Governing by Panic

• Published date: 01 March 2016
• Date: 01 March 2016
• Author: David M. Woodruff
• DOI: 10.1177/0032329215617465
• Subject Matter: Special Section Articles

Politics & Society

2016, Vol. 44(1) 81 –116

© 2015 SAGE Publications

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DOI: 10.1177/0032329215617465

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Special Section Article

Governing by Panic:

The Politics of the Eurozone

Crisis*

David M. Woodruff

London School of Economics and Political Science

Abstract

The Eurozone’s reaction to the crisis beginning in late 2008 involved not only efforts

to mitigate the arbitrarily destructive effects of markets but also vigorous pursuit

of policies aimed at austerity and deflation. To explain this paradoxical outcome,

I build on Karl Polanyi’s account of a similar deadlock in the 1930s. Polanyi argued

that a society-protecting response to malfunctioning markets was limited under the

gold standard by the prospect of currency panic, which bankers used to push for

austerity, deflationary policies, and labor’s political marginalization. I reconstruct

Polanyi’s “governing by panic” theory to explain Eurozone policy during three key

episodes of sovereign bond market panic in 2010–12. By threatening to allow financial

panics to continue, the European Central Bank promoted policies and institutional

changes aimed at austerity and deflation, limiting the protective response. Germany’s

Ordoliberalism, and its weight in European affairs, contributed to the credibility of

this threat.

Keywords

Karl Polanyi, euro, Eurozone crisis, Ordoliberalism, European Central Bank

Corresponding Author:

David M. Woodruff, Department of Government, London School of Economics, Houghton Street,

London WC2A 2AE, UK.

Email: d.woodruff@lse.ac.uk

*This is one of four articles in the March 2016 issue of Politics & Society on the topic of “The

Contradictory Logics of Financialization.” The papers were originally presented at a workshop held at

the Marconi Center in Marshall, California in May 2013 that was supported by the journal and a grant

from the Ford Foundation.

617465PASXXX10.1177/0032329215617465Politics & SocietyWoodruff

research-article2015

82 Politics & Society 44(1)

A fundamental, and quite puzzling, contradiction marked Eurozone leaders’ efforts to

deal with the effects of the world financial crisis that began in 2007–8. On the one

hand, both the Eurozone as a whole and individual European states sought to prevent

the transformation of crisis into catastrophe by evading the onset of well-known

vicious circles. To combat bank runs and the downward spiral of debt deflation, gov-

ernments offered deposit guarantees and bailouts, while the European Central Bank

(ECB) provided liquidity to the financial sector on an unprecedented scale.1 To avoid

a fall in consumer prices that would reduce incentives to spend and thus put further

downward pressure on prices, the ECB sought to cut market interest rates and increase

the money supply. Against the tendency of recession to breed more recession as spend-

ing and investment retrench in reaction to reduced demand, governments deployed

expanded spending on unemployment support and other automatic stabilizers and—in

2009, at least—explicit demand stimulus. Later, Eurozone leaders did not simply stand

aside in the face of an accelerating feedback loop between falling bond prices, higher

government interest costs, and the prospects for budget balance. Instead, they worked

to ease financing constraints for affected national governments. In short, national and

international policy responses to the Eurozone crisis were replete with measures pre-

mised on the belief that it would be too costly to allow assets to find their own price

on markets where pessimistic expectations could feed on themselves.

On the other hand, accompanying this impulse to reject the sovereignty of the price

mechanism and to build bulwarks against price collapses was a contradictory

impulse—one that sought to enforce the sovereignty of the price mechanism and dis-

mantle bulwarks against deflation. Above all, a number of governments, pushed by the

ECB and other European institutions, made efforts to fight high levels of unemploy-

ment by promoting declines in wages—for instance, reducing minimum wage rates,

decreasing public sector salaries, reducing unemployment benefits, weakening and

decentralizing collective bargaining, and forcing renegotiation of labor contracts in

recessionary conditions.2 Meanwhile, fiscal demand stimulus that would have moder-

ated downward pressure on wages and other prices was short-lived, and from 2010

states across Europe pursued austerity, seeking to balance budgets through tax rises

and spending cuts. Eurozone members also adopted new treaty obligations intended to

make austerity in reaction to budget difficulties effectively mandatory.

Thus, Eurozone governments and institutions pursued policies designed at once to

protect societies from markets and to subject them more fully to them. They used both

fiscal and monetary policy instruments to ward off vicious circles of declining growth

or financial implosion, yet did not turn these same instruments to promoting virtuous

circles of expansion. Rather than a comprehensive victory for the point of view that

prices cannot safely be left to find their own level, or for the rival claim that maximal

price flexibility assures rapid adjustment and resumption of growth, one finds a dead-

lock between contradictory impulses.

This stalemate was not unprecedented. In his 1944 masterwork The Great

Transformation (henceforth TGT), Karl Polanyi traced the interwar European catastro-

phe to a similar deadlock, one which likewise kept the widely shared impulse to pro-

tect the social fabric against arbitrarily destructive markets from growing into a

Woodruff 83

successful recovery program. Polanyi located the root of this deadlock in the use by

bankers of the shadow of financial panic to keep democratic politicians in check. As

he put it,

Under the gold standard the leaders of the financial market are entrusted, in the nature of

things, with the safeguarding of stable exchanges and sound internal credit on which

government finance largely depends. The banking organization is thus in the position to

obstruct any domestic move in the economic sphere which it happens to dislike, whether

its reasons are good or bad. In terms of politics, on currency and credit, governments

must take the advice of the bankers, who alone can know whether any financial measure

would or would not endanger the capital market and the exchanges. . . . The financial

market governs by panic.3

On Polanyi’s argument, the gold standard endured as long as it did, despite the tremen-

dous difficulties it entailed, because financial interests feared the political conse-

quences of unorthodox policy by labor governments and wished to retain the potential

to govern by panic. The end of the gold standard, by making a currency panic impos-

sible, meant “the political dispossession of Wall Street.”4 No longer constrained to

heed the counsel of bankers, governments could launch innovative attacks on eco-

nomic crisis, as the United States did in the New Deal. However, FDR’s unilateral

decision to take the dollar off gold was exceptional. Elsewhere, financial leaders

retained their capacity for obstruction, and would agree to abandon the gold standard

only when labor had been politically neutralized.

Where the gold standard was still in force, and where a drain of gold arising from

trade deficits and capital movements threatened convertibility, financial interests used

the prospect of panic to push for austerity and deflation. These policies aimed to

achieve the adjustment of international relative prices, restoring trade balance. They

were frustrated, however, by a “countermovement,” animated by “the principle of

social protection aiming at the conservation of man and nature as well as productive

organization.”5 Workers resisted decreases in wages, agriculturalists decreases in food

prices, and enterprises the destructiveness of a general deflation. Therefore, “authori-

tarian interventionism” in service of “vain deflationary efforts” weakened democracy

but did not achieve its aim.6 Economically, this led to an incoherent policy premised

on deflationary goals that could not be attained (and were destructive to the limited

extent they were). Politically, the direct opposition between economic and political

power meant an undermining of democracy. Only the demise of the gold standard

could break the stalemate between the popular principle of social protection and the

political leverage of financial interests.

With appropriate but remarkably limited modifications, this article contends,

Polanyi’s arguments about the political and economic consequences of the gold stan-

dard can explain the puzzling contradictions of Eurozone policy diagnosed above.7

That this should be so might well have surprised Polanyi himself. After all, the euro

was not linked to gold nor even fixed to any external currency. At no point in the crisis

was there even a remote prospect of a generalized flight from the euro. Moreover,

Polanyi’s account of the agenda motivating the bankers of the Great Depression era to