Opinion: Austerity and defying the Laws of gravity

“It’s ideology, stupid.” – a subtext to the Queen’s Speech

On Five Live a bond trader says that austerity isn’t working and the government should be more expansionary. In Wake Up to Money a fund manger says that austerity has been overdone and it’s time for countries like Germany and Britain to borrow more.

Yet on Tuesday’s Today programme, David Laws continued to advocate austerity.

It is more and more apparent that ‘economics’ is being used to serve the ideology of a smaller State, damning the idea that the State should have different responsibilities at different times, especially when the private sector is unable to take a lead.

Laws was exceptionally revealing. Justifying his thinking, he said that the scale of the deleveraging in theUKeconomy had been a surprise and was the prime cause of the slowness of recovery and the delay in the effectiveness of expansionary fiscal contraction.

This truly beggars belief.  Deleveraging and the process of converting assets (especially property assets) into cash began in 2007 as canny speculators began to get out at the top of their market.

As Steve Keen has demonstrated, it is the change in the pace of debt which directly affects the economy. We know that the Bank of England missed this turn and as the money GDP of the country fell by 8% they failed to reduce interest rates and provide the necessary compensating monetary stimulus.

Far from managing the reduction of the money supply with expansionary policy the Bank made matters worse by insisting that bank balance sheets be strengthened, giving a further twist to the deleveraging vortex.

There followed the Coalition’s austerity drive which could have only one result, further focus by families and firms on paying down debt shelving investment decisions in the face of plummeting demand and fear of job losses.

It beggars belief for Laws to say that the scale of this process comes as a surprise. It results from everything he has advocated over the last five years.

But, like the bond trader and the fund manager, does he revise his position?

No, there followed calls for austerity to continue.

The pernicious fallacy of expansionary deficit reduction has done enormous harm to the economy since 2010, killing off the recovery that was in progress. It is precisely Coalition economic policy, the message it gave out and the expectations it created, that has seen our recovery stall.

Reducing government expenditure, and especially capital expenditure (which is mostly contracted out to private sector firms), whilst expecting the private sector to make up the gap defies the Laws of Gravity.

Planned cuts have hardly begun yet the private sector sees no reason to risk its reserves until it detects a recovery in demand, the pound has lost much of its advantage from earlier depreciation and the Coalition is relying on a policy that has no empirical evidence to support it.

Everywhere the mood is changing, but not inBritain, where Cameron and Clegg continued to plough their furrow, appropriately in a tractor factory.

Deep down this has more to do with the ideology of rolling back the state and not much to do with the jobs, homes and the wellbeing of ordinary folk.

* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams

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31 Comments

  • Bill le Breton 9th May '12 - 11:10am

    Tommy, it may well be the bond trader and the fund manger who would indeed benefit from government financial expansion along with 60million others who would do so too, but I thought it was the bond trader and the fund manager who, we were told, would between them force up interest rates and sell UK shares if we ever rejected the austerity story.

  • Richard Dean 9th May '12 - 11:13am

    You are both wrong. It is the bond trader and fund manager who will find ways of profiting from whatever decision we make, and especially one that involves changing something. 🙁

  • Let’s be absolutely fair. The cuts and austerity agenda are part of the reason why the economy has stalled; they are indeed a major cause. However, the problems in the Eurozone are also to blame: the initial calculations were made in a context of a forecast Eurozone recovery. Instead, our major export market is now on its knees.

    What should have happened the moment that it was clear that the Eurozone was on this path is that austerity should have been softened. Policy needs to be supple, not rigid – I find it inexplicable that somehow rigidity is perceived as a strength.

  • Richard Dean 9th May '12 - 11:30am

    I agree with Christian de Feo on this. I don’t think it helps to make ridiculous and unsupportable claims like “economics is being used to serve the ideology of a smaller State”. The government seems to be frightened of markets, perhaps wisely because markets determine interest rates and we need to borrow a lot. Markets get worried when big changes of policy seem likely, or when they see what they believe is an incompetent government. So Christian’s approach is the responsible way to go, IMO.

  • We need to kick the habit of relying on insane amounts of debt for economic growth. I remember back when the crisis started I was working for a large german company that had for years been criticised by the markets for being under leveraged, but after the crash they were sitting pretty as they had considerably lower levels of debt than their competitors and were years away from having to refinance. And wouldn’t you know they’re still investing in the UK today.

    You’re right about the planned cuts having hardly started, we need to stop dragging out the pain and get it over and done with, so that rather than worrying about the effects of cuts, the private sector can be glad that they’re over and find themselves with much more credit to play with because the governments no longer soaking up the supply.

  • jenny barnes 9th May '12 - 12:33pm

    look at the graphs. The economy was recovering till 3q 2010. From then on, arguably when Osbornes first budget started to take effect, the lack of demand in the economy has led to it flatlining. Why do people think it’s going to recover on current policies? It’s just as likely that we’ll have another big drop in economic activity. As they used to say about the Russian stock market “remember your investments can go down as well as further down”
    What the economy needs is demand, not more cuts. Sigh.

  • Richard Dean 9th May '12 - 12:46pm

    Yes, Osborne is probably being too timid. Europe may be making poor decisions too. One sure way to make bankers flee is to offer them haircuts. Keeping your nerve looks like the name of the game, and no-one’s been doing it.

  • Mike Barnes 9th May '12 - 1:30pm

    It’s obvious to anybody that’s ideology behind the austerity agenda. Paul Krugman and co are not far left nutcases, they are the economic establishment and their solutions are textbook economics.

    What are the ‘answers’ the right half of the coalition offers? Tax cuts for the wealthy, welfare cuts for everybody else, and workplace ‘reforms’.

    Please tell me how making it easier to fire people is going to rescue the economy? Which textbook is that in?

  • Bill,

    I would agree with your overall premise that a flexibility of approach is required in responding effectively to conditions in the global economy.

    Our fiscal plan is to eliminate the structural budget deficit by 2017 and put overall debt on a downward sloping path as a % of GDP. The success of this plan is largely dependent on a return to trend growth (2%-3%) from 2013/2014 onwards.

    Planned reductions in government spending are largely focused on departmental budgets as the largest areas of public spending – health and social security continue to grow apace. I think we do need to maintain a clear distinction between the elements of the structural deficit that are comprised of current spending and those that are related to investment in economic infrastructure that has ongoing future benefit.

    Much of the deficit spending in the Labour years was on renewal of social infrastructure – schools and hospitals. What we need now is a big program of housing and economic infrastructure development. In London, we have Crossrail underway. This type of project needs to be replicated in other areas of the country.

    Private debt deleveraging, as you note, is driven by lack of confidence and job security. The government needs to take the lead in stimulating investment in housing and infrastructure, if we are to retain the confidence of the bond markets that we can return the economy to the growth path needed to achieve our deficit reduction plan.
    Infrastructure development has relatively long lead-in times, so the first priority should be site-ready housing developments.

  • mike cobley 9th May '12 - 2:50pm

    @Joe B;

    “The success of this plan is largely dependent on a return to trend growth (2%-3%) from 2013/2014 onwards.” And how will this come about? – when workforces are willing to accept payrates so low that investors will at last think it worthwhile investing here again?

    “Planned reductions in government spending are largely focused on departmental budgets as the largest areas of public spending…” Loosely translated, the 100s of thousands of public sector workers who have been essentially thrown overboard; “…we do need to maintain a clear distinction between the elements of the structural deficit that are comprised of current spending and those that are related to investment in economic infrastructure that has ongoing future benefit.” Does this mean the effort that is going into the PFI-sation of public services, specifically the NHS? On reflection, this programme of the marketisation of public services is the ONLY area where government efforts are focussed and unwavering. I would suggest that the consequences of the last 2 years of austerity are intentional, not accidental. Both the Tories and the Clegg Liberals despise the large state, and are keen to shrink public reliance upon it. Clearly our dependancy should be upon the market, not the state.

  • of course the cuts are being driven by an ideological belief in a smaller state. The Conservative arguing for it for the best part of the last four decades, there is no secret that they believe in that kind of thing. Here’s the thing, if you don’t want to go along with it,, stop supporting it.

  • This is all driven from a Tory (and in my opinion David Laws must be counted as a Tory these days) ideological agenda.

    The deficit is composed of two parts – cyclical and structural. The cyclical part goes away if we get a growing economy, and if we get sufficient economic growth we can start to tackle the structural part.

    Trying to tackle both at once during a recession is unwise to put it mildly.

    Joseph Stiglitz, Nobel prize winner in economics and former chief economist of the world bank happens to agree with me.

  • Mike,

    the deficit reduction program being pursued is almost identical to that proposed by Alistair Darling before the last election. That should tell us that whatever government was in power a broadly similiar program of deficit reduction would be in effect.

    The current public sector deficit is unsustainable. The shortfall cannot be funded by either tax increases or ever increasing levels of borrowing. Of the three options for dealing with the deficit – status quo, deeper cuts/highertaxation or accelarating growth, I would suggest that stimulating growth while holding current (non-capital) spending within the existing envelope is the only credible option at present.

    I think public housing and economic infrastructure development can provide the necessary stimulus to growth. This stumulus combined with supply-side measures to liberalise planning and the availability of mortgage finance can kickstart private housebuilding to meet the overwhelming demand that exists for affordable housing.

  • Graeme,

    The problem is we can’t all reduce our level of borrowings at the same time without tanking the economy and putting most of us out of work.

    Bill refers to this in his article above “As Steve Keen has demonstrated, it is the change in the pace of debt which directly affects the economy.”

    What is supposed to happen is that when the economy is growing the government should run a budget surplus and pay down debt so there is room to increase borrowing when the economy downturns. This did not happen from 2000 to 2007. Instead a budget deficit was run each year, even with abnormally high tax receipts from the boom in financial services and housing bubble. Debt was run up to and beyond what was then regarded as the maximum safe level of 40% of GDP. Off balance-sheet PFI deals ran debt obligations up even further and the financial crisis just blew the whole concept of 40% debt to GDP out of the water.

    Now, in a severe recession, the government has no alternative than to increase borrowing levels until such time as the private sector in aggregate reverses debt reduction/net saving. This is when private sector growth returns and the government can begin to reduce its level of borrowing.

    This reversal of private sector debt reduction/net saving will only come about with the return of confidence i.e. when real wages/spending power start to increase and firms see increasing demand for their products and services. The government needs to create this confidence in a resurgent economy with its own capital spending program.

  • Richard Dean 9th May '12 - 7:12pm

    When I hear people say there’s “no alternative”, I always suspect there IS one – but perhaps one that the person doesn’t like, or one that’s outside the box. Greece is showing us now that there is an alternative for them, and France may do that too. Greece appears to be assigning a cost to their austerity that is larger that others do. Sometimes apparently crazy ideas work – how about us joining the Euro for instance? Are there benefits, or more problems?

  • Andrew Suffield 9th May '12 - 7:28pm

    Paul Krugman and co are not far left nutcases, they are the economic establishment and their solutions are textbook economics.

    Indeed. That’s why the government is following their plan, and borrowing vast amounts of money to invest in the economy.

    What are the ‘answers’ the right half of the coalition offers? Tax cuts for the wealthy

    Yup. Fortunately they lost the argument: this year’s budget substantially increased tax on the wealthy.

  • @joe
    Re: eliminating the deficit by 2017

    I thought the plan was to do this by 2015? Oh thats right when austerity kicked in and revenue from a stalling economy dropped the target was revised. If the economy continues to flatline will the target by put back again… say to 2019? If the means of assessing a plan is to measure outcomes against targets then conveniently shifting the said target renders the assessment worthless.

  • “this year’s budget substantially increased tax on the wealthy.”

    Perhaps on the very wealthiest, but according to the IFS analysis of measures anounced in the budget to take effect by April 2014, those in income deciles 5-9 gained from the budget by more than the average , and those in deciles 1-4 and 10 gained by less than the average.

    So the wealthiest 10% were the biggest losers, but the remainder of those on above-average incomes were the winners.

    http://www.ifs.org.uk/budgets/budget2012/budget2012robjoyce.pdf

  • Simon McGrath 9th May '12 - 9:32pm

    Cutting back the size of the state – to say the level of 2005 sounds pretty good to me. But as it happens public spending has increased and is planed to carry on doing so. Hence the govt borrowing nearly £500bn over this Parliament.

    How much more money do you think we should spend?

  • Stephen Donnelly 9th May '12 - 9:42pm

    Get real. We have a huge public spending deficit, and and increasing debt. Labour, Tory and Liberal politician all know that the deficit must be cut. There is some debate about where the cuts (or taxes increases) should fall, and the timing. It is not a debate about austerity or growth. Of course Labour frame it in that way, they are in opposition. We are in government and do not have the luxury of opposing changes without proposing an alternative. The current policy is not an Orange Book plot led by David Laws, we just bearing the responsibility of being in government. Time to grow up, the ‘peter pan’ days of permanent opposition are behind us, thankfully.

  • Bill le Breton 10th May '12 - 6:32am

    Thanks for the comments. My apologies for not being able to offer a reply until now.

    Joe seems to have done a good job in replying on my behalf on a number of specific areas. Thanks Joe.

    Stephen W accuses me of being ideological – which I admit.

    David Laws has been a powerful force behind a shift in the thinking of a group of people who now command the direction of the Party and who have since 2010 considerable power to affect the fortunes of the country.

    That he was surprised by the scale of the deleveraging that would occur following 2008 and following the communications activity of the Coalition seems to me to call his authority into question and should call for a re-think in that ‘leadership’s’ contribution to the economic policy of the Coalition.

    Simon McG goes to the heart of the matter: How much more money do you think we should spend?

    Before defining ‘we’ may I answer that we should create sufficient demand to take inflation to 5 or 6% and the growth of NGDP to 7 or 8% for three years and to then target a level of NGDP growth of 5% there on.

    This should be communicated with the same sense of purpose that surrounded the drive to austerity.

    This should be done with further QE, but also, because I don’t believe that the private sector will respond until it seems stimulus with ‘its own eyes’, I think that this should be done through government investment projects commissioned from the private sector.

    This drive should be part of a reform package that is dependent on structural supply side reforms and tax reductions on employment.

    The best way to reduce the proportion of the state’s activity in the economy is to grow the economy. Restoring the economy to its trend growth rate and clawing back the capacity lost would reduce the proportion of the state well on the way to 40%.

    There is a time for us to influence the economy through state action and a time for it to withdraw. To me that is part of the definition of a truly ‘unservile state’.

  • Andrew Suffield 10th May '12 - 7:42am

    I answer that we should create sufficient demand to take inflation to 5 or 6% and the growth of NGDP to 7 or 8% for three years

    If only there was some magic hole into which you could pour deficit money to increase GDP more than you increase inflation. Then government would be easy.

  • Bill le Brerton 10th May '12 - 12:12pm

    Andrew, that is why the target is NGDP, not RGDP. Inflation is part of the solution. Look what happened to the demand for stamps when the Government gave notice that the price would rise on the 30th April.

  • Richard Dean 10th May '12 - 1:33pm

    The crisis seems to be global. We are a trading nation but our exports go to markets where demand is collapsing, and our investors may prefer the higher returns they can get elsewhere for lending to governments and for developing businesses. Are we all playing Prisoner’s Dilemma? Domestic action alone looks unlikely to solve the problem.

  • Bill,

    “This should be done with further QE, but also, because I don’t believe that the private sector will respond until it seems stimulus with ‘its own eyes’, I think that this should be done through government investment projects commissioned from the private sector.”

    The Bank of England has not gpne for more QE today. The BBC report from Stephanie Flanders explains why A sticky wicket for the bank.

    An increase in inflation is only useful if there is spare capacity in the economy to meet demand. If we are supply constrained and there is not spare capacity we will get stagflation, as we had in the ’70s, i.e. low real growth and high unemployment coupled with high inflation – the worst of all worlds. If real incomes fall then much of the benefit of a reduction in nominal debt as a % of nominal income is lost.

    Unfortunately, noone seems to know for sure how much productive capacity has been lost as a result of the recession. Official forecasts reportedly assume that the 2008 crisis has done more permanent damage to the UK economy than either the Great Depression or World War II.

    If ,however, what we are experiencing is, a demand-deficient economy, weakened by imported price pressures and tighter fiscal policies. then both monetrary expansion using an NGDP target and fiscal stimulus can help in turning the situation around.

  • Richard Dean 10th May '12 - 8:24pm

    @Liberal Eye. Interesting, and yes, defying gravity is what we need to do.

    It is perhaps more like lack of confidence that is at the heart of the mess we are in. Deleveraging is a possible strategy to get confidence back. But is it? Is debt self-sustaining? Government ‘s need to borrow soaks up money that would otherwise be available for private investment, which slows the economy, which increases government’s need to borrow. But government spends what it borrows, which means it is actually a stimulus, so deleverageing will also damage the economy.

    Are there other ways out of the circle? Maybe new ways to manage risk spectra – increase risk here, reduce it there, in ways that get things moving?

  • Bill le Breton 11th May '12 - 7:15am

    Joe,

    Flanders does end her piece thus: ‘It is also possible that (this estimate of insufficient capacity) is too gloomy: what we are witnessing is, simply, a demand-deficient economy, made even weaker by imported price pressures and, to some extent, tighter fiscal policies.’

    And, Liberal Eye, in the above paragraph we could go ‘up stream’ from demand and substitute confidence i.e. ‘what we are witnessing is a confidence-deficient economy’. (Richard, might we agree?)

    Which, to me, goes back to the central issue that the choice is between a leadership which oversees managed decline, downwards, until firms and families believe it is ‘safe’ to begin spending again – The Austerity Route.

    Heaven knows how much capacity and how many life chances will have been destroyed by that time. But I am sure that that is not the Liberal route.

    Or, a leadership that manages expectations positively, upwards.

    Such leadership sees a situation like the one we have now to introduce substantial change to the way our society works.

    Where Government negotiates with the public an expansionary policy in return for fundamental change; change to make markets more competitive and less monopolistic, change to taxes on employment, change to taxation on wealth (see Joe’s piece on LVT), job guarantees in return for changes to benefits, a government that enables.

    Just following these ideas gives an echo of the kind of Queens Speech that could have begun a period of RESURGENCE.

    Flanders mentions that this period may have witnessed the destruction of more economic capacity than in either the Great Depression or World War II.

    In that war, the then Prime Minister often wrote a three word, supremely positive minute on reports. These would serve us well now: ‘Make It So’.

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