftwing party Podemos. Conversely, as Varoufakis observes, a hardline treatment of Greece served “as a deterrent to any other politician in Spain, Italy, Portugal or indeed France, who might be tempted” to challenge the reigning orthodoxy.

It would be easy to cast Varoufakis as naïve, but he isn’t. Rather, he is a believer in the European project.

In short, Greece had to be made an example of so people in the rest of Europe wouldn’t get ideas. Varoufakis is bluntly told at one point that austerity is necessary not to improve Greece’s repayment prospects, but “to demonstrate to Paris what is in store for France if they refuse to enact structural reforms.” Or as the Slovak finance minster—“Schäuble’s keenest cheerleader in the Eurogroup”—put it, “We had to be tough on Greece because of their Greek Spring.” But this dynamic might also have worked in Greece’s favor if they had stuck to their guns. Rather than risk an example of successful noncompliance, the creditors might have compromised instead.

As for the third component of the Greek response—replacing the leadership at the Bank of Greece—Varoufakis doesn’t think much of it. It is certainly true that Stournaras, the holdover governor, did everything he did to undermine the Syriza government, deliberately stoking panic in financial markets in direct violation of a central banker’s core responsibility. And it is true that, officially, the final decision to shut down the Greek banks was made by the Bank of Greece, not the ECB. But Varoufakis is convinced that Stournaras was just following instructions from his masters. Against those in Syriza who see control of the central bank as critical, he insists that it is just “a branch office of the ECB.”

I’m not sure he is right about this. On paper, at least, the euro system gives considerable autonomy to the national central banks, and it is easy to find examples of national central bank leaders defying the central authorities in Frankfurt (most visibly, Jens Weidemann of Germany). Any future European government considering a challenge to the authorities will need to explore whether, and how, the national central bank can become a strategic asset.

We’ll never know whether Varoufakis’s “Plan X” could have worked. When the moment came it was not activated. Faced with the troika’s final ultimatum in June, the Syriza government put it to a referendum—and then ignored the public’s resounding vote of “No.”

Varoufakis makes a convincing case that, contrary to what some have alleged, he did have a coherent plan for dealing with a breakdown in negotiations. But it is also clear that he was not really prepared to use it. In a small but telling detail, the alternative payments system is always described as a “deterrent,” as if it is merely leverage to get a better deal from the authorities, not as a step toward greater independence from them. And while the basics of the plan were in place when he took office, neither he nor his staff seems to have put much effort into developing it further.

Despite all the evidence, he seems to have been convinced to the end that the creditors would eventually come around. It is striking that whenever he talks about the need for more time, the benefits of waiting just a bit longer, it is in the hopes that the creditors will at last see reason. Even after the “No” vote, preparing the alternative payments system is only one of four priorities for his staff; number one is developing yet another offer for the creditors to reject. When he assures Alexis Tsipras, then the Prime Minister of Greece, that Merkel will “100%” accept his new proposal if she is rational, one wants to reach through the page and shake him and say, “Yanis, haven’t you been reading your own book?” The dejected Tsipras has a clearer view of the situation when he replies that new proposals don’t matter: “They want to destroy us.”

Game theorist that he is, Varoufakis must know that the bargaining power of the weak depends on their exit options.

It would be easy to cast Varoufakis as an academic out of depth in the deep waters of power. But I don’t think he is naïve. Rather, he is a believer in the European project.

The tension between believing in Europe and regarding its current stewards as enemies comes out clearly in his discussion of capital controls—the restrictions on financial payments across borders. Many people thought that the new Syriza government should have immediately limited payments from bank accounts in Greece to accounts outside it, slowing the bank run and making the Greek banking system less dependent on emergency liquidity of ECB and BoG. But Varoufakis rejected this, writing, “Capital controls are inconsistent with monetary union.” And later, “capital controls would be detrimental to the EU member states common interests and for that reason alone we had to oppose them.” Here and elsewhere, he comes across as a committed European—an honorable stance but perhaps not the best fit for the position he occupied.

The same logic plays out with the Bank of Greece. Tsipras and the rest of the Syriza leadership urgently wanted to replace the hostile Stournaras as bank governor. But Varoufakis is against it: “For as long as the ECB negotiated with us in good faith, I argued, we needed to show respect for its Greek branch.” It is an old story—the insurgent who unilaterally disarms in an effort to show good faith while the authorities have no intention of reciprocating.

Five months of being stonewalled, lied to, and vilified by the European establishment did nothing to diminish Varoufakis’s faith that the future of democratic, egalitarian politics lies at the European level. The book ends with him, now out of office, barnstorming France and Germany to build up a new Europe-wide political movement. His refusal to give in to cynicism or despair (or return to the safe harbor of academia) is inspiring, and indeed, there is no one better to make the case for a humane, democratic Europe.

But, from the outside, one might still wonder if his way is the only way. It is exhilarating to imagine a genuinely democratic Europe, one that reflects the collective choices of the continent’s people as a whole. But perhaps the best route to this model of integration would be, paradoxically, for some countries first to de-integrate—to reassert their sovereignty and reject the free movement of money and goods that have defined the European project in favor of a model in which economic ties are managed in the service of a national program of development.

The greatest strength of the deep establishment that Varoufakis struggled with so valiantly is the idea that there is no alternative. In Europe today, integration is presented not as something that will bring a better life for ordinary people, but rather something for which they must sacrifice—since the alternative is unthinkably worse. As long as there is no credible path to prosperity and sovereignty outside Europe, why should the authorities feel compelled to offer them inside? Game theorist that he is, Varoufakis must know that the bargaining power of the weak depends on their exit options.

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Germany and Brexit: Berlin won’t put economic interest above its political support for European integration | British Politics and Policy at LSE

If the UK wants to secure favourable terms during the Brexit negotiations, it will be crucial to win the support of Germany. But what are Germany’s key priorities? Luuk Molthof writes that the 2015 Greek debt negotiations offer some insights into the German approach, and that the UK is likely to be disappointed if it believes Germany will put economic interests above its political support for European integration.

A sigh of relief was heard on both sides of the channel when Jean-Claude Juncker announced on 8 December that ‘sufficient progress’ had been made in the first round of Brexit talks, opening the way for the second, and much more important, phase of the negotiations. Some commentators saw the breakthrough as a sign that the British government had finally acknowledged its place as the junior partner. Indeed, to be able to move on to the trade talks, Theresa May had given in to most of the EU’s demands.

Yet the British government still seems fully confident that it will be able to negotiate a bespoke trade deal for itself. At the heart of this optimism is the assumption that some EU countries, such as Germany, the Netherlands, and Belgium, have a significant interest in good trading relations with the UK and won’t want to harm themselves economically merely to ‘punish’ Britain for leaving the EU. The British government seems to be particularly counting on Germany, the EU’s central power, whose export sector is seen as being much too dependent on the British economy for it to allow Britain to walk away without a deal.

However, many German politics experts have warned the British government not to keep its hopes up. According to Charles Grant, “Germany’s top priority is to ensure that Brexit does not weaken the EU, and that means the UK must not be allowed any kind of special arrangements that could undermine the European institutions”. In a similar vein, Sophia Besch and Christian Odendahl point out that “politically, nothing is more important to Germany than the stability and integrity of the EU”.

To understand why the British government would do well to heed these warnings, it is useful to be reminded of Germany’s role in the 2015 Greek bailout negotiations. The case is illustrative for two reasons. First, Germany’s decision back then to agree to a third bailout package for Greece, despite the apparent failings of the first two packages, is indicative of Berlin’s willingness to prioritise political over economic ends. Second, Germany’s refusal to soften Greece’s bailout conditions, even after repeated attempts by the Greek government to put pressure on Berlin, suggests that Germany is not one to soften its position at the behest of a junior negotiating partner.

Berlin’s willingness to prioritise political over economic ends

What the British government tends to forget is that for Germany, the EU is first and foremost a political project. In its efforts to further and safeguard European integration, Germany has often prioritised political over economic interests. So too in the summer of 2015, when Germany, alongside the other eurozone countries, agreed to extend a third bailout package to Greece. To be sure, over the course of the Greek debt negotiations, Germany never lost sight of its economic interests, refusing to grant Greece its much wanted Schuldenschnitt and remaining firm in its insistence on a strict reform programme. However, it always kept a larger perspective in mind.

Greece had received two bailout packages before, the first in 2010 and the second in 2012. An important motivation for both bailouts was the concern over a potential domino effect in the case of a Greek default and/or exit from the eurozone. Another – at least in 2010 – was the exposure of German and French banks to Greek debt. In bailing out Greece, then, Germany and the other eurozone countries acted perfectly in line with their own economic interests.

The situation in 2015, however, was markedly different. Not only had the chances of a domino effect been significantly reduced, Europe’s banks had written off most of their Greek debt. The economic argument for bailing out Greece yet another time was therefore not particularly strong, especially since Greece was increasingly seen as a Fass ohne Boden, or a bottomless pit. The reason why Germany ultimately agreed to another bailout was because a Greek exit from the eurozone would undermine the euro’s credibility as an instrument of political integration. Most significantly, a Grexit would mean that European integration would no longer be an irreversible and linear process – note that this was before the Brexit referendum. Speaking to the Bundestag on 19 March 2015, Merkel stated:

I have repeatedly said: If the euro fails, Europe fails. Some found and still find this too dramatic. But I remain insistent; for the euro is much more than just a currency. It is, next to the institutions that we have established, the strongest expression of our willingness to really unite the populations of Europe in prosperity and peace.

Economically, it may well have made better sense to let Greece go. Yet in order to protect the euro’s role as a political instrument, Germany was willing to bear the economic costs. Similarly, Germany is likely to be willing to bear the economic costs of a no deal Brexit should that be necessary to protect the integrity of the internal market.

Germany is not one to soften its position at the behest of a junior negotiating partner

Just like the British government is currently expecting the German government to eventually soften its position and give in to certain demands, so too did the Greek government expect the German government to eventually soften its austerity demands and perhaps even write off some debt. Greece found out the hard way, however, that Germany is not one to soften up when negotiating with a junior partner. Over the course of the 2015 debt negotiations, the Greek government made continued attempts to put pressure on Germany to adjust its position, using delaying tactics, insisting Germany still owed Greece compensation for WWII, and even calling a domestic referendum on the bailout conditions. All these attempts proved futile and in fact only strengthened Germany’s resilience.

Only after Germany’s finance minister, Wolfgang Schäuble, started talking about the option of a temporary ‘timeout’ from the eurozone, did it dawn on the Greek government that it had vastly overestimated its negotiating position. In the end, the Greek government inevitably caved, accepting all of the conditions that had been so resoundingly rejected by the Greek population in the bailout referendum. The drawing out of the negotiations had been a costly affair for all involved, but primarily for Greece. The British government faces a similar suboptimal outcome should it fail to come to the realisation soon that it is indeed the junior negotiating partner, that time is really not on its side, and that empty threats to walk away from the negotiations without a deal aren’t likely to change anyone’s mind, least of all Germany’s.

The fact that Germany is likely to prioritise its political interests over its economic interests in the Brexit negotiations, and is unlikely to give in to the demands of a junior negotiating partner, is not to say that Germany does not seek a good trading relationship with Britain. It is merely to say that it won’t agree to a type of deal that undermines the EU institutions simply because it doesn’t want to see a drop in Mercedes’ sales. Indeed, even the German industry itself has let it be known that the integrity of the internal market should not be sacrificed for access to the UK market. The British government would do well to keep this in mind and prepare a realistic vision for its post-Brexit relationship with the EU, instead of waiting for the Germans to lend them a helping hand.

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Note: This post was originally published on our sister site EUROPP.

About the Author

Luuk Molthof is a Research Fellow at d|part, a political think tank based in Berlin. He completed his PhD in Political Science at Royal Holloway, University of London. His thesis examined Germany’s role in European monetary history and provided an explanation for Germany’s reaction to the euro crisis.

All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.

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Paid work is never enough: we need to pay attention to the quality as well as the quantity of jobs created

Getting people into employment will not on its own ensure decent living standards and reduce poverty, finds Peter Taylor-Gooby. His research shows that, while higher employment is associated with lower poverty, other factors are more important. The most important factor in reducing poverty levels across the countries looked at was the strength of contractual rights, and other policies, such as access to child care, policies to reduce discrimination against women were also significant.

Most people think paid work is the royal road to a better life for people of working age. The value of work is at the centre of policy thinking across the board, from Labour’s Compulsory Jobs Guarantee to UKIP’s commitment to ‘enroll unemployed welfare claimants onto community schemes or retraining workfare programmes’. Ian Duncan Smith’s Universal Credit puts work ‘at the centre of our welfare system’. The EU’s 2020 Growth Strategy ‘is about more jobs and better lives.’ And so on.

The idea that getting people into work will solve the problem of achieving decent living standards for those of working age was given extra impetus as unemployment rose from about 5 to over 8 per cent between 2008 and 2012, paralleled with a rise in working-age poverty. Now unemployment is falling back towards pre-crisis levels but, as IFS analysis shows, poverty among working age adults is failing to respond. The poor quality of many of the new jobs indicates short-comings in the case for paid work as the foundation of welfare.

Most of those in poverty live in working households. Among families the proportion in households with at least one member in work rose from 50 to 68 per cent between 1996 and 2013 according to the DWP’s Households Below Average Incomes statistics. The job market started to recover from its low point in 2012 but many of the jobs on offer are far from satisfactory. The number of part-time workers rose from 7.2 million to 8.2 million between the recession in 2008 and 2014, the numbers of involuntary part-timers from 0.7 to 1.7 million and the number of temporary workers from 1.4 to 1.7 million. The Labour Force survey shows a doubling of zero-hour contracts between 2007 and 2013 to 300,000.

These statistics suggest that we need to pay attention to the quality as well as the quantity of jobs created. Our new research examines factors affecting employment and poverty across 17 European countries for the period of prosperity and growth between 2001 and 2007. This is the time when the sun shone, the most favourable period in recent history for the work = welfare = decent living standards project. The research shows that, even at this time, new welfare was much more successful at getting people into work than at reducing poverty.

Employment rates rose across Europe, especially for women. However, far from declining, poverty rates also increased (by the standard EU 60 per cent of median income measure) from 18 to 18.6 per cent between 2001 and 2007 in the UK, and also in other successful economies such as Germany (11 to 15.2 per cent), Sweden (9 to 11.5 per cent) or Poland (16 to 17.3 per cent). One explanation is to do with access to paid work. Governments need to make sure that even more people move into work. This is the logic that lies behind the EU’s Employment Strategy and Horizon 2020 programme and behind national work-centred policies such as Universal Credit. Then the great recession swept everyone towards work at any price policies, redoubling the stress on paid work.

These were the good times, when, if ever, the link between work and decent incomes should be strongest. Higher employment is associated with lower poverty, but the analysis shows that, even during this period, other factors were more important. In fact the most important factor in reducing poverty levels across the countries was the strength of contractual rights. Other policies such as access to child care, policies to reduce discrimination against women were also significant.

The level of employment plays a role in ensuring decent living standards, but one that is less powerful than that of employment rights. The suggestion is that while employment is probably a good thing, if we want people to be better off, we also need to make sure that the quality of jobs is adequate. The best way to ensure that is to strengthen contractual rights against dismissal and to promote trade union membership. Recent trends in policy to weaken employment protection, to undermine the role of trade unions and to introduce high fees for access to employment tribunals move us in entirely the wrong direction. Shovelling people into low-paid jobs is all the fashion, but it is not the answer to the problem of poverty among those of working age.

For more, see “Can ‘New Welfare’ Address Poverty Through More And Better Jobs?” by Peter Taylor-Gooby, Julia M. Gumy and Adeline Otto.

About the Author

Peter Taylor-Gooby is Research Professor of Social Policy at the University of Kent’s School of Social Policy, Sociology and Social Research. He chaired the British Academy New Paradigms in Public Policy Programme (2010/2011) and is Chair of the REF Social Work and Social Policy and Administration panel 2011-15, a Fellow of the British Academy, a Founding Academician at the Academy of Social Sciences and, previously, a Fellow of the Royal Society of Arts and President of the British Association for the Advancement of Science, Sociology and Social Policy Section.
Related

The Coalition’s Social Policy Record 2010-2015

This paper summarises nine detailed reports assessing the social policies of the
UK Coalition government elected in 2010. What did the Coalition set out to
achieve? How much was spent and saved? What policies were enacted and with
what effect?
– The Coalition made ‘tackling our record debts’ its most urgent task. However, it also aimed to
deliver radical reforms to achieve ‘a stronger society, a smaller state and responsibility in the
hands of every citizen’.
– Rapid and far reaching reforms were enacted: re-structuring the NHS; expanding the number of
Academies; starting to introduce Universal Credit; pension reforms; widening non-state provision,
increasing local autonomy and reducing eligibility for services and benefits.
– The Coalition’s decisions to offer relative protection to schools, pensions and the NHS meant that
its austerity programme was more limited overall than its rhetoric suggested, and was
concentrated in particular policy areas. Total public spending fell by 2.6 per cent between
2009/10 and 2014/15. However, “non-protected” services were cut by around one-third.
– Although the Coalition stressed the importance of the “foundation years”, real spending per child
on early education, childcare and Sure Start services fell by a quarter between 2009-10 and
2012-13 and tax-benefit reforms hit families with children under five harder than any other
household type. Provision for adult social care users fell 7 per cent per year during the Coalition
period to 2013/14.
– Despite a promise that the better-off would carry the burden of austerity, changes to direct taxes,
benefits and tax credits affected poorer groups most. After initial protection ended, estimates
suggest that poverty increased to 2014/15 and will get worse in the next five years.
– It is too early to assess the full effect of the Coalition’s structural reforms (such as changes to the
school system). Whoever is elected in May 2015 will face many continuing issues including child
poverty, unaffordable housing, pressure on the NHS and social care from an ageing population, a
regionally unbalanced economy, low wages and insufficient affordable childcare. The ‘cold climate’ for social policy – very high public sector debt and a high deficit – also remains.

The Coalition’s Inheritance

The Conservative – Liberal Democrat Coalition that took power in May 2010 inherited a particularly tough fiscal climate. By the end of 2009/10 net public sector debt had reached £956.4bn (62 per cent of GDP), while the current budget deficit stood at £103.9bn (6.9 per cent of GDP). These figures were very high for the UK by recent standards and reflected the impact of the global financial crisis that affected most major world economies in similar ways. Strategic choices had to be made: should public spending be maintained in a Keynesian move to support economic growth, or cut in order to pay down the debt quickly? Should efforts to balance the public finances focus on tax increases or spending reductions? Who should bear the burden of these efforts?
On the issues that are the principal concern of our enquiry – social outcomes, poverty and inequality – the Coalition inherited a better situation than its predecessor. Labour’s social policy programmes had delivered expanded public services. Socio-economic gaps in access to services had decreased. Economic and social outcomes, such as pupil achievements and child poverty, had also generally improved, while differences between the most and least deprived social groups narrowed.

But a lot remained to be done. Child and pensioner poverty had fallen, but overall income inequality had not. There were still large social class gaps in health, early childhood development, school achievement, university participation, and neighbourhood living conditions. An ageing population made the funding of health, social care and pensions increasingly challenging. Other pressures included rising unemployment, concerns about the quality of care, and a chronic under-supply of housing.
What were the Coalition’s aims and goals?

The incoming Government declared that its most urgent task was to tackle the country’s debts. But it also insisted that fairness would lie at the heart of its decisions “so that those most in need are most protected”. The better-off would be expected to: “pay more than the poorest, not just in terms of cash, but as a proportion of income as well”.
Beyond deficit reduction, the Coalition set a further goal of improving social mobility and creating a
society where “…everyone, regardless of background, has the chance to rise as high as their talents and ambition allow them”. Reforms to ‘welfare’, taxation and education were promised, with devolution of decision-making powers from central to local government and communities. Defining its core values as “freedom, fairness and responsibility”, the Coalition pledged to deliver “radical reforming government, a stronger society, a smaller state and power and responsibility in the hands of every citizen”.
What did the Coalition do?

Cut public spending, rather than raising taxes

A fundamental decision announced in the Coalition’s first, “emergency” Budget was to target deficit reduction through spending cuts (77 per cent) much more than tax increases (23 per cent). On the taxation side of its strategy, the Coalition raised the VAT rate from 17.5 to 20 per cent, and increased Capital Gains Tax for higher rate taxpayers. Yet room was also made for sizeable tax cuts – including raising the Income Tax personal allowance from £6,475 to more than £10,000. Corporation Tax was cut, and, from 2013/14, the Income Tax rate for people earning over £150,000 was reduced from 50 per cent (recently introduced by Labour) to 45 per cent.

Gave relative protection to the NHS and schools, but made deep cuts to other budgets

The Government chose to maintain spending in some policy areas and implement deeper cuts
elsewhere. Budgets for the NHS and schools, accounting for more than a quarter of total departmental expenditure, were relatively protected. Spending on health grew in real terms by 2.7 per cent between 2009/10 and 2013/14: a real increase although a smaller growth rate than in previous years and much lower than the increase in need (for example as measured by the increasing elderly population). Schools expenditure fell by less than one per cent up to 2012/13 (the latest data available). A Pupil Premium, paid to support pupils from low-income families, helped maintain school budgets and also directed money towards those in more disadvantaged contexts.
Although funding for schools and 16 to 19 year-old learners was protected, the budget for adult skills training was reduced by 26 per cent between 2009/10 and 2013/14. Higher education spending was also cut – by 44 per cent in the short-term – as government grants for teaching were replaced with student tuition fees and loans.
The biggest losers among ‘non-protected’ services were those provided by local councils. Between 2009/10 and 2014/15, local government funding in England fell by an estimated 33 per cent. Within particular service areas, spending on children aged under five fell 21 per cent between 2009-10 and 2012-13, with falls of 11 per cent for early education and 32 per cent for Sure Start. These reductions coincided with a 6 per cent increase in the number of under-fives. Spending on housing and community amenities, which includes funding to build social housing, fell by 35 per cent between 2009/10 and 2013/14. All the main central government funding streams for neighbourhood renewal were removed. Budgets for residential homes and other adult social care community services were cut by 7 per cent between 2009/10 and 2013/14, while the population aged 65 and over grew by 10 per cent.
Uprated pensions, while reducing other social security budgets

Pensions were protected from Coalition commitments to curtail spending on social security. A ‘triple lock’ was put in place requiring them to be uprated each year by earnings growth, price inflation or 2.5 per cent, whichever was highest. In contrast, cuts were made elsewhere by restricting eligibility for tax credits and working-age benefits and imposing new conditions on claimants. Benefits were made less generous by a change to the inflation index used for annual adjustments and by below-inflation increases from 2012-13, as well as cuts for particular groups.
Restructured the welfare state
Alongside spending cuts, the Coalition embarked on an extensive restructuring of welfare state
institutions. In education, it vastly extended Labour’s programme of directly-funded Academies, and enabled ‘Free Schools’ to be set up by groups of parents, charities or other institutions. Higher education regulations were changed to allow new providers to offer degree qualifications. In the NHS, government introduced major reforms emphasising competition, decentralisation, a range of provider types (public, private and third sector) and outcomes. Delivery of a new, consolidated Work Programme, helping jobseekers to gain employment, was contracted-out on a ‘payment-by-results’ basis. Social housing providers were encouraged to seek more private funding for new homes, charge rents closer to market levels, and move away from ‘tenancies for life’.

‘Localism’ provided another key theme. Government regional offices and regeneration programmes, were abolished in favour of local decision-making. Local government finance was reformed to provide more incentives for economic development. In addition, two elements of the social security system – the Social Fund and Council Tax Benefit – were devolved to local authorities, both with reduced budgets. New rights were also conferred on community groups. Local government assumed new responsibilities and powers in the context of public health and the public health budget was devolved. However, with the exception of public health, the expansion of local powers and responsibilities took place at a time when budget cuts gave local authorities less capacity to make use of them.
The Coalition also shifted the boundaries of welfare provision, in many cases moving away from
‘progressive universalism’ towards greater targeting. Eligibility was restricted for some benefits and services. Extra conditions were imposed, particularly for out-of-work benefits, along with tougher penalties for not meeting them. In some areas, financial responsibility underwent a wholesale shift from the state to the individual; for example, by trebling university student tuition fees in England and by introducing adult learning loans. In social care there were moves in both directions: on the one hand tighter eligibility criteria for receipt of social care services shifted responsibility towards individuals and their carers; on the other hand the Care Act 2014 introduced a lifetime cap on the total long-term care costs individuals would in future be required to pay.

Embarked on reforms to the content and design of services

In some policy areas the Coalition’s reforms went deeper into the content and design of services, living up to its promise of sweeping changes. These changes are described in detail in the papers that underpin this summary report. For example, the school curriculum and examination system in England were overhauled, justified on the grounds of making them more rigorous, and a new system of teacher training was introduced. In adult skills training, the Coalition instituted changes to the length and quality of apprenticeships, designed to bring England closer to European systems. One of the most ambitious reforms was a complete overhaul of working-age benefits and tax credits, bringing most of them into a single system, Universal Credit (UC), designed to incentivise work and get rid of complicated overlaps in means-tests and taxation. While many people support the principles behind UC, it proved challenging to implement, and there are remaining concerns about its design and the capacity of the IT system to cope with the number of monthly changes in circumstances which will be required. Just 18,000 people were receiving it late 2014, against an original target of 2 million.
What were the results?

Cuts in many services and increasing pressure on others

‘Unprotected’ services have been substantially reduced. In adult social care, where spending was cut despite a growing elderly population, there was a falling caseload (down 25 per cent from 2009/10 to 2013/14) (Figure 1) and ‘intensified’ focus on supporting those with the greatest needs. Housing policies made little impact on the supply of new homes. Between 2010 and 2013 an average of 139,000 new homes per year were completed, compared with 190,000 under Labour. There were 17 per cent fewer adult learners as course funding was curtailed, and loans introduced. Centrally funded neighbourhood renewal activity was drastically reduced, while economic regeneration programmes performed well below expectations in terms of business and job creation. Despite Government endorsements for voluntary activity and a ‘Big Society’, Third Sector budgets also fell, with cuts estimated between 50 and 100 per cent in some deprived neighbourhoods.

Falling number of people receiving community-based, residential or nursing care
services through local authorities, (England).

In early years services, the number of Sure Start children’s centres fell from 3,631 in April 2010 to 3,019 in June 2014, although survey data showed that many of those remaining expected to maintain, or even expand, the services they provided, in part by making them more targeted. There was also new early education provision for 2-year olds and the number of health visitors and Family Nurse Partnership provision for teenage parents expanded.
‘Protected’ areas have been less hard hit. In education, the Coalition kept school funding resources broadly stable. In England, the number of schools increased, pupil-teacher ratios were maintained, and while the average class size increased in primary schools, it fell in secondary schools. Although there were more 16-19 year learners, the proportion not in education, training or employment fell. Health services were protected relative to other areas but pressures on access and quality began to emerge as increases in demand outstripped increases in spending. The proportion of cancer patients seen within 62 days declined and fewer hospitals met their Accident and Emergency waiting-time targets. Public satisfaction with the NHS, measured by the British Social Attitudes Survey, fell from 70 per cent in 2010 to 60 per cent in 2013. Among employment services, the new Work Programme proved cheaper, though no more effective, than its predecessors.
Tax and benefit changes benefited richer groups more, while contributing nothing to deficit
reduction

Despite the Coalition’s insistence that “those with the broadest shoulders should bear the greatest
burden”, the poor bore the brunt of its changes to direct taxes, tax credits and benefits from May 2010 to 2014-15. Up to 2014/15, the poorest twentieth lost nearly 3 per cent of their incomes on average from these changes (not allowing for VAT and other indirect taxes) and people in the next five-twentieths of the income distribution lost almost 2 per cent. With the notable exception of the topmost twentieth, those in the top half of the distribution were net gainers from the changes. Perhaps surprisingly, overall the ‘welfare’ cuts and more generous tax allowances balanced each other out, contributing nothing to deficit reduction.

The combined impact of direct tax and cash transfers was mostly regressive, moving
incomes from poorer households to those that were better off.

Early protection for the poor, but increasing poverty later

As a result of decisions made under Labour and initially continued, benefits rose in line with inflation during the Coalition’s first two years at a time when real earnings fell during the recession. The result was that poverty measured in relation to median incomes (before housing costs) fell until 2012-13. Income inequality also fell during election year 2010-11 and held steady up to 2012-13 at its lowest level for a quarter of a century. However, figures measuring poverty against a fixed income threshold show an increase over the same period – the more so when housing costs are taken into account.
These latest official figures pre-date most of the Coalition’s welfare reforms coming fully into effect.
Modelling analysis by the Institute for Fiscal Studies suggests there will already have been a sharp rise in relative poverty (and in poverty against a fixed line) between 2012/13 and 2014/15 for children and for working-age non-parents, and then a further rise to 2020/21, with the relative child poverty rate reaching 21 per cent, up 3.5 percentage points from 2012/13. Qualitative evidence suggests growing hardship since 2013 among households affected by a combination of falling real wages, rising fuel and food costs, changes to benefit rules, and sanctions.
Pensioners were protected, children less so

As far as taxes and benefits (including pensions) are concerned, pensioners continued to be relatively favoured. As a share of national income, transfers to pensioners had increased under Labour from 5.4 per cent of GDP in 1996-97 to 6.6 per cent in 2009-10. This was also the proportion in 2014-15, although a peak of 6.9 per cent was reached in 2012-13. However, pensioners with care needs were affected by cuts to adult social care.

Meanwhile the cost of working-age benefits not related to having children fell from 3.4 per cent in
2009/10 to 3.1 per cent in 2014/15, and spending related to children from 2.8 per cent to 2.3 per cent of GDP by 2014-15. Concerns about future social mobility might be raised as young children in low-income families were affected by cuts to spending on services, as well as by reductions in benefits for the underfives. On the other hand, poorer school age children received additional help through the Pupil Premium. Fears that the abolition of the Education Maintenance Allowance and the rise in university tuition fees would widen socio-economic gaps in further and higher education participation have not been borne out to date. In fact the proportion of young people not in education, employment and training fell for the first time in a decade in 2013, and increasing numbers of disadvantaged young people applied to university.
Too early to tell for many social and economic outcomes

Most data indicating changes in outcomes are only available until 2012 or 2013, making it impossible to assess the full impact of Coalition policies. The data available to date show that progress in many areas continued in the new government’s early years, but much of this must be considered the legacy of the previous government, since many policies were not fully implemented in the period covered. An exception is education, where, up until 2013, attainment continued to improve and socio-economic gaps to narrow, although no immediate accelerating effect of the Pupil Premium was evident. Early indications are that these gaps may widen when 2014 results are released, since poor pupils have tended to rely more on the vocational qualifications that now carry less value in school league tables.
The overall picture is that there has been little significant change, as yet, in many of the key indicators of social progress and equity. Health inequalities remain deeply entrenched. There is no evidence of closing socio-economic gaps in child development. Gaps in worklessness and poverty between the poorest neighbourhoods and others reduced as the economy recovered, but not quite back to their preeconomic-crisis levels. The Coalition did preside over positive trends in employment, which rose to a new peak in summer 2014, higher than before the crisis. But wages fell and much of the increase was in self-employment and part time working. Some indicators were less positive. Unmet needs for care among the elderly increased. Housing became increasingly unaffordable and homelessness increased.
Still high levels of debt and deficit, and further cuts to come
The protection of health, schools and pensions from major spending cuts meant that even with
reductions of around a third in some other services, the scope for budget savings was limited. Overall, the effect of all the Coalition’s measures in the current parliament has been to cut public spending by 2.6 per cent in real terms, from £674bn in 2009/10 to £656bn in 2014/15 (at 2009/10 prices). As GDP grew, this brought spending down from a peak of 47.1 per cent of GDP in 2009/10 to 43.7 per cent in 2014/15.
The current budget deficit was reduced from 5.9 to 3.5 per cent of GDP. However, public sector net debt rose to 80 per cent of GDP by 2014/15. Current plans to address this are predicted to reduce public spending overall to 38.2 per cent of GDP by 2018/19. Day-to-day spending on public services (excluding benefits and debt repayments) is predicted to fall to its smallest share of national income at least since 1948.

Conclusions

There is no doubt that the Coalition Government formed in 2010 faced a very tough fiscal climate and ongoing social policy challenges. Its response was to seek to reduce the deficit quickly. It also decided to achieve most of its fiscal rebalancing through public spending cuts rather than increased taxes, and to protect the NHS, schools and pensions – all very big areas of public spending – from major cuts. And it implemented some expensive commitments, notably increasing the income tax personal allowance to £10,000 and a more generous system for uprating state pensions.
These decisions meant that while the overall reduction in public expenditure has been less than three per cent, very substantial cuts were made in unprotected areas, largely in local services. In the tax and benefits system, pensions were protected and benefits to lower income families were reduced, while there were tax reductions for some better off households. Despite the aim that the better-off should contribute a greater share of income than the poor, the reverse was the case across most of the income distribution. Poverty rates measured against a fixed threshold rose to 2012/13 (the latest official data) and are predicted to rise further, and there are signs of increasing material deprivation and hardship arising from a combination of rising costs of living, reductions in the value of benefits and eligibility and short-term benefit sanctions. Meanwhile, the ‘protected’ NHS has experienced real average annual expenditure growth rates that have been positive but exceptionally low, while adult social care services have been cut.

Although current public attention rests on ‘the cuts’, the Coalition’s large-scale reforms designed to
reduce the size of the state, stimulate private and voluntary provision and increase personal
responsibility may ultimately prove its biggest legacy. It is too soon to establish their effects on social and economic outcomes. Whoever is elected in 2015 faces a welfare state in flux, with fundamental changes to the NHS, schools, and benefits still underway. At the same time, many problems that the Coalition inherited remain. Increasing need for health and social care, unaffordable housing, a regionally unbalanced economy, and continuing labour market inequalities all remain to be tackled, as do child poverty, insufficient high quality affordable childcare, a weak system of apprenticeships for young people and relatively ineffective mechanisms for helping workless people back into work. The next Government, like the Coalition, will need to address these issues in the context of high public sector net debt and a current budget deficit, and with many of the most straightforward cuts already made. The climate for social policy and those most affected by it will remain cold for the foreseeable future.

Further information

The full version of this paper The Coalition’s Social Policy Record: Policy Spending and Outcomes 2010-2015, is available at http://sticerd.lse.ac.uk/dps/case/spcc/RR04.pdf. It is a summary of nine detailed accounts of changes under the Coalition in all the topics mentioned in this paper: cash transfers, health, adult social care, housing, employment, the under fives, schools, further and higher education and area regeneration. Readers wanting further details are advised to go to the individual papers which can be found at http://sticerd.lse.ac.uk/case/_new/research/Social_Policy_in_a_Cold_Climate.asp. All the papers are part of
CASE’s research programme Social Policy in a Cold Climate (SPCC), funded by the Joseph Rowntree Foundation, the Nuffield Foundation, and Trust for London. The views expressed are those of the authors and not necessarily those of the funders.

Ruth Lupton, with Tania Burchardt, Amanda Fitzgerald, John Hills, Abigail McKnight,
Polina Obolenskaya, Kitty Stewart, Stephanie Thomson, Rebecca Tunstall and Polly
Vizard

The Coalition’s Record on Adult Social Care: Policy, Spending and Outcomes 2010-2015

Approaching 1.3 million older people and younger disabled and mentally ill adults
use social care services in England, and 3.2 million are cared for informally, by their
families and friends. How did the Coalition respond to long-term pressures that are
putting care services and carers under growing stress?

– The Government legislated to make more people with modest wealth eligible for publicly funded
support, by raising the capital threshold used as a means test from £23,250 to £118,000 (from
2016) and introducing a lifetime cap on care costs. However, this cannot be expected to have much
impact on continued under-funding for social care as a whole.
– Public spending on social care has failed to keep pace since the mid-2000s with demand for
services from growing numbers of older people. Spending cuts imposed by the Coalition intensified
the pressure on social services from 2010 onwards.
– Overall spending is projected to have fallen by 13.4 per cent over the Government’s five years in
office. Already by 2013/14, 17.4 per cent less was being spent on services for older people. By
contrast, the number of people aged 65 and over increased by 10.1 per cent over the same
period, including an 8.6 per cent increase in the population aged 85 or over.
– The number of people receiving publicly-commissioned adult social care services fell by one quarter
between 2009/10 and 2013/14 from 1.7 million to below 1.3 million. Care at home and other
community-based services were hit especially hard, resulting in an average 8 per cent reduction in
the number of users each year.
– The number of people with learning disabilities using community-based services grew slightly, but
all other client groups experienced cuts. The number of service users among working-age adults
with mental health problems dropped by 37 per cent and the number of physically disabled users
aged 65 or over fell by 32 per cent.
– Local services were increasingly targeted on adults assessed as having the most complex needs.
The proportion of social care clients being supported for five or fewer hours a week declined from
37 per cent to 28 per cent between 2009/10 and 2013/14. The proportion receiving care for more
than ten hours a week increased from 34 per cent to 45 per cent. At the same time, nearly three quarters
of councils now arrange some social care visits as short as 15 minutes.
– Monitoring of care services based on users’ perceptions suggests some quality of life outcomes
have improved. Nevertheless, statistics on the abuse of vulnerable adults show 37,685
substantiated cases in 2013/14, while Care Quality Commission inspections revealed serious
concerns about the quality of care in a fifth of nursing homes and a tenth of residential care
homes.

http://sticerd.lse.ac.uk/case/_new/news/year.asp?yyyy=2015#772

The Coalition’s Record on Health: Policy, Spending and Outcomes 2010-2015

David Cameron promised in 2010 to “cut the deficit, not the NHS”. But how have the Coalition’s policies – including health reforms which are widely viewed as going beyond election commitments – impacted on health?

– While the Coalition has ‘protected’ health relative to other expenditure areas, growth in real health spending has been exceptionally low by the standards of previous governments. Average annual growth rates have lagged behind the rates that are deemed necessary to maintain and extend NHS care in response to increasing need and demand.
– Forecasts warn of an NHS ‘funding gap’ as wide as £30bn by 2020/21 unless the growing pressures on services are offset by productivity gains and funding increases during the next Parliament.
– Major health reforms emphasising decentralization, competition and outcomes have been implemented. These have transformed the policy landscape for the commissioning, management and provision of health services in England. The overall framework for political responsibility and accountability for health services in England has also changed.
– Minimum care standards, inspection and quality regulation have been revised and strengthened following the Mid-Staffordshire NHS Foundation Trust Public Inquiry.
– Key indicators point to increasing pressure on healthcare access and quality. These include indicators on patient access to GPs, accident and emergency services and cancer care. Public satisfaction with the NHS is considerably lower than a peak reached in 2010.
– The UK’s ranking on OECD “international league tables” remained disappointing for some health outcomes including female life expectancy and infant mortality.
– Suicide and mental health problems remained more prevalent following the 2007 economic crisis.
– Health inequalities remained deeply entrenched. The difference in average life expectancy between men living in the poorest and most prosperous areas of England is nine years, and six years for women.

http://sticerd.lse.ac.uk/case/_new/news/year.asp?yyyy=2015#772