The 5 myths about the UK economy which it suits everyone to perpetuate

The economy is the big issue: it was at the last general election, it has dominated and will dominate this parliament, and it will be the big issue at the 2015 general election. Yet trying to get behind the political rhetoric to discover the economic reality is surprisingly tricky. The purpose of this post is to look at what I see as the top five myths currently being perpetuated about the economy, and to explain why I think our current debate is misleading the public and diverting us from finding proper answers.

Myth 1: UK public spending is reducing

So keen has been the Coalition and Labour (for their own different reasons) to talk up the extent of the Government’s spending cuts that the reality has been forgotten. Public spending is going up year-on-year under the Coalition, rising from £690bn in 2010-11 to £744bn (+8%) by 2014-15. If we allow for inflation, there will be a modest reduction: from £690bn to £668bn (-3%) by 2014-15.

That figure of £668bn public spending in the final year of this parliament will be higher than in every single year of the last Labour Government’s 13 years in office, bar its final one. Indeed, Coalition spending in 2014-15 would be higher even than that final Labour year (2009-10) if it were not for the increased cost in servicing the national debt.


(Graph from Burning our Money blog; data from Tullett Prebon economic and fiscal database.)

Myth 2: The Coalition is bringing UK debt down

Not surprisingly, given 1) the economy isn’t currently growing and any recovery is forecast to be weak, and 2) the Government is continuing to maintain historically near-record levels of public spending, the national debt is forecast to continue rising throughout the lifetime of this Parliament. Yet politicians, including Nick Clegg as well as the media, persist in confusing the different concepts of deficit (at its simplest, the excess gap between what we earn and what we spend as a nation in a year) and debt (the accumulation over years of all our borrowing).

So, for the record, here are the public debt figures for the UK. The UK’s debt is increasing throughout this Parliament on the following three measures:

  • Nominal figures: from £903bn (2010-11) to £1,251bn (2014-15);
  • As %-age of GDP: from 61% (2010-11) to 69% (2014-15);
  • At 2010-11 values: from £903bn (2010-11) to £1,125bn (2014-15).


(Graph from The Spectator; data from Tullett Prebon economic and fiscal database.

Myth 3: Ed Balls’ ‘too far, too fast’ claim has been justified

The present dire state of the UK economy has led many to argue that Ed Balls’ repeated warnings, originally delivered in his Bloomberg speech in August 2010, that the Coalition Government is cutting ‘too far, too fast, have been justified. As we’ve seen, however, the reality is somewhat different: public spending in real terms does not even start to reduce until next year (2012-13), and even then it shrinks by just 1% of GDP.

It is true, though, that Labour’s publicly declared plans for the deficit at the 2010 general election were more modest in scope than those adopted by the Coalition. It is quite another question whether they would have stuck to them: after all, it was Labour’s Alistair Darling who warned of ‘cuts deeper than Thatcher’, and Liam Byrne who admitted there was no money left. But let us assume Labour would have done what they said they would: what then would have been the result for the British economy?

This is a counter-factual question which has been assessed by the Ernst&Young ITEM team using a model identical to the Treasury’s to work out the macroeconomic impact of sticking to Labour’s fiscal plans between 2010 and 2012.

The results? Well, under the most likely scenario of Labour’s looser fiscal policy (identified in the graph below as Labour 2), economic growth would have been fractionally lower (2.0%) than under the Coalition (2.1%) in 2010, identical in 2011 (0.7%) and slightly higher in 2012 (0.7% cf 0.4%):


(Graph from Centre for Policy Studies; data from Ernst&Young ITEM club.)

Overall, the marginally higher growth of Labour’s looser fiscal policy would have resulted in 70,000 fewer unemployed. However, that reduction would have been obtained with an increase in debt across the three years of £26 billion — the equivalent of £370,000 per job — to be repaid by the nation later.

In any case, Labour’s ‘too far, too fast’ mantra is built on sand. The reality is the Coalition has so slowed down its original deficit reduction programme that it is now less stringent than Alistair Darling’s. Yes, that’s right — the Coalition’s fiscal plans under David Cameron are looser than Labour’s fiscal plans were under Gordon Brown:


(Graph from The Spectator.)

Myth 4: Obama’s approach is the reverse of the Coalition’s

Trying directly to compare and contrast two different economies such as the UK’s and US’s is tricky. Nonetheless, many, especially on the left, have pointed to Obama’s policies — and the relative success of the US economic recovery — as evidence that the Coalition’s supposedly more extreme austerity policies are therefore flawed.

Yet it’s hard to square this direct comparison with reality. In fact, Obama cut federal spending by 0.9 per cent in real terms from 2010/11 to 2011/12, identical to the UK’s average real term cuts across this parliament. And, as this graph shows, the US deficit reduction plan is forecast to be ‘faster and almost as far’ as the UK’s:


(Graph from The Spectator; no live web-link.)

Fiscally, then, there is more similarity between the US approach and the UK’s. If you want to look for an Obama comparison that holds, you’d be better placed looking at the similarities between his taxation policies and those of the Lib Dems.

Myth 5: There’s an easy, immediate solution to all this

There is something rather ‘Alice in Wonderland’ about the current UK economic debate. The Coalition argues that it is taking historically tough action to bring down the deficit and curb the national debt. The evidence just does not support this assertion. Labour meanwhile asserts that it is the Coalition’s fiscal toughness which has driven the UK back into recession, even though the differences between the Coalition’s approach and Labour’s are minimal.

In short, it suits both sides in this argument to pretend that the dividing lines between their two economic approaches are wider than they are: it maintains the pretence that the electorate faces a great ideological choice between the Coalition and Labour. This illusion is promoted by a media which is also much happier to portray imagined conflict than it is to present the messy reality.

The closer reality is that neither the Coalition nor Labour is at all sure how to respond to the current economic slowdown. The growth of the Blair/Brown years was driven by a massive expansion of personal and government debt, as Tim Morgan has noted here in his pamphlet The Quest for Change and Renewal:

Between 2000 and 2009, the big drivers of the economy were private borrowing and public spending. Reflecting this, the CREF (construction, real estate and finance) sectors expanded rapidly on the back of private borrowing while big increases in real public spending drove up output from HEPA (health, education and public administration) … the rapid growth between 2000 and 2009 in both CREF (+42%) and HEPA (+28%) masked a languishing in the rest of the economy (–5%), with real output from manufacturing plunging by 26%.

These differential rates of growth left a huge proportion of the economy incapable of growth. In 2009, the public spending driven HEPA sector accounted for 19% of all economic output, whilst borrowing-dependent CREF activities represented a further 40%. Add in a retail sector beleaguered by the squeeze on real disposable incomes and almost 70% of the economy is incapable of growth. Thus seen, Britain’s growth prospects are grim, because a huge proportion of the economy is skewed towards, and dependent upon, the dead-and-buried drivers of private borrowing and public spending. And growth is critical to the Coalition’s fiscal plan, because that plan cannot work unless revenues increase in response to a brisk expansion in output.

The usual attempts at an economic fix have failed, as consumers, companies and government de-leverage after a decade or more of maxing out their debt. The Government (both Coalition and then Labour) has tried to boost private spending by keeping interest rates at close to zero, while the Government (both Coalition and then Labour) has injected huge sums of public money into the economy — some £825bn through a combination of deficit spending and quantitative easing. So far none of this has worked, though it may of course have prevented the situation from becoming even worse.

Conclusion

The first step toward a diagnosis is to acknowledge the extent of the problem. Yet that isn’t currently happening in our debates on the economy. Political debate instead turns on the minute differences which separate the Coalition’s and Labour’s remarkably similar economic approach.

It suits the political parties, and it suits the media. But as a result myths are taking hold — that the Coalition is embarking on ‘slash and burn’ austerity, or that the national debt is being wiped clear — which distort the reality of the situation. And this only makes it harder to begin grappling with our problems.

* Stephen Tall is Co-Editor of Liberal Democrat Voice, and editor of the 2013 publication, The Coalition and Beyond: Liberal Reforms for the Decade Ahead. He is also a Research Associate for the liberal think-tank CentreForum and writes at his own site, The Collected Stephen Tall.

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59 Comments

  • Andrew Suffield 18th Jun '12 - 8:23am

    Agreed. I have been saying this for some time. We need to stop bickering over insignificant details and start looking for the real problems.

  • Good stuff, Stephen.

    One point – “This illusion is promoted by a media which is also much happier to portray imagined conflict than it is to present the messy reality.” Does anyone else think Leveson should be addressing this issue? I’m much more concerned about this journalistic laziness than I am about much of the other stuff that’s being explored.

  • Richard Dean 18th Jun '12 - 9:15am

    May I suggest …

    Myth 3a, that tiny differences between predictions are significant.
    They are not. The differences between the predictions the three graphed policies are far too small to draw any conclusions from, apart from the conclusion that they basically give the same growth.

    Myth 5a, that there is no solution, and
    Myth 5b, that the solution is complicated.
    If we believe we will fail to find one then we are rather likely to actually fail to find one!

    Myth 6, that economists know what they are talking about, and that present theories of macro-, meso-, and micro-economics and banking are correct. We wouldn’t be in this crisis if they did/were!

  • Andrew Tennant 18th Jun '12 - 9:24am

    I hate it when anyone compares with the Darling Plan’s forecast deficit numbers and they don’t include Darling’s assumptions. Darling assumed a cynically unrealistic growth rate of 3.5% every year. The numbers are fantasy, a meaningless fudge – they allowed Labour to dodge the difficult choices and pretend the public finances would get better. The reality is that Labour would have borrowed far more or else had to amend their plans post-election more along the lines the government are now taking.

  • Rebecca Taylor 18th Jun '12 - 10:19am

    Great article Stephen.

    We need to tackle some of these myths. Various conversations I’ve had with random member of the public (including a Leeds taxi driver yesterday) seem to indicate that “the government is making big cuts” message has been taken up (whether coming from government or Labour), although most accept that some austerity is necessary.

    Another point: why are we not more often pointing out that no-one should be taking lessons in economics from Ed “light touch regulation” Balls. Alistair Darling was and remains in my opinion more credible. I think this is a Labour weakness that should be better exploited. Am I on my own there?

  • Absolutely brilliant article! (and I’m a former Tory, now UKIP).
    It really is so refreshing to read something that concentrates on the economic facts & debunks all the ridiculous rhetoric from all sides. Congratulations, I will be linking to this extensively on my FB, Twitter & Blog. Everyone should read it.

  • agree with Sid. Perhaps we should all be writing to Leveson..

  • David Freeborn 18th Jun '12 - 10:48am

    I’m afraid I disagree with point 4. The overall US deficit is falling at a comparable rate to the UK’s precisely because they are cutting the structural deficit more slowly- meaning that their economy is now growing much faster.

    For almost the entire period since March 2007, and particularly since March 2010, the US has run a looser overall fiscal stance – a more stimulative fiscal policy – than the UK, even taking the full operation of the larger automatic stabilizers in the UK into account. Cumulatively, since 2007Q1, the difference has amounted to 3% of GDP.

    The evidence in so far as it exists really does suggest that a looser fiscal policy helps to stimulate growth, and the US has been doing this much better than the UK. For example take a look here:
    http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech560.pdf

  • Myth1: Although total spending is going up, much of this is as a result of the recession we are now in, and the consequent increase in the benefit bill. There are significant reductions occuring in budgets that effect “front-line” services all across the country at the moment.

    Myth2: I’m in agreement with you here, and worry about what Nick Clegg said. Its not clear to me whether he a) Just mis-spoke (but he’s a politician who very rarely does this. A physicist wouldn’t confuse speed with acceleration, say) b) genuinely doesn’t know or c) deliberately use the wrong word in an attempt to confuse

    Myth 3: You final point is itself built on sand. It is the failure (or the absence) of the growth plan which causes all the problems and means the Coalition is missing not only its own deficit reduction targets, but even the Darling ones. The talking down of the economy in the run-up to the last election (“age of austerity”), and past it (“Britain is bust”) led to the double dip recession that meant that Osborne’s boasts of “securing the recovery” were false.

    Myth 4: There is some truth in what you say, but we should be adjusting our deficit reduction plans based upon the strength of OUR economy, not on how other countries react to the strength of theirs. (Ours isn’t doing too well: http://i793.photobucket.com/albums/yy220/bojk/photo.jpg since the coalition took over).

    Myth 5: Is this a myth? Does anyone seriously say there is an immediate solution to this? We need to get the economy growing, and then we need to get the deficit down (in that order). Neither are easy and neither can be done without posing and answering some difficult questions.

  • Richard Dean 18th Jun '12 - 11:02am

    Concerning Myth 2, could someone please explain why real debt is projected to continue to increase? Why is the deficit (Myth 3) projected to continue? What will it pay for?

    Also, why has manufacturing gone down so much in Myth 5, while CREF went up? Is this a consequence of something, or is it a driver of something?

  • Hmm, well Stephen doesn’t quite say it, but myth 1 seems to be verging onto the territory of Fraser Nelson’s “austerity, what austerity?” mantra, which is of course nonsense.

    http://www.ippr.org/?p=782&option=com_wordpress&Itemid=17

  • Avoiding the issue much – cutting 100s of thousands of public sector jobs means a) a big cut in the revenue take, and b) a big cut in disposable income, leading to a slump in demand and growth flatlining. Also, no mention is made of the proportion of the public sector spend that is wasted on PFI, on projects that either fail to deliver or which are ditched before they get going; also, there is the money siphoned off in the form of excessive profits, exec salaries and bonuses and shareholder dividends. Yes, to my mind that constitutes waste.

    And if this deficit truly was the most momentous and threatening crisis to face Brit ain since WW2, why haven’t taxes on the wealthy (er, who have most of the wealth!) gone up in order to solve the problem? Another problem taxing the rich would solve would be their urge to subvert the democratic process – that would be a win-win!

  • LondonLiberal 18th Jun '12 - 11:38am

    A really interesting article, Stephen, thanks.

    At my (local government) place of work the other week we had a presentation about the rise in public spending in relation to cuts in local government finance. The things that struck me about that, in relation to the above were:
    1. Given that the NHS is protected in real terms (by a marginal 0.1%) and accounts for a huge chunk of public spending, the global total hides significant cuts in other budgets (eg housebuilding has had a 60% cut, and local government a 28% cut in this CSR). So, echoing Aaron above, we mustn’t let the graph in Myth 1 hide the fact that a lot of people are feeling agreat deal of pain.
    2. The ageing population and increasing medical technology orf course means that healthcare inflation is much higher than GDP anyway, so even this 01% represents an effective cut in real funding over this CSR.
    3. Demographics also place great pressure on other budgets – our ageing population need ever larger amounts of adult social care, and at the other end of the age spectrum there is a crisis of funding for primary school places in London, yet local authorites have less money than ever.
    4. We are of course financing the costs of the recession through debt interest payments – thata ccounts for a significant chunk of public spending. But we are also financing the costs of unemployment from taxes. Investment in things that are necessary and which create wealth, like building new social and private housing, would boost GDP, reduce umployment, and thus doubly benefit the state by paying out less JSA and getting more tax revenue.

  • LondonLiberal 18th Jun '12 - 11:42am

    @ MIke Cobley

    “And if this deficit truly was the most momentous and threatening crisis to face Brit ain since WW2, why haven’t taxes on the wealthy (er, who have most of the wealth!) gone up in order to solve the problem? ”

    They have. LibDems doubled Capital Gains Tax (ie on unearned income) from 14% to 28% in June 2010.

  • LondonLiberal 18th Jun '12 - 11:43am

    apologies – CGT went from 18% to 28%, not 14%.

  • Richard Dean 18th Jun '12 - 11:58am

    Myth 7. News that increases share prices is good news.

    No, it just means the beasts smell a meal. When share prices rose recently after a Spanish bank bailout was agreed, it meant that the stock market expected Spanish banks to buy shares. Share prices fell back quickly again when it became clear that Spanish banks weren’t going to invest that 100 bn in shares.

  • @ Andrew Tennant
    Picking up your point about Darlings assumptions – He also based his figures on strong growth within the Eurozone and World Economy, with growth around 4.5% for the current period, leading to an export led recovery within the UK. Oil assumption was at $72 barrel. CPI inflation at 1.5 – 2%.

    Further, in relation to ‘Myth 3′ – Based on the figures, for the period 2014/15 – The period prior to the next GE he made an assumption that borrowing would be 4.4% of GDP :
    Page 4 http://webarchive.nationalarchives.gov.uk/20100407010852/http://www.hm-treasury.gov.uk/d/pbr09_completereport.pdf
    Against the figure of 4.3% in the current budget assumptions:
    Page 24 http://cdn.hm-treasury.gov.uk/budget2012_chapter1a.pdf so the call of Ed Balls of ‘too far, too fast’ seems somewhat hollow!

  • Myth X The Treasury is Competent

    “using a model identical to the Treasury’s to work out the macroeconomic impact of sticking to Labour’s fiscal plans between 2010 and 2012.”

    Without going into the result of this can anyone trust a treasury forecast ? In all the years I have taken an interest in politics they have tended to be wide of the mark. Not that many independent economists have been much better at any strategic level forecasting.

    @Dave Page
    “There’s also the myth that there’s an awful lot that any UK chancellor could do about growth, with the storms in the Eurozone battering at our coast. ”

    This is true, but a buck that politically cannot be passed in this way. In large part that is due to the early tendancy of the coalition to blame all economic woes on Labour without acknowledging the 2008 – 2010 period of crisis. This means that they will be judged in the same way. I said on this site two years ago that a decent analysis should have been done to show what the difference in position would be had the Lib Dems / Conservative positions been taken at key times such as budgets. Often it would have been little, both coalition parties supported reducing regulation on banking and both would have spent at similar levels throughout much of the Blair years (Lib Dems honestly talked about a 1p take raise to allow this, whilst Tories would have cut taxes). But there would have been a difference and it would have been favorable to the Lib Dems.

    Instead a myth that there would have been no problems without Labour was formed which will come back with bells on now it is clear we will be a poor economic state come the next election…..

  • Full marks, but Myth one is not a myth – in real terms, spending is falling. That is the only way to look at it.
    CREF spending can rise – there are lots of unemployed construction workers etc.

  • The BBC is the big problem as it pushed the cuts agenda all the time, notably on its regional TV programs. On my local programme they never fail to bring up hard luck stories and blame them on the cuts. And we pay for this biased rubbish through a mandatory licence fee.

    Also we need to cut through the swathe of employment regulations. small firms cant cope with all the hoops they have to jump through to employ people. Employers with less than 100 employees should be exempted from a lot of this.

  • Nice article. Good outline and conclusion.
    Growth, (or lack of it), is clearly the key to this. And yes, there is, no, immediate easy solution. But we will have to look for a solution or, a solution will be imposed upon us by unfolding events.
    We all want growth. But what if we are hitting the ceiling? What if the clear logic that, you cannot have infinite growth in a finite world, is beginning to slap us in the face? Not what you want to hear? No, me neither, but reality has a habit of imposing upon us, things we don’t want.
    Sometimes it’s good to see how other nations previously dealt with a contraction in their living standards. We have several near term examples, of which Argentina, Russia, Cuba, Greece and Iceland are a few. All had to endure austerity and contraction in their lives, but one country stands out as having dealt with it truly, as if ‘they were all in it together’, which is Cuba.
    No,.. I’m not suggesting we adopt communism. But the last time we were all in it together in Britain, in the 1940′s we took our austerity jointly, stoically and with good grace, because we had a common purpose ; to win a war.
    Well we are at war again. Our enemy is undefined, and frankly doesn’t need to be defined. All we need to grasp is that our joint survival is under threat. And we should group, to jointly fight that threat, as we did in the 1940′s.
    It’s not perhaps the solution you were looking for, and you may be laughing at the suggestion now, but I can guarantee that within 5 years you will be looking out on that beautiful manicured, (but useless) lawn, and begin thinking, ‘I could grow potatoes, carrots, onions and lettuce in that space in my garden.’
    Get ahead of the curve. Dig up that lawn now, and beat the rush to self imposed austerity. You know it makes sense.

  • Alexsandr’s comment sums up the danger of ‘myth’ 1. Completely out of touch – cuts are happening.

  • The horrible reality of myth 1 is this: all of the cuts to public services are only producing the most modest reduction in real spending. Depending on your perspective, this shows either how austerity is a false economy, or how out-of-control public spending was. The reality is probably a moderate dose of both.

  • Bill le Breton 18th Jun '12 - 1:56pm

    Myth (would it now be) 8: monetary policy is loose, because interest rates are historically low.

    The tight monetary environment remains the real limit on the recovery of the UK economy – as it is in Europe (tight everywhere other than for the German economy), as it has been for over a decade in Japan (raising interest rates every time growth returns) and as it is in the US.

    As evidence here are Osborne and Cable.

    Osborne said two very interesting things on Thursday night before the Governor of the Bank of England spoke:
    “… inflation in the UK has been significantly above the Bank of England’s 2% target since the end of 2009.

    That is due to a combination of commodity price shocks, the lagged effects of a lower exchange rate and a worsening underlying productivity performance, and it has very important implications for fiscal policy.

    Looking backwards it means that over this period looser fiscal policy would almost certainly have been offset by tighter, or less loose, monetary policy.” quote ends

    Put another way – if Parliament had loosened the Bank’s inflation target, fiscal loosening would have had a greater positive impact.

    Secondly, he said, “Looking forwards, it is very hard to argue that monetary policy – in all its forms – has run out of road.”

    A hopeful remark but why doesn’t he just pick up the phone, change the target and instruct the MPC to do whatever it takes to reach that new target? Could it be that Cameron and Clegg are resisting this?

    At least Vince Cable appears to be ‘getting it’. Here’s Vince, “In the 1930s, the abrupt departure from Gold – so much condemned by the City – had the strongest possible effect on expectations of rising money GDP.”

    What the rest of his speech reveals is his belief that what is needed is a monetary announcement (a new and NGDP growth target?) that is so ‘abrupt’ that it succeeds, to quote him again, ‘in making people expect rising money spending in the economy …’

    To me that is achieved by a co-ordinated fiscal and a monetary stimulus made effective by and operating through the expectations following from a new target.

  • Tim Nichols 18th Jun '12 - 2:42pm

    It’s a good analysis for the most part, but it doesn’t fundamentally change the main division in this debate between Keynesians and economic neoliberals. Keynesians are not going to be surprised by any of this as they knew plan A would not help – the surprise is for economic liberals who believed that monetarist policies and fiscal contraction would get us back to growth and allow us to borrow less.

    Labour’s analysis and narrative is closer to Keynesian, but not the bold and fully fledged Keynesian approach that many would like to see. So it might be more pertinent to critique Krugman than to critique Labour in terms of what the views are of many opponents of the Coalition. A Coalition vs Labour analysis is very Westminster-centric.

    While there is rightly criticism from Stephen for those who conflate debt and deficit, this article too often conflates deficit reduction with spending cuts. In the case of the US, we can see that the fact that they have returned to their pre-recession GDP level, while we are still in a depression trough over 4% behind our pre-recession peak, is a key factor in how they US is able to plan to reduce its deficit at only a slightly slower rate than the Coalition is proposing. They do not have to make anything like the same scale of spending cuts to achieve this.

    The article also makes the mistake of focussing in myth 1 on the fact that public spending is not reducing. That’s not really the crux of the issue. Yes, we know that, but the crux of the issue is the cuts. Just because public spending is not decreasing yet – and will only decrease a relatively small amount in real terms – it does not mean that the cuts are not happening. The Coalition is making very real major cuts in a lot of areas. We need to consider not just what the government is spending overall, but how it allocates its spending. Most of the planned cuts have still to be made, but when they are all made (assuming that happens) in 2014/15 and we are back to 2009 real terms level of spending then we will have had major cuts in some areas, but spending will have risen in others.

    For example housing benefit spending will have gone up, despite housing benefit cuts. This will be because, despite cuts to housing benefit for some families and the much trumpeted benefit cap (which saves very little but does great harm) market rents are rising and the elderley population is incrasing (HB for pensioners is a massive part of it). A Keynesian approach would involve building of more social housing and the introduction of rent controls, which would do much more to bring down the cost of HB than tabloid-candy like the benefit cap.

    There’s a few key points about the difference with Labour’s apprach that aren’t properly brought out by this analysis.

    * The final chart under Myth 3, headed ‘The Deficit’ should not be read as indicative of Labour’s planned spending cuts. While the Coalition has an 80:20 ratio of cuts to tax rises, Labour proposed 66:34. The Coaltion’s ratio is more likely to reduce aggregate demand and therefore to put downward pressure on GDP than Labour greater emphasis on taxation (especially if they had some asset taxation in mind – something Miliband says the are looking at – because that can increase aggregate demand).

    * Labour’s narrative behind their plans was focussed on the importance of getting the economy growing again to reduce the deficit. To be consistent they would therefore have been likely to slow down their fiscal contraction from Darling’s proposals in repsonse to negative economic indicators. I don’t take the Ernst&Young counterfactual seriously – these kinds of

    * The Coalition has focussed spending cuts in areas known to have high fiscal hindrance impacts – e.g. £20 billion of cuts to benefits and tax credits which go to households with the highest marginal propensity to spend. Labour’s cuts would be very unlikely to have been focussed so wrecklessly on areas with such high fiscal hindrance impacts.

  • Roland de Gustibus 18th Jun '12 - 2:58pm

    I agree with the analysis and have a suggestion. If the public sector and households have so indebted themselves they can’t be stimulated into growth, then perhaps we should look at the corporate sector. According to Andrew Smithers, corporations are sitting on a cash surplus of 6% of GDP, when a deficit is more usual.

    Some may have legitimate concerns about the return they might get for investing that cash, but I think there’s evidence in the excessive wage inflation of senior executives that another reason they’re not spending is investment is a cost, and cost reduces profit now, which reduces the bonus pool.

    Therefore action to increase the power of shareholders (bulging coffers doesn’t do them much good), or restrict executive pay to a multiple of median pay in their organisation might be a step in the direction towards more investment, more profit in the long-term, and ultimately growth.

  • I don’t understand Myth One. A “real cut” is the standard definition of a “reduction”.

    And what does this mean?

    “Coalition spending in 2014-15 would be higher even than that final Labour year (2009-10) if it were not for the increased cost in servicing the national debt.”

    Is debt interest not counted in the above figures?

  • A good article, apart from perpetuating the silly story about the note left, saying that there was no money left.This was a joke and I think it is silly to keep repeating this, as a truism.
    After all, there was lots of money left, as in the bailout loans offered to Ireland, etc, etc.

  • David Boycott 18th Jun '12 - 3:28pm

    “is reducing”?!

    Surely “is declining” or “is being reduced”?

  • Charles Beaumont 18th Jun '12 - 3:40pm

    Excellent article.

    But many people simply cannot believe that these cuts aren’t causing deep pain. So, please note this key point from the OBR on the 2012 budget: “We expect £6.2 billion less expenditure than we forecast in November, thanks largely to central government departments under-spending against plans by more than expected”
    http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/1910/191005.htm

    The government can’t even spend the money it’s allocated. This isn’t some Taxpayers Alliance tub-thumping anti-state position, but a question of capacity. If different policies existed, of course the money might get spent, but government underspending is a common phenomenon.

  • Old Codger Chris 18th Jun '12 - 4:29pm

    I’m looking forward to Prof Niall Ferguson’s Reith Lectures starting tomorrow on Radio 4. He claims that US debt is heading towards eye-watering levels – http://www.bbc.co.uk/news/world-18456131

    I’m sure others will disagree with Ferguson. Should be an interesting debate.

  • David Allen 18th Jun '12 - 6:39pm

    An excellent article, which isn’t to say that it gets everything right. It’s excellent because it tries to deal in facts and explode myths, and by golly don’t we all need that!

    The obvious question it raises is – who made the myths, and why?

    I think the Coalition were primarily to blame. The phoney atmosphere of crisis in the immediate aftermath of the General Election helped the Clegg Lib Dems to overturn their principles and join the Tories. They pretended to be panicked into forming a “strong” government which would undertake the necessary draconian cuts. They were not.

    Labour embraced and exaggerated the same semi-mythical story because it also suited them to paint the Coalition as heartless cutters. To be fair to Labour, their line was gifted to them by their opponents, and there was more truth in it when they first said it than there is now.

    As Stephen comments, now that the draconian cuts story has served its purpose, the Coalition are moderating their policies. However, there is no evidence that this is being done because it is what the country needs. It is being done to safeguard against Labour beginning to convince people that austerity is harmful and thereby gaining votes.

    Stephen is quite right: the myths are harmful, and act to perpetuate the real problems. Unfortunately, myth-making shifts votes. Sensible actions, however, probably won’t shift votes. This is because no sensible action is likely to achieve a favourable result in a short enough timescale to gain credit for the political party which took the sensible action.

    Hence, our politicians will carry on myth-making. Our voters have an intuitive grasp of this situation, which is why they are gradually giving up on voting.

  • Andrew Suffield 18th Jun '12 - 7:16pm

    Also, why has manufacturing gone down so much in Myth 5, while CREF went up? Is this a consequence of something, or is it a driver of something?

    Consequence: manufacturing has been moving to China and similar nations, due to the low cost of workers there and the extremely high cost of employing people in the UK, relative to the value of the goods produced.

  • Richard Dean 18th Jun '12 - 11:53pm

    “Manufacturing has been moving to China and similar nations, due to the low cost of workers there and the extremely high cost of employing people in the UK, relative to the value of the goods produced”

    Then if we want to get manufacturing up again, we need to find out what we can supply that those nations need and can’t economically make or do themselves, and we need to develop exactly those industries. I wonder what those industries might be?

  • John Carlisle 19th Jun '12 - 9:36am

    Excellent article and thought-provoking comments.
    @Richard’s last comment about outsourced jobs: We can and do compete with manufacturing jobs in China where wage inflation is rife . Remember the cost to the OEM must include transportation and the variation in lead times. Forging has already come back. The Chinese factories that are cheaper are usually those trained by the Japanese, following the Deming model.
    Also, the comparative costs of geeks producing games etc. is marginally lower here than the outsourced equivalents.
    A couple of questions: 1. How can construction go down when the demand is so huge at every level, from infrastructure to housing? Is it just that money is not being released? If so, might it be time to re-examine Marshallian economic theory?
    2. The Libdems have a group working on a growth strategy. What has happened to it?

  • Matthew Huntbach 19th Jun '12 - 4:21pm

    Stephen Tall

    The first step toward a diagnosis is to acknowledge the extent of the problem. Yet that isn’t currently happening in our debates on the economy.

    Yes, and I am afraid with your “Myth 1″ you are part of the problem and not part of the solution.

    I am sorry to see so many Liberal Democrats using this line, which used to be a right-wing Tory line. While accepting its literal truth, when given without qualification, as here, the implication is “There are no real cuts, so what are you complaining about?”.

    Apart from increased spending on welfare following from higher unemployment which others have noted, there are many other factors driving up public spending, most obviously the quite phenomenal increase in lifespans in recent years. It really is phenomenal – go into any corner shop and see the 100th birthday cards on sale, when just a few years ago reaching 100 was considered something freakish – yet it seems hardly to be realised just what an impact it has. The result of this is that keeping still in the amount of state spending required if services and pensions are to be kept steady means greatly increasing public spending. So people see services cuts and to say to them “They aren’t really being cut, spending is going up” is disingenuous. When politicians and political spokespeople use the line of Myth no. 1, the response from ordinary people is not “Oh, I see, sorry I didn’t realise, carry on you’re doing a grand job”. It’s “You are so out of touch, what you are saying cannot be true, it doesn’t fit in with life as I and those I know experience it”. So, Stephen, just who are you trying to impress with that line? The only people who are impressed with it are extreme economic right-wingers who like to use it to make an excuse that the cuts in services they support aren’t real and the plebs should stop moaning about them.

    If we are going to have a sense of reality in politics we must START with being honest about the realities of what is pushing up public spending. Once we have done that, then we can be honest about whether the response should be to cut services or increase taxation. Note that “solutions” such as “people should put more money into private pensions” do not really solve the underlying problem, they are just more of the public-private jiggery-pokery that gas so messed things up as we see now. If the argument is that a rising proportion of GDP spent on public services is bad because it is anti-productive, I don’t really see how it changes things if instead of that money being collected from workers in taxes and paid to the retired in pensions it is collected from workers in rents and share dividends and paid to the retired in pensions. Why is one supposedly restrictive on enterprise and the other not? In both cases, one person works and someone else benefits.

  • Your argument here, Matthew, is one I have used several times, about the nature of the spending. In my view, the correct approach is that we need more spending during this period – whether we call this “Marshall Plan” or whatever. There are several strands here
    1 Yours, that it is positively unfair to reduce spending on services as dramatically as it is happening (care, educational support and health are taking the big money hits, but other services eg libraries are taking a bigger pro rata percentage)

    2 Benefits – of course the number of people supported and crude amounts will go up at a time of short time working and highish unemployment, but that is at the same time as real benefits levels are being cut, in a number of ways.

    3 Trade Unions are historically weak, so cannot negotiate adequate wage rises to compensate for price rises.

    4 We have an environmental and resource crisis, which should be provoking massive investment in transport, in renewable energy, in insulation, in better housing, to name but a few.

    We, of the “new politics” tendency, are not publicly recognising the scale of change needed to confront current challenges. We are in a season of international summitry. One might hope our leaders rise to those challenges, not make wishy washy excuses, and try to put the blame on anyone but themselves.

  • We seem to have acted very like Japan by creating a combination of public and private debt in our bubble that’s very close to Japanese levels. Like them we preserved our zombie banks and have gone into an extremely low interest rate regime . The price for Japan has been decades of low growth combined with ever increasing debt to GDP ratios. Our policy has been so like Japan’s the likely outcome has to be the same – decades of low growth and a rising debt/GDP ratio.

  • @ Mike Cobley

    “Avoiding the issue much – cutting 100s of thousands of public sector jobs means a) a big cut in the revenue take, and b) a big cut in disposable income”

    Cutting public sector jobs means a reduction in revenue take? Every pound in tax paid by a public sector employee is first paid for by a private sector employee (probably £1.50). It would be cheaper to pay public sector employees nett of tax and reduce the admin costs.

    A reduction in disposable income? Reduce the size of the state and you reduce the tax burden on the private sector, which increases real disposable income .

    Funny!
    ————————————–

    Lots of discussion about how we can compete – we need to reduce our costs. I don’t just mean our wage costs, I mean our input costs – our cost of living is too high. Some things we can control, some things we can’t. Why don’t we start by reducing the cost of things we can control? Where is the vision for how we can get through this? More of the same? And again? And again? When will someone ‘fess up and admit it just ain’t working, we need to try something else. “A bankers solution to a bankers crisis” – now who was it that said that…

  • @Pytyr

    “Every pound in tax paid by a public sector employee is first paid for by a private sector employee (probably £1.50).”

    That simply is not true. You don’t understand how money works in an economy if you think the private sector pays for the public sector. Both the public and private sector are both part of the same economy, exchanging goods and services using money. Neither sector pays for the other, unless you start from the premise that one sectors does absolutely nothing of any worth. I therefore presume that you think the public sector does nothing of any worth?

  • @Pytyr
    “Reduce the size of the state and you reduce the tax burden on the private sector, which increases real disposable income ”

    No it doesn’t. It reduces the real disposable income of those working in the public sector by an equal amount.

  • Stephen, I think it’s too easy – I’d call it lazy thinking – to label them myths when each is a fine example of a Straw Man.

    I know that your analysis has gone down well with many in our ranks but it is more a case of mythologizing differences over economic policy than getting to the nub of important issues.

    On what you call myth 1: I think that you are confusing spin, over broad public spending totals, with the real political and economic cleavage: a political and economic argument about the damage done (to the poorest and most disadvantaged) by changes to the pattern of public spending and taxation.

    The serious dispute – amongst serious folk, from all the political parties – is about the distributional impact of changes in taxation and spending. Liberal Democrats need to focus on who is being hurt and who is not…and how badly.

    Because so-called Keynesian stabilisers account for such a high proportion of our public expenditure only a fool/spinner would subscribe to the proposition that government can wave a policy wand and transform the ratio of public spending in the economy in a few short years and least of all in an economic trough.

    Although they may often fail to put it clearly the anger coming from Liberal Democrats who find themselves at odds with their colleagues in government is about the extent to which ‘we are all in it together’, rather than about crude totals. While you are undoubtedly correct about what has happened to the broad totals I think you have missed an opportunity to raise the quality of the debate and get to the nub of the political differences (which do exist).

    On myth 2 what you’ve written also looks more like mythologizing than myth spotting. Serious observers of the economy – from across the political spectrum – know that public expenditure isn’t plummeting. Your ‘myth’ is a fine example of spin – a bit like scoring a goal…but it’s into an open goal; you’re just confirming what almost everyone who lives beyond the world of sound bites knows. It rather looks, to me at least, as though this piece of mythologizing is aimed at enabling you to move smartly on to your ‘myth 3’ – what appears to be the real political purpose of your journey into myth making and myth debunking.

    On myth 3 – cutting too far and too fast – it seems to me you have seized on an opportunity for a bit of Punch and Judy. If I may render part of what you say in street lingo: ‘Ed Ball’s got it wrong – ya boo and sucks to him (and to them)’. Unfortunately it is precisely the kind of knock about that frustrates me – Liberal Democrats should be doing their best to get away from it. The big issue is how much more government should be spending (rather than how much it is cutting) AND what that spending should consist of. In truth that is the ground onto which the serious and informed economic debate has moved. Just consider the two Mansion House speeches for example and Martin Wolf’s increasingly strident columns in the FT.

    What is particularly worrying – to me at least – is that this is the point where you join the ranks of the myth makers. Apparently each ‘new’ job (what about the ones that have been lost and are being lost?) will cost £370,000. Do you really want to rest your case on nonsense figures plucked out of the air, just like the OBR, which is now so thoroughly discredited and having to constantly revise its estimates to catch up with reality?

    The truth is that our party is part of a Government that is cutting – when it should be boosting the economy. It is time for a Liberal Democrat (Keynesian inspired of course) to offer lessons on counter cyclical monetary AND fiscal policy; there are occasional hints that Vince Cable wants to do so, but – for some unaccountable reason – feels inhibited in doing so. Vince has heard of the multiplier, the liquidity trap and the paradox of thrift – even if many of his fellow Liberal Democrats have not.

    We face a massive under-utilisation of our national resources. The trough in economic activity, which we entered some years ago, needs to be counteracted in ways that invest for the nation’s future at historically low public borrowing costs. We need to spend (and we can spend) in ways that begin to restore public revenues and help limit growing dependence on welfare benefits. When we start to climb out of the dead zone then it will be time to cut public sector debt. Ask Richard Koo about the logic of such a strategy – in ‘a balance sheet recession’, take a look at what Bill Martin and Robert Rowthorn of University of Cambridge have recently had say about unused capacity in the UK economy Is the British Economy Supply Constrained? and read Mervyn King’s Mansion House speech really carefully.

    When the UK economy starts to climb out of the dead zone (the NIESR have a rather nice monthly chart showing where we are – and have been) let’s get stuck into an intelligent and informed, an unspun, debate about substantial rather than spectral political differences over economic policy making. In the meantime – as we have our own currency and it floats freely against other currencies – we are in a position to cope, as a nation, with adjustments in its value.

    We can put our national interest first, and for Liberal Democrats – in the current environment – there should not be too much doubt about where that lies.

    If the pound falls further that will help rebalance the UK economy – something as a party we say we want.

    Of course the relative value of the currency is of particular concern to very powerful asset holding interest; those interests are arraigned against pursuing policies that hurt ‘the City’. As a Liberal Democrat I want to focus on the balance of interests for the nation as a whole, rather than on smoke screens. Don’t you really want to do the same?

    The real myths (the two principal myths) are that government is powerless (before wholesale money markets) and that adding to government debt is equivalent to a private household borrowing beyond its means. These are the myths that your piece give a remarkably good impression of wanting to perpetuate/leave unchallenged.
    The latter is the myth that Osborne and company believe has a real grip on the British public imagination, based on focus group research. Unfortunately I think Osborne and company are right about that…and we must shoulder some of the blame for its perpetuation. It is a myth that is becoming increasingly difficult for them to square with panic announcements from the Bank of England and the Chancellor himself about what we need to do to stimulate economic recovery in the UK and in the Eurozone.

    On myth 4 – you begin by giving yourself an intelligent warning: US politics is different. Unfortunately you go on to ignore that warning. What Obama would like to do and what he has been able to do are two completely different things.

    Obama’s people get it – at least they do now. Unfortunately Larry Summers only really got it after he had left the White House. Obama is locked in. What he can do and what he would like to do are very different things. It isn’t a case of a myth…it’s, I am very much afraid, another case of a convenient misrepresentation and inexcusable simplification.

    On myth 5 – mythologizing appears to have taken the lead again. There is no-one I take remotely seriously, including those I disagree with very strongly, who subscribes to the proposition that ‘There’s an easy, immediate solution’. This is exactly the kind of nonsense (playground) allegation – about the mind set of those who disagree with us – which gives popular journalism and political speech making their (well deserved) bad name.

    There are alternative strategies and there are profound disagreements about them; none of the alternative strategies – that includes the approach I favour – are being promoted seriously by people who pretend they are a magic fix for the British economy. For those who go just a little way below the surface the alternatives currently being advanced by economically and politically literate people come with substantial economic health warnings.

    Lining our political opponents up in order to shoot them down because they are dishonest spinners…and doing it by spinning hard ourselves simply devalues the political currency we all have to use.

    I am desperate to see more Liberal Democrats challenging economic mythologizing but we have a clear political responsibility to begin by stopping adding to it

  • Ed, a thoughtful and well-presented comment.

    I would agree with much of your analysis. Specifically the importance of the distributional impact of changes in taxation and spending and the inability of government to transform the ratio of public spending in the economy in a few short years.

    You emphasize the need for counter-cyclical monetary and fiscal policy and cite the economic rationale of a Keynesian stimulus – the multiplier, the liquidity trap and the paradox of thrift.

    You implicitly acknowledge that stimulus spending can only be effective to the extent that the economy is not supply constrained and reference the University of Cambridge study as evidence that “we face a massive under-utilisation of our national resources.” I believe that the evidence supports the existence of substantial capacity in the economy.

    You go on to note “the real myths (the two principal myths) are that government is powerless (before wholesale money markets) and that adding to government debt is equivalent to a private household borrowing beyond its means”

    Put this way these statements may be categorised as myths. However, maintaining confidence in the currency both domestically and internationally (and hence the ability to borrow at competitive interest rates) does require conforming to financial market perceptions of fiscal prudence and sustainability. There is ample evidence that historically high levels of public debt lead on to loss of market confidence and the kind of run on sterling that we have seen five times now since the war.

    I would concur with the view that there is no easy, immediate solution. However, I would also suggest that in the absence of urgent radical measures to generate demand and economic growth, that the spare capacity that currently exists will be lost and our ability to manage deficit reduction will go with it. Consequently, I would advocate a series of short, medium and long-term measures as follows:

    1. Immediate tackling of inequality and distributional impacts by:
    (a) Minimum wage job guarantee for all eligible workers seeking full-time employment.
    (b) Citizens minimum guaranteed tax credit to replace unemployment and incapacity benefit as well as personal tax allowances.
    (c) Co-financing of housing associations for major program of affordable housing development.
    (d) Making available government guarantees for long-term fixed rate mortgages.

    2. Increase in capital spending program of £30 billion per year:
    (a) To finance local authority social housing and infrastructure development.
    (b) To implement £500 billion national infrastructure plan over ten years.

    3. Supply-side measures
    (a) Replacement of business rates, council tax with Land value tax
    (b) Merger of income tax and NI into single flat rate and replacement of higher rate income tax with Land Value Tax.
    (c) Single combined and simplified policy for regulation of SME activities – covering trading standards, health and safety, consumer protection, taxation and employment regulations.

    4. Industrial strategy
    (a) to support and develop new technologies, nascent industries and exports to emerging markets.
    (b) to develop the skills and training required to support an enhanced engineering and manufacturing base.

  • david thorpe 22nd Jun '12 - 5:30pm

    spending is fallin in real terms which is what matters

  • There are so many myths put forward by the mainstream media, including the BBC, it is difficult to know where to start. I think the problem is the complete misunderstanding of how macro economics works and that includes all the political parties.
    I find the best analysis is provided by Professor Bill Mitchell, http://bilbo.economicoutlook.net/blog/.
    His analysis, along with Paul Krugman, should provide the basis of the social democratic economic policy we should be advocating. Deficit reduction, you know it doesn’t make sense!

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