Contribution to the workshop “Beyond Neoliberalism and Neo-illiberalism: Economic Policies and Performance for Sustainable Democracy” at the New School

Let me tell you a little bit about my adult life as experienced through crises. In 2008, I moved to the UK, and the first crisis hit and was very apparent. The global financial crisis affected mounts of demography and my own economic outlook. It also resulted in an excessively large PhD cohort at the LSE at the time, because many decided to postpone their entry on the job market. Many of these PhD students decided to study this crisis and what came from it: I was one of them.

The global financial crisis was followed by the debt crisis, which was very salient in Europe. It was followed by the refugee crisis, the austerity crisis, and the COVID-19 pandemic, which had dramatically different outcomes across countries, depending on the handling of the crisis. More recently, we now have the Ukraine war and the energy crisis.

This multitude of cascading crises is happening in the context of a global heating crisis as an overarching challenge, and a global demographic imbalance where our social system and our economic and social organizations face a demographic pyramid that does not promise a demographic dividend. Hence, many institutions (i.e., the monetary system, the unified currency, the trading system) are challenged by something that mankind has not seen before. I see two extreme paths and many muddled paths that this can go.

It is in this context that my research on austerity has unfolded and continues to unfold. I have studied in particular the origins and the causes of austerity, as well as the consequences of austerity in the UK from a policy standpoint. Most recently, this work has been focused on the COVID-19 pandemic and its handling. I am currently working on an ambitious piece of work on the handling of the energy crisis that emerged from the war in Ukraine and the climate crisis more generally.

What crises have in common

Throughout my research, I was struck to see that there is something that connects it all, and this is something I came to realize last year while reconnecting with some of the readings from my youth, particularly those in psychology. The narratives behind the attacks on the democratic organization of society, particularly those coming from the political right, tend to often lean on the perception of government inaction, or its inability to deliver. For this reason, I believe that the empirical work many economists are doing to study and analyze the unintended consequences of policies is incredibly vital. This work allows us to understand why these unintended consequences exist in the first place. This type of loop is the common denominator that surrounds all of the above-mentioned crises. This is also what brings us here to this conference to discuss the threats to liberal democracy and alternative social organizations that are being championed; such as illiberal forms of governments, potentially technologically augmented dictatorships or autocracies.

By living through and researching these crises, I have started looking for the commonalities they exhibit. We start with a shock, or a crisis, which is followed by a policy response that often comes in too little and too late, and has a specific signature depending on which party is in power (this is particularly observed in countries that possess a majoritarian two-party system like in the UK and the US). When they come from the political right, these policy responses are typically increasingly regressive. They are facilitating or encouraging outright fraud or leakage of public funds. In other words, they tend to benefit larger firms more than smaller firms by being explicitly anti-competitive and reinforcing monopsony power, or of a market power of specific firms. They further actively erode state capacity and to some extent further skew relative prices, in particular intergenerationally. Because policy responses tend to come with a specific ideology, and oftentimes too little and too late in a specific flavor, they produce unintended consequences, which requires costly fixes of these policy errors. The narratives around how these fixes should look like, because of the development of the media ecosystem, in particular the emergence of social media, oftentimes result in two very unappealing options: the extreme left interpretation and the extreme right interpretation.

There needs to be a policy response to fix policy errors, which automatically creates an industry of action that my recent experience over the last three years suggests that there is something common here that governments oftentimes simply cannot deliver. This is where the connection to austerity comes in as I think it has eroded said state capacity. The consequence of producing biased and politically shaped policies produces intentional or unintentional errors that again will need fixing. This contributes to an erosion of trust and a reduction of resilience. This will in turn produce voluntary political disengagement of some groups and potentially result in erratic shifts in turnout that make the process of predicting political outcomes and navigating political engagement increasingly difficult. I argue that this volatility of voter turnout and the difficulty to predict elections is one of the features of populism. It is about activating a voter pool that has selected to be disengaged. A consequence of the erosion of trust is the rise of extreme individualism, which undermines our ability to overcome collective action problems. The minimum group size threshold that one needs, as economists would call it, might increase and make the collective action problem more complicated. Other consequences in the forms of exit also exist. Instead of exercising their voice, some may exit through deaths of despair or poor mental health, which ultimately puts us in a worse situation when the next crisis hits, triggering the same cycle.

I have seen policymaking in a range of countries from the more democratic spectrum to the less democratic spectrum. I have engaged with policymakers, and many of them actually want to do evidence-based policy making. But they do not seem to be able to do so, and I have some hypothesis on why this is the case. One thing that I find increasingly shocking, and I observed this, is that a lot of the institutions that are archetypal institutions in rentier economies, such as heavily institutionally dualized labor markets are seeping into Western market systems. The UK is actually adopting a lot of policies that are very similar to what you would see in the Middle East and North Africa, practices of bonded labor which we know is shrinking the size of the pie, due to the inefficient allocation of workers to jobs. It is the rejection of individual freedom and a rejection of human relationships that may be built on an ethics of care and mutual respect.

All that raises the specter that some countries may essentially be importing the rentier economy and their institutions, just as I and many others are actively advocating to help the natural-resource rent driven rentier economies to cast away with that institutional legacy or primal instinct – to help them build thriving economies. So, where are the rents – if they do not have a natural resource origin? The answer may well be: politics. Because every crisis provides short-term economic opportunities, for money to be made by addressing the crisis. And even if this is done with the best of intentions of all involved, within a highly polarized society that finds itself confronted with new and vulnerable technologies of mass communication, the invariable policy mistakes and errors that happen – intentionally or unintentionally, feed cycles of distrust, ultimately further eroding state capacity and resilience.

The energy crisis that we have seen in the wake of the Ukraine war and the policy response to address it provides a unique opportunity to study and evaluate the quality of said policies across countries. This is essentially what I am currently working on. It is bringing together my own life experience, all of my past research through which I tried to illustrate the zero-sum failures of past interventions and many more deep and very personal emotions.
In terms of the narratives around policy failures and inaction, there are typically three lines of argument: 1) the lack of data, 2) the lack of time or 3) the lack of evidence. On each of these three points, I believe we have a good understanding of why these barriers do exist. On paper, all the right data exists, it may just not be available to those who can make best use of it from a societal perspective. In terms of time, typically, some crises are more predictable than other crises – the climate crisis has been well predicted now for decades. In terms of the evidence, we know that this is heavily influenced by influence industries, and the absence of experts, in particular the lack of incentives for experts to engage in the boring work of policymaking and working with government departments.

In the wake of the energy crisis, I have reached out to government entities, systematically across 165 local authorities in the UK, as part of an RCT. There was a lot of engagement and willingness to engage with experts who have proactively reached out. The problems are often of a logistical nature. Around this framing and discussion of deliberative attacks, which indeed exist, there are also a lot of logistical issues that impede effective, agile and timely response by the public sector which is in charge of developing the menu of policies that politicians eventually evaluate. This is an important insight that we cannot ignore about the plumbing of our societies. Following my discussions with politicians and policymakers, it was clear to me that they want to listen to the evidence and to follow the signs, but very few are competent or able to tell apart what is good quality research evidence from bad evidence. And again, these are normative terms. In general, and on average, designing policies for a country, for all citizens, is a highly complex task. Listening to the evidence is hard, in particular if those who should be listening to the evidence are not well trained to tell apart what is good from what is bad evidence, in terms of the quality. I think the research community can and should do more to actually offer their help and our profession should get better at offering reward and recognition for this type of work.

What I have also noticed in policymaking is that a lot of policies, a lot of times, the do- nothing scenario is the counterfactual. That is “what is a specific policy proposal being evaluated against?”. And obviously, if this is the framing that decision makers approach a problem on, then doing nothing in most instances, around a crisis, is not an option. If this is the only counterfactual the public is informed about and that has been considered, and what the evaluations were, for example through mandatory economic impact assessments, that are routine practice in the UK, then this is a big problem. The public needs to demand more and demand better to understand what is the menu of options that is being considered. And last but not least, I must emphasize that there is a lack of skills. The reason why many of my freedom of information requests take a long time in most instances suggests that they simply do not know how to extract granular individual level data, to anonymize it in a way that is not disclosive. Protecting the right of privacy of those whose data is being represented is important, but that obviously is a barrier then for the research community. We would not want to be in a world where access to data is available only to some private sector players, and some in government. This is why I expect, in not too long, that there will be a discussion of privacy as a policy parameter. Neither too much, nor too little privacy is, in my opinion, desirable.

The internal organization of government is also a central challenge, as governments and executive branches of ministries are organized in silos with limited inter-operation, communication and cooperation. The Cabinets are organized in silos, which makes combining and merging data that is necessary to design good policy options really difficult. This brings us to the challenge of systems competition. In my experience working with governments, I have seen data rooms in countries that I would describe as being quite far from Western notions of (representative) democracy. The concerns about data governance are, I have observed, very strongly founded. Looking forward, I believe this is where Western societies need to develop an alternative view and significantly up their game.

Austerity as a signature zero-sum policy

Austerity is a signature zero-sum policy that showcases many of the aforementioned issues. The specific design of the UK’s implementation of austerity was very much informed by ideology, shaky cross-country empirical evidence, and cross-country regressions that I do not think would uphold the quality standards of modern applied and economics research. They would not stand up to that scrutiny. And that, I think, is an important qualifier. Austerity, in particular how it was implemented in the UK, reflected the political realities of the time: old people turn out to vote while young people are disengaged (voluntarily or involuntarily, that is a different question). In terms of welfare reforms and from 2010 onwards, we have seen a realignment of government spending along the age divide. Pension spendings have increased continuously, while spending that benefits future generations (education) was drastically cut and increasingly privatized through higher tuition fees. This was followed by drastic cuts in welfare and protection spending, which mostly benefits the current working generation (see figure 1). Those policies were hitting the poorest regions the hardest and exacerbated the existing divide. Those policies ticked all the boxes of what you would expect for the implementation of austerity. Looking at the data, it is consistent with what one would expect in a society that is organized by those who vote: those who turn out to vote get to have their say and influence policy.

Figure 1. Composition of government spending (2002-2014)

Source: Fetzer (2019) Did Austerity Cause Brexit?

Now, what were the effects of these austerity policies? I have written a paper that I think very cleanly separated and showcases how austerity basically caused Brexit through a range of mechanisms (see Fetzer, Thiemo. 2019. “Did Austerity Cause Brexit?” American Economic Review, 109 (11): 3849-86). The most important mechanism is that without austerity, sub-national politics in the UK would not have evolved in a way that creates the political pressures inside the Conservative party to put a referendum on the table in the first place. The vote that has swung in favor of Brexit was quantified to around 10 percentage points, directly attributable to austerity, which is the signature of populist politics. The marginal voter was very much an accidental Brexiteer, as someone who wanted to send a message, whereas the average Brexit voter was one of those old signature demographic groups that we tend to associate with a support for populism and nationalism. What we saw was the coalition bringing both these groups of voters together during the campaign, which ultimately swung the result in their favor.

The bigger context is the economic challenges and I argue that the welfare state as it was designed was just a band-aid to a larger, systemic problem. As seen in the graph below, within the same individual over time, for low-skilled people, there has been a drastic decline in labor income that has been stabilized by an expansion of benefit payments up to the point when austerity essentially put a halt to it. The cuts in the welfare state put a hold to the acceleration of benefit payments, which resulted in a decline in gross incomes, eventually leading to polarization. This polarization is driven by many factors across the skill divide and can be observed across regions, age groups, skills groups and ethnic groups, resulting in an increasing stratification of society.

Figure 2. Erosion of welfare state removing a “band aid”

Source: Fetzer (2019) Did Austerity Cause Brexit?

The welfare state was a band-aid. Austerity ripped that band-aid and Brexit was the consequence of it. Now, what is Brexit’s legacy? The legacy is: the pain continues, and the pain endures.

In a recent paper, I have looked at the economic consequences of Brexit across regions (see Fetzer, Thiemo and Wang, Shizhuo. 2020. “Measuring the Regional Economic Cost of Brexit: Evidence up to 2019”. CAGE, Working paper no. 486). Not only has austerity given rise to Brexit, the empirical evidence suggests that the alleged cure may be making matters worse. Brexit led to a cull in SMEs, a collapse in trade relationships, and a more concentrated and hence less competitive market. This was followed by a shock in international science collaboration that affected researchers and their work. Overall, the cure seems to be worse than the disease and it is estimated that any Brexit benefits will not appear before 2050. Since the vote, the narrative has been completely shifted around, and this is why I argue it is so important to study the unintended consequences of policies rigorously and carefully. This requires a careful distinction of quantitative as well as qualitative work. As argued earlier, policymakers cannot deny evidence, at least in (somewhat) liberal democracies such as the UK, and high-quality research that is hard evidence can inform the policymaking process and become an effective constraint.

With the change in the media landscape (i.e., professionalization of data journalism), informed research can constrain policymaking and serve as, as well as reinvent, checks and balances. I am hoping to make a contribution here over the coming months and years.

Finally, it is crucial to remember that austerity itself is not a policy but rather a general reduction in government spending and there are many ways of undertaking it. Curiously enough, many of the policies that have been lumped together under the austerity bundle can be rationalized (i.e., in the context of fighting climate change). One must therefore not be blindsided by austerity’s big label and understand that the devil is in the detail. It is the job of the profession of economics to make sure it equips its graduates with the skillset to do the right thing, know where to find which literature to read, which data to use, how to analyze it, skills many policymakers of our time lack.

I would like to add on a note that reflects my ongoing struggle. I do not think humans are genuinely bad. We are all shaped by our own experiences and preconceptions and many more things. How we read evidence and interpret what is happening in the world is shaped by many factors and the last twenty years have seen drastic changes to how information is produced and how it is consumed. We should not lose sight of this as this may create noise. I am a firm believer that the world would be better with more dialogue, more data and more hard research as this can produce less polarized debates. We should speak more with each other, than about each other. Researchers need to do more to actively explain their work. And I also sense that society may need to face some debates that it has actively shied away from, for a long time. Consensual approaches to policymaking empowered or constrained by rigorous evidence, though, may require giving up some of the spoils that come with political power: the control over political rents, that may mostly be information rents. Humanity is facing an existential crisis and we simply can not afford to succumb to narcissism. Strengthening and re- building state-capacity is vital. And since the Global North is ultimately asking the Global South not to follow its specific development path – owing to the carbon footprint that it entails – it is vital that the Global North is pushing ahead. The onus is on us.