Austerity, Mark Blyth argues, is dangerous. As a consequence, he launches a full-out attack on the “growth through austerity” regime that Europe has embraced in an attempt to push policy onto an alternative path. Blyth defines austerity as “a form of voluntary deflation in which the economy adjusts through the reduction of wages, prices, and public spending to restore competitiveness, which is (supposedly) bets achieved by cutting the state’s budget, debts, and deficits” (p. 2). Such measures are dangerous for three reasons: they do not work, the underlying rationale is a lie, and they rest on a fallacy of composition. Austerity does not work because deflation increases, rather than reduces, the real debt burden. Austerity is a lie because the underlying problem is weakness in the banking system and not sovereign debt. Austerity rests on a fallacy of composition that resides in the savings paradox: If everyone saves, aggregate demand collapses and income falls. Moreover, the author claims, austerity is not only dangerous but unnecessary.

Blyth develops this argument in three parts. Part I details the origins and evolution of the series of financial crises that engulfed the United States and the European Union beginning in 2007. He shows that with the exception of Greece, current sovereign debt problems do not reflect excessive state spending, but result from bailing out banks. Part II explores the intellectual history of austerity. He traces the origins of this dangerous idea back to Locke, Hume, and Smith and then forward to F. A. Hayek, Milton Friedman, James Buchanan, and Alberto Alesina. Blyth uses this intellectual history to argue that contemporary enthusiasm for austerity reflects an ideological commitment to roll back the welfare state, highlighting the way that economic theory and public choice theory created an ideational bias against effective state economic management. Part III focuses on austerity’s natural history. Here, Blyth demonstrates that austerity has never worked—it did not work in the Great Depression, it did not work during the 1980s and 1990s, and it is not working in contemporary Europe. He concludes the work by offering one possible alternative to austerity that is strongly informed by the more heterodox approach taken by the Icelandic government.

‘The book’s principal success lies in its ability to place contemporary austerity in a much broader historical context. Doing so allows Blyth to demonstrate convincingly that Europe’s austerity regime is a contemporary manifestation of three mutually reinforcing and historically recurring distributive conflicts. Most obviously, austerity reflects a struggle to distribute the costs of a banking crisis between banks and “society,” or, more meaningfully, the low- and lower-middle-income working class. He argues that the decision to bail out the banks places most of this burden on workers. This domestic distributive struggle is reinforced by an international distributive battle between international creditor countries and international debtor countries. This battle pits German lenders against Greek and other southern European borrowers. Finally, austerity has generated a more fundamental distributive struggle over who should pay to insure individuals against the risks inherent in a capitalist economy. Should these costs be socialized to support the core functions of social democratic welfare state, or should individuals be required to self-insure against these risks? And this deeper battle is unfolding within countries but also across the EU as a whole as it considers the degree to which the European Union should accept responsibility for the economic and financial mistakes of individual countries. What strikes me most is that although the ongoing struggle between creditors and debtors receives most of the attention, the more important issue at stake is a struggle between postwar European social democracy and a somewhat romanticized neoliberal alternative.

While Blyth offers a compelling critique of the austerity regime and highlights the dangers it contains, I found the alternative to austerity that he offers unpersuasive. The book presents the Icelandic model as its inspiration for an alternative to austerity. For those unfamiliar with the details, Iceland responded to its banking crisis in 2008 in a quite different manner than most other European countries. The Icelandic government refused to bail out Iceland’s largest banks. Indeed, given the magnitude of the banks’ foreign debt—which at the onset of the crisis was seven times Iceland’s GDP—the government could not bail them out. Instead, the government guaranteed domestic deposits, nationalized the banks, and defaulted on other (mostly foreign) liabilities. The government borrowed from the International Monetary Fund and accompanied these steps with what Blyth calls “financial repression”: the imposition of capital controls. The author suggests that this approach generated a short crisis and a more rapid recovery than one sees with austerity programs. The broader lesson he draws is more succinct: “above all, don’t bail your banks” (p. 240).

Yet Iceland’s solution does not scale up easily. Iceland is tiny, its national income is $15 billion, and although Icelandic banks’ foreign liabilities were large relative to Icelandic GDP, they were tiny relative to the global financial system. Consider that Iceland’s total private foreign debt was $85 billion; Lehman Brothers alone held $613 billion at the time of its collapse. Thus, when Iceland’s banks defaulted, they posed minimal risk to global finance. German banks, Iceland’s largest creditors, had only $21 billion at risk (compared to $240 billion they had in Ireland); the UK had only $4 billion at risk. Thus, refusing to bail out Iceland’s banks was painful, but it was not deadly. The same cannot be said about the consequences of refusing to bail out the banks in the United States, the UK, and Germany or in those countries that are indebted to them. In these countries, allowing banks to fail would likely have catastrophic global consequences that would retard recovery substantially. Moreover, Iceland essentially forced the cost of its crisis onto foreign creditors. The idea that all governments could do so simultaneously suffers from the very fallacy of composition that Blyth decries in his critique of the austerity regime. Thus, while there may well be alternatives to the austerity regime, he does not convince me that the Icelandic model is one of them.

Nevertheless, Austerity is compelling and essential reading for anyone who wants to understand fully the case for and the even stronger case against austerity.