How do you cut a deficit without killing-off recovery? Governments, whether in Greece, the UK, or even the US, seem caught between a rock and a hard place. Yet Keynes suggested another alternative: tax the rich. Its good for growth and doesn't break the bank.  Surprisingly, it looks like the forthcoming election in the UK may be fought over substantive differences in economic policy. A few months ago the Conservatives were making the running with accusations of financial profligacy and talk of immediate measures to cut the deficit. But Labour has clawed back credibility, with leading economists [1] agreeing that securing growth must come first. In the US, the Republicans have pursued similar tactics to the UK Conservatives, being accused by Paul Krugman of politically motivated “deficit hysteria [2]”.

Putting growth before the deficit is classic mainstream Keynesianism. But what happens when markets will no longer finance a country's borrowing? In the Eurozone, the debate has been dominated by the fear of Greece, Spain and other countries becoming unable to finance their deficits. Ireland is already engaged in savage cuts in the midst of its continuing recession. This could yet be the fate of larger economies like the UK if the promised recovery is not as robust as hoped. Keynesian economists argue, with good reason, that such cuts will only push economies deeper into recession. But when government are “maxed-out”, what alternative is there?

Mainstream Keynesianism has always focused on the role of anti-cyclical deficit spending. However, Keynes recognised that his General Theory also had other policy implications. One was that reducing economic inequality can stimulate demand, and therefore growth. It has been left to the fringes of Keynesian to keep such ideas alive. A recent book, The Great Financial Crisis, [3] by socialist economists John Bellamy Foster and Fred Magdoff , is exemplary. It traces the origins of the current crisis from the decline of capitalism's post-war “Golden Age” until the present. Its broadly Keynesian analysis is worth summarizing.

Explaining capitalism's “Golden Age”
The “Golden Age” of the 1950's and 1960's – when growth was high and unemployment low – was created by a conjunction of conditions that sustained strong aggregate demand. They included state spending on the Cold War and on the rebuilding of Europe and Japan. They also included conditions promoting a high “propensity to consume” - this means a strong preference for spending on goods and services rather than for saving.

The Depression and the war were a period of relatively weak consumption and high savings. During the postwar period people had some catching up to do and the means to do it. Economic inequality was low thanks to high wages, progressive taxation and the welfare state, and this also encouraged spending over saving. This is simply because low and middle income groups tend to save less of their income than the wealthy. Redistribution (or a fairer initial distribution) thus increases demand. Strong aggregate demand made it attractive to invest savings in the real economy, promoting high employment and growth.

The Golden Age becomes leaden
In the late 1960's, the “perfect storm” of demand stimulating conditions began to subside. The postwar reconstruction boom was over, and consumer markets became more saturated. To these factors we can add ageing populations and growing inequality. The result, though it may seem paradoxical given the recent consumer booms in the US and UK, had been an increasing tendency to save, and not consume.

A trend of increasing saving can be bad for growth. As I have described in greater detail elsewhere [4], it tends to reduce the attractiveness of output-expanding investment in the real economy. And savings have other places to go. Savings may be invested in productivity improvements that cut costs without expanding output, or speculated on rising asset prices (houses, shares) or lent back to consumers through mortgages, credit cards, and the like. As the 1980's, 90's and 00's progressed, speculation and consumer borrowing grew ever more important as outlets for excessive savings.

As inequality has increased, the well-off have saved ever more. And in effect they have lent ever more money to the less well-off. Germany, Japan and China have suffered from chronically weak demand; their well-off savers have lent to the lower income groups of the US and UK who were persuaded to fuel consumption with massive debts. These flows are nothing more than a redistribution of wealth from the rich to the poor. They had the effect of maintaining global demand.

But the problem is that the world's savers want their money back; demand has simply been borrowed from the future.

Beyond debt-dependent growth
Public borrowing has so far prevented a collapse, but is really only an extension of the credit bubble. Governments are acting as debt-fuelled consumers of last resort. But this is arguably not worse than the “deficit hysteria” that seeks to shrink the state, and that believes recovery will be achieved by unleashing the forces of “enterprise”. This has nothing to do with the economic realities of the last decades. The reality is that as long as non-debt-fuelled demand stagnates, so will non-debt-fuelled growth. An alternative is needed.

Policies of tax and spend can increase demand by taking money that would be saved and spending it. And, as Keynes wrote in the General Theory [5] (Chapter 8, II), “If fiscal policy is used as a deliberate instrument for the more equal distribution of incomes, its effect in increasing the propensity to consume is, of course, all the greater.”

What is needed is a redistribution of wealth that doesn't have to be paid back. This can occur through state spending on infrastructure, such as proposals for a Green New Deal, or on service provision. More effective still would be welfare provision that enhances the spending power of the poor. But such measures will only have the desired, sustainable effect if they are neither funded by borrowing, nor by regressive taxation. Funds must come from taxation, and the more progressive, the better. Better still would be an industrial policy that sought to raise real wages and to reduce the enormous gulf that has opened up between the pay of top managers and that of ordinary employees.

As the Governor of the Bank of England, Mervyn King has rather poignantly noted [6], the major industrialised countries all seem to be counting on export-led growth. Everyone hopes the demand will come from everyone else. It can't happen. Whether for Greece, the UK, or elsewhere, progressive policies offer perhaps the only way to cut the deficit and stimulate growth, and thereby perhaps even allow the orderly unwinding of our massive debts.

Published on openDemocracy (http://www.opendemocracy.net)