In recent discussions of deficit reduction my ear was caught by a survey or economists, organised by the Centre for Macroeconomics and the a press release from the National Institute for Economics and Social Research, both suggesting that austerity had not helped growth, and the Office for Budget Responsibility being quoted as saying that cuts reduced growth by one percentage point in each of the first two years of the coalition and by five percentage points over its lifetime.
The subtlety lies in a quote from Charlie Bean, former Deputy Governor of the Bank of England, that the main purpose of the austerity programme was to stabilise the banking system.
The banking system is vital to any country. Soon after Syriza was elected in Greece and announced an end to austerity I heard a rumour that some Greek government bonds had hit 15% interest: as government bonds are usually the at the bottom end of the range of interest rates in an economy that would point to scarily high borrowing costs for everyone. Banking is a major part of the British economy, which makes us even more vulnerable to the effects of an excessive deficit. That means it clearly makes sense to balance the budget.
But economists suggesting that the austerity programme has harmed growth point out the other side of this. Publicly the Liberal Democrat policy on the deficit sounds like a compromise between brutal cuts from the Tories and reckless borrowing from Labour. Serious cuts harm growth. Too much borrowing strains the banking system. Between these two is a fine balance: in many ways the best way to reduce the deficit is for the economy to grow so that tax revenues rise and some people move from being on benefits to being in work. Cutting too deeply risks making the deficit worse and creates human misery.
There are also places where spending public money in the short term pays for itself. I’ll illustrate this with two examples from North West Leicestershire, where I am the Parliamentary Candidate.. I am pushing for the railway line from Leicester to Burton-on-Trent to be re-opened, both for regeneration and for spreading the benefits of HS2. The County Council wants to close the Snibston Museum in Coalville, and I am keen instead for it to receive more investment, making it also an engine for regeneration. Both of these need public money. If either is left to the private sector, their priority will be to make a profit. If they instead are funded by the state they get paid for by the regeneration they create, which ultimately ends up with people needing less in benefits and able to pay more in tax. It is not borrowing with no hope of repayment, or choking off growth by cutting, but allows judicious spending to pay dividends, recognised in community and financial terms.
The Liberal Democrat balanced position on the budget deficit is more than a compromise between Labour and Conservatives: it’s a wise path to sustained recovery which steers problems of excessive austerity and excessive spending.
* Mark Argent was the Liberal Democrat candidate for Huntingdon in the 2019 and 2024 General Elections.
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14 Comments
I don’t think this article introduces new insight or says anything particularly powerful, but tries to justify the current bland split the difference and economically flawed approach. Focusing on the amount of public spending (rather than where the state spends money) also doesn’t take us very far. I heard Dr Cable say at Spring Conference (text availbale at http://www.libdems.org.uk/vince-cable-speech-to-spring-conference-2015) that:
“We have a vision of a British industrial renaissance in which financial institutions cease to operate like a casino and there is adequate long term investment – private and public. We are now seeing a welcome recovery in business investment. But badly needed public investment in public transport, social housing, science and skills is being held back.
The Tories say the government cannot borrow more for investment. But this is foolish economics. It surely depends what the borrowing is for.
Borrowing for productive investment is not the same thing as borrowing to pay for salaries or benefits. It generates the future income to make debt sustainable.
That is simple common sense as any business understands. At a time when interest rates – the cost of government borrowing – are very low it is simply negligent not to invest in our future.”
I found the word ‘negligent’ esp striking.
Bankers before the people then.
It is good to see a Liberal Democrat parliamentary candidate state that this coalition government by pursuing austerity has reduced economic growth by 5%. It seems that the government decided on austerity because of their belief system. They believed that if they didn’t have austerity borrowing costs would have increased. There is an alternative belief that this would not happen because the Bank of England could have used the normal methods to increase the money supply and to keep interest rates and bond rates low rather than quantitative easing which seems to have been mainly to aid the banking system achieve more sustainable levels of reserves.
Our policy is to continue with austerity, but we could have adopted a policy similar to Labour’s. That we would increase the tax take by increasing wages by increasing the Minimum Wage and by pursuing policies to get most employers in the UK to pay the Living Wage.
Michael – Labour’s policy is to slow down the rate of growth in the minimum wage (though they might not be too economically illiterate to realise it themselves), so I don’t think that we would have helped people by copying them.
It strikes me as obvious that any spending reduction will slow down economic growth. Just think about it – imagine that we created £1 trillion of new spending the economy would go up as a result. Similarly, when you cut govt spending you are going to take a hit on growth. The question is in the medium to long term how much of future taxation are we willing to spend on historical purchases and what proportion of our economy is sustainable working for profit generation vs. public services.
I would say that it’s reasonably impressive that this govt more or less halted the continued increase in the share of the economy by the govt whilst at the same time managing (even briefly) the best rates of growth in the developed world. It seems self-evident that we are going to get zero credit for any of this if even our own leading activists have no clue/ are determined to adopt the opposition’s untrue narrative.
Michael GB
“They believed that if they didn’t have austerity borrowing costs would have increased. There is an alternative belief that this would not happen because the Bank of England could have used the normal methods to increase the money supply and to keep interest rates and bond rates low rather than quantitative easing”
Could you define what you consider “normal methods” there could be a variety of interpretations to that.
Few sensible people dispute that there is a balance to be struck in deficit reduction vs the impact on aggregate demand. Political rhetoric may suggest otherwise but I prefer to look at the government’s actions and the parties’ actual proposals (insofar as these can be divined).
Establishing that, other things being equal, a fiscal contraction creates a drag on growth is not sufficient to show that it is unnecessary or self-defeating. It does not follow that borrowing would be lower without the fiscal tightening, even if aggregate demand had been higher. You have to assume implausibly high ‘multipliers’ for this to be the case. Bear in mind also that the majority of the 2010 budget deficit (which was more than 10% of GDP) was generally agreed to be structural, ie would not simply disappear by itself as the economy recovered.
Then there were the claims in 2010 that the private sector could not possibly pick up the slack from public sector job losses. In fact it has done so on a scale that far exceeded the government’s expectations, with the result that unemployment is much lower than originally forecast and the employment rate is at an all-time high. We can argue about the nature of those new jobs (most of which have been full-time) and about the implications for productivity; but it doesn’t change the fact that the predictions of an employment collapse as an inevitable result of fiscal tightening were, thankfully, spectacularly wrong.
You mention the OBR. The OBR’s forecasts for economic growth over the next parliament assume current government policy as set out in the Budget. They show solid economic growth in the 2.3% to 2.5% range on the current fiscal plans. This is slightly higher than what the OBR believes is the economy’s long-term potential growth rate – thus enabling the ‘output gap’ to be closed by 2018. They do not show the planned fiscal tightening pushing the economy back into recession.
It’s also worth noting that the alternative fiscal consolidation scenario proposed by the Lib Dems is not expected to boost real GDP significantly. This is because it follows the same overall tightening path as the Budget version for the first two years of the next parliament before moving to a looser stance. Only in 2017-18 could this be expected to boost GDP, because by 2018-19 there is no output gap to close anyway – meaning that looser fiscal policy will simply result in higher expected inflation and tighter monetary policy in response.
Likewise, the fiscal loosening for 2019-20 announced by George Osborne in the Budget compared to the Autumn Statement did not lead the OBR to revise up its forecast of real GDP for that year, though it did cause an upward revision of inflation.
The Treasury document which outlined the Lib Dem plans (entitled ‘An alternative fiscal path beyond 2016-17′) made this point explicitly: “The impact on real GDP of fiscal policy changes in later years is likely to be fully offset by monetary policy… This assumption is consistent with the OBR’s treatment of changes made to the 2019-20 Total Managed Expenditure assumption in Budget 2015.”
So the OBR’s position is that higher public spending (or lower taxes) after 2017-2018 would affect the composition of GDP but not its total level. It follows that the case for, or against, the Lib Dem fiscal plan compared to the Tory plan is not about growth or demand at all. It is about the relative priority that we should attach to public spending today versus the debt burden that we pass on to future taxpayers.
This is a matter of judgement on which reasonable people can disagree; it is not something that can be ‘proved’ either way by simplistic assertions. But the Lib Dem position does jar with Nick Clegg’s grandiose rhetoric about “wiping the slate clean for future generations”. In fact he is happy for debt to continue to rise, and the debt-to-GDP ratio to decline pretty slowly from its current very high level, in order to keep public spending 1.6% of GDP higher than under the Tory scenario but tax levels only 0.5% of GDP higher. That is a perfectly valid position but by no stretch of the imagination does it constitute “wiping the slate clean”.
After Danny Alexander revealed the Lib Dem ‘shadow budget’ the Economist noted that the fiscal path he set out has an even more ‘rollercoaster’ profile than the one George Osborne has pencilled in: “Mr Osborne was accused yesterday of planning a rollercoaster ride for departmental spending. Mr Alexander criticised that, but his plan tightens almost as much, then loosens even more, making spending still more volatile.”
Moreover, despite the distinction between borrowing for investment and borrowing for current spending that the Lib Dems are keen to emphasise, their plan does not in fact envisage higher capital spending than the Tory scenario, but higher government consumption: “When the extra spending does appear, Mr Alexander’s does not use the extra flexibility to fund more investment, despite his rhetoric. Instead, his extra borrowing funds more day-to-day spending. That suggests the aim is for shallower cuts to public services, not more infrastructure or housing that could boost economic growth.”
Too much of the ‘growth’ in recent years has been rather like the calories in refined sugar – a statistical boost yes, but empty of real nutrition and which, if continued too long, can only lead to bad outcomes.
Specifically, too much ‘growth’ was and is driven by unsustainable borrowing – that is borrowing that doesn’t lead to a long term increase in the productive capacity of the economy. It’s gone on consumption by a large part of the population to compensate for their stagnant earnings (especially when measured net of housing costs). In the City it’s gone largely on gambling.
So the timeline of the crisis as it’s usually told is wrong. When it started (in the sense that governments realised there was a problem) much of he banking sector was ALREADY bankrupt. That was because it had made loans that could never be paid back because they hadn’t increased productive power of the economy.
What has happened since the crisis broke into public view is therefore about who should take the vast losses racked up by the banking sector. In a properly functioning market economy that would of course be the banks – if you make a sufficiently serious mistake you loose your money and go out of business. But there is far too much money at stake for the economic and political elites to allow market forces to operate since doing so would rob them of much of their wealth not to mention credibility. That makes life tricky for the politicians. Do they work for Joe Public or for the elites to which they mostly belong or aspire to belong? Do they create a level playing field or one strongly tilted towards the banks?
If the latter, they have to find a plausible justification in terms of economics even if that means believing in the economic equivalent of perpetual motion. Welcome to austerity as a cure for a banking crisis. It has been tried as a response to a banking crisis dozens of times since WW2 but has NEVER worked. (The few apparent counter examples turn out on examination to be down to other causes such as a fortuitous major oil strike.)
In Britain’s case there is a further twist to this. Since Thatcher governments have been opposed to the 1970s style backing of (and sometimes subsidy for) selected industries. Memories of British Leyland and sundry other turkeys loom large in the Westminster imagination. And yet that’s exactly what they’ve done – complete with absolutely stunning levels of covert subsidy – with the City, Britain’s supposed jewel in the crown. And now I think the political class as a whole is stumped. Despite brave talk of “pump-priming” initiatives and “kick-starting” things they don’t have a clue between them.
So the question remains. How is the government apparently making austerity work – at least to a point. The answer I suggest is that they focus exclusively and deceptively on the very narrow concern of the government deficit. Cast the net a bit wider and you see we are borrowing from foreigners at a prodigious rate via the current account deficit which is the balance on our international trade plus financial flows from investments made/received and the dividend flows on past investments. Strangely (or perhaps not so strangely) the government doesn’t like to talk about it – it’s been running at over 5.5% in recent quarters which is comparable to Greece before the crisis and wholly unsustainable. That’s the deficit we should really worry about.
As for the left/liberal end of the spectrum’s favourite nostrum of ‘ending austerity’ they don’t explain how spending money you haven’t got is going to improve things in the long run.
GF: I agree with some of your analysis, in that the economy was unsustainably reliant on debt-fuelled household consumption for several years before it manifested itself in the 2008 crisis – certainly from about 2003 onwards, arguably from even earlier. In those circumstances one might have expected the government accounts to be in surplus, as they were in plenty of other countries that were undergoing credit booms or long cyclical upswings – but in the UK the government was adding substantially to overall consumption growth throughout this period.
You refer to the “vast losses racked up by the banking sector” being crystallised in the financial crisis. I agree, but would highlight two points relating to this. The first is that the direct costs of bailing out banks did not contribute to the public sector deficit, but were treated as a series of financial transactions (since the government took equity stakes in the banks and the explicit intention was to sell the bank shares again and recoup the cost). It affected the volume of gilts the government had to issue at the time but not the measure of the deficit that has been the focus of UK fiscal policy debate throughout. The 10.2% of GDP peak fiscal deficit did not include bank bailout costs; it was the underlying gap between revenues and spending after stripping out “financial sector interventions”.
The real impact of the banking crisis on the public finances came not through the bailout measures, but through the knock-on effects on the real economy and tax revenues. The plunge in GDP mean that public spending on existing plans swallowed up a much higher percentage, while tax revenues fell far short of the projections on which those spending plans were predicated.
You are right to identify the banks’ unsustainable levels of lending and leverage as the root cause of the 2008 crisis – but by the same token the crisis revealed that the public sector had been financed throughout this period by an unsustainable revenue base. When the “frothy” receipts from the property market and financial sector ebbed away, they left a large hole which neither the last government nor the coalition proposed to fill by broadening the tax base in other areas or raising rates across the board. That meant that public spending would have to be significantly reduced as a proportion of GDP to bring it into some semblance of balance with revenues. This would always have been a wrenching process – but it did not help, to say the least, that the budget was already significantly in deficit before the crisis, even with the aid of the boom-time tax revenues. Fiscal policy had been relentlessly pro-cyclical for years, and the starting point was much weaker than it should have been as a result.
Coming back to today’s situation, I share your concern about the size of the current account deficit. Much of this appears to have been driven by UK residents receiving lower income on their overseas investments: there has been a sharp deterioration in the ‘primary income’ balance whereas the overall trade deficit (goods and services) has been more stable. However, the expected contribution from net trade to GDP growth over the coming years is pretty feeble, with rising exports largely offset by rising imports.
It’s true that much of the impetus for growth has come from household consumption, and is expected to continue to do so. Given that household spending accounts for about two-thirds of our total GDP, it is hard to have GDP growth without it playing a major role. Interestingly, consumer spending growth in recent years has not been driven by households running down their savings or borrowing more; despite the squeeze in average real wages, the total amount of income from employment has increased significantly because many more people have been earning, and this has boosted total consumer spending.
And while trade is still disappointing, business investment is now growing pretty stoutly: 5.3% in 2013, 6.8% in 2014, and forecasts of between 5% and 7.5% through to 2018. So in some respects at least the recovery appears to be broadening out, with household consumption growing roughly in line with overall GDP, business investment rising as a share of GDP, and house price growth moderating. The poor current account position is symptomatic of continuing structural weaknesses though, as you say.
Alex: the logical conclusion from the OBR’s arguments is that we need to move the deficit reduction plans- loosening now and tightening in 2018-20 when it won’t affect the economy, or am I missing something?
@ Peter
“Labour’s policy is to slow down the rate of growth in the minimum wage”
The increases in minimum wage have been:
2006 increased by 5.94%
2007 increased by 3.18%
2008 increased by 3.8%
2009 increased by 1.2%
2010 increased by 2.19%
2011 increased by 2.53%
2012 increased by 1.8%
2013 increased by 1.94%
2014 increased by 3.01%
2015 increased by 3.08%
The Labour Party has set £8 as their target for the end of the next Parliament. This could be done by increasing it by 26 pence every year.
2016 – £6.96 – 3.88%
2017 – £7.22 – 3.73%
2018 – £7.48 – 3.6%
2019 – £7.74 – 3.47%
2020 – £8.00 – 3.36%
Therefore the Labour Party’s policy is not to slow down the rate of the minimum wage. In my example the rate of growth is higher than all years accept 2008 and 2006.
@ Psi
“Could you define what you consider ‘normal methods’”
Normal methods are for the central bank to buy government bonds to reduce interest rates.
@ Alex Sabine
I believe that the OBR estimate for the ‘output gap’ are to low as I don’t accept that the UK was at full capacity in 2005.
Good discussion with excellent contributions from GF and Alex Sabine as always.
In fairness to the author these economic arguments often have to be boiled down to often over-simplified representations for campaigning purposes in hustings and door-knocking.
Describing the economic policy of the last five years as austerity is not a classification that I believe would have been recognised or accepted by John Maynard Keynes. For all the rhetoric of George Osborne. what was in effect delivered was the economic plan as proposed by Alistair Darling in 2010, with much of the heavy lifting done by an unprecedented loosening of monetary policy coupled with annual deficit financing in excess of 100 billion – until this year when economic growth reduced it to circa 90 billion. There was no repeat of the disastrous policies of the late twenties/early 1930’s depression years.
Notwithstanding this, both Nick Clegg and Vince Cable have acknowledged that the coalition had anticipated a faster economic recovery and capital spending was cut back too deeply in the first two years of this parliament. That this was recognised and partially addressed in subsequent budgets is to the credit of the coalition government.
The Treasury inspired canard that the fiscal deficit represents the only serious challenge to the nation’s prosperity has come to dominate this election campaign and coverage in papers such as the Daily Mail. You do not have to be much of an economist to see that a chronically weak productivity performance, a widening current account gap and stagnant wages are matters of much greater import.
A serious debate about how best to raise competitiveness and living standards has been replaced by a facile and futile squabble about whether the government should balance the budget in 2018 or 2020. Vince Cable remains one of the few economists/politicians to stress the importance of implementing and maintaining a long term industrial and skills strategy underpinned by public investment in public transport, social housing, science and skills to address these underlying structural weaknesses.
I wish I had more time to engage with the debates on this forum in more detail, but like the author campaigning priorities call and that will have to wait until after May 7.
@ Philip
“Alex: the logical conclusion from the OBR’s arguments is that we need to move the deficit reduction plans- loosening now and tightening in 2018-20 when it won’t affect the economy, or am I missing something?”
Hi Philip, sorry for the slow reply. I would put it this way: Given the ‘destination’ the Lib Dems want to get to – cyclically-adjusted current budget balance, with a small surplus to help nudge the debt ratio downwards – the route Danny Alexander set out in his alternative budget looks a bit odd. A sharp but uneven tightening for the first three years (strengthening the CACB by 0.4% of GDP in 2015-16, then 1.7% in 2016-17 and 0.8% in 2017-18) followed by a slight further tightening in 2018-19 and no tightening in 2019-20. The implied path of public spending is even lumpier: real-terms cuts over the first half of the parliament followed by substantial real increases in the final two years.
In a way you can explain this trajectory by saying it simply assumes a ‘return to normal’ once the fiscal repair job is deemed to have been completed. In other words, you finish the task of balancing the books and then you can start to increase spending again roughly in line with national income. There is an advantage to this approach in terms of debt dynamics: you get the debt-to-GDP ratio coming down earlier, with (modest) ongoing savings in debt interest costs. And politically speaking, it enables you to show ‘light at the end of the tunnel’ and to start turning the spending taps on in the run-up to the 2020 general election.
But in terms of sensible planning of public service funding, this stop-go, famine followed by (relative) feast approach makes much less sense. It is doubtful that any business or household would consciously plan their finances in this way (assuming they were not forced to by cash-flow constraints). It means government departments and public service managers will be asked to take sizeable chunks out of their budgets only to have them more than reinstated a year or two later.
And as you suggest, based on the OBR projections for the evolution of the economy and the output gap, there is no obvious rationale for front-loading the fiscal tightening from a macro standpoint. Accepting the Lib Dem end goal as given for the moment, it might be better to spread the adjustment more evenly across the five-year period – so, relative to the current Lib Dem plan, yes this would imply a somewhat looser stance initially (especially in 2016-17) and a correspondingly tighter stance towards the end of the parliament.
My own view is that Lib Dem policy is too complacent about the high debt-to-GDP ratio and that – like the Swedes following their financial crisis in the early 1990s – we should eventually be running overall budget surpluses to manage debt down more aggressively. So I think the medium/long term objective isn’t sufficiently ambitious, and – provided there is a continued private sector recovery – I would trim the public spending plans for 2018-19 and 2019-20 (but not in the next few years). However, if I only wanted to hit the less demanding Lib Dem fiscal targets, I would spread the adjustment in the way that you indicate rather than front-loading cuts and then boosting budgets substantially in the ‘out’ years.