A few days ago, Stephen Tall posted his Five Myths About the UK Economy. But in fact understanding what is really going on in the economy is much harder than it first looks. One thing he was definitely right about was that the economy is the big issue and trying to get behind the political rhetoric to discover the economic reality is surprisingly tricky. I decided to post my own three myths about the UK economy.
Myth 1: Cuts aren’t really taking place
The latest fashion for conservative commentators is to deny that real cuts are even taking place. This government, they argue, is a phony, not really committed to cutting the deficit. Examples include the Spectator’s Fraser Nelson and the ever mild-mannered Peter Hitchens, who assures us, in no uncertain terms, that Britain will soon turn into a rainier, more miserable version of Greece.
They are, of course, wrong.
As this IPPR report shows net spending in real terms on public services fell by 0.5% this year- this is the first fall since the financial year 1955/56. Increases in expenditure are entirely accounted for by debt interest and net social benefits. And these figures don’t take into account capital spending. Public net investment fell by 24.9 per cent between 2010/11 and 2011/12 (a cut of £9.5 billion). And all of this is before the majority of the cuts have even started.
Myth 2: America is cutting even faster than the UK
Baroness Warsi recently claimed: that the US “has cut its debt further and faster than the UK… it’s a myth to say they haven’t”. Assuming that she has made the usual mistake of equating debt with deficit (neither country is cutting its debt!), then she is right. But not for the reasons she thinks. Here’s why.
America has been cutting its government spending more slowly than the UK. A recent speech by Adam Posen for the Bank of England entitled “Why is their recovery better than ours? (Even though neither is good enough)” concluded, taking both local and central government into account, cumulatively the UK government tightened fiscal policy by 3% more than the US government did since 2007.
In the US, the economy has now grown back above its pre-crisis peak, whereas the UK economy is still lagging behind. Unemployment in the US is now falling, whereas it’s been more or less static in the UK (today’s figures notwithstanding). Private investment and consumption are recovering in the US but not the UK:
He concluded that the weak consumer spending and high inflation in the UK were due to the faster pace of cuts in the UK, and the rise in VAT. But Warsi is right on one thing: despite cutting more slowly, the American deficit is falling faster than the UK’s: it has fallen by 5% of GDP, over twice the rate of 2.4% it has fallen in the UK. The reason? Economic growth. Incredibly, by cutting government spending more slowly, the US is cutting its deficit faster than the UK, by encouraging economic growth.
Myth 3: Austerity can be expansionary
Last year an IMF study of 173 programs in 17 advanced economies since the 1970s concluded that all had led to recession and not economic growth. The study concluded
“fiscal consolidations typically have the short-run effect of reducing incomes and raising unemployment. A fiscal consolidation of 1 percent of GDP reduces inflation-adjusted incomes by about 0.6 percent and raises the unemployment rate by almost 0.5 percentage point… fiscal consolidations are contractionary, not expansionary.”
Clearly, it’s too simplistic to say that the government’s cuts have caused the double dip recession (there are plenty of other factors, not least the Eurozone crisis), but with our economy still reeling from the crash and unemployment still so high…
One thing Stephen was absolutely right to say is that the debate is misleading the public and diverting us from finding proper answers. There’s a huge amount of confusion about the current austerity programs here and abroad, about who is cutting by how much, and who is cutting faster than whom. The debate has been dominated by ideology and insults on both sides, instead of a careful analysis of the evidence. If we’re to understand the problems in our economy, we first need to understand what is actually happening.
* David Freeborn is a Liberal Democrat supporting physicist from Oxford.