Less is more
Austerity may be a dirty word, but it is too soon to write its obituary Ryan Bourne
‘History is written by victors,” Winston Churchill is erroneously thought to have said. Yet it is the political losers of the 2010s currently penning the obituary of “austerity”.
Emboldened by Boris Johnson’s claim it would be “a mistake” to slash government spending again postCovid-19, Left-wing economists and commentators are doing intellectual victory laps.
The 2010s are fast being chronicled as defined by a tragic macroeconomic mistake – with the British people impoverished by government efforts to eliminate its deficit.
Don’t get me wrong, certain decisions over the decade were highly challengeable. Real government expenditure was effectively held steady for 10 years – an unprecedented containment that saw spending fall sharply relative to GDP, albeit only to its 2006/07 level.
Within that envelope though came controversial choices: to reassign spending from the young (in-work benefits) to old (the state pension triple-lock), and from local government (social care) to central (the NHS).
Population growth, ageing, and ring-fencing of certain departments, meanwhile, meant unprotected spending areas saw vast cuts relative to demands. Some, such as police cuts, proved false economies.
So yes, let’s argue about the fairness or broader impacts of particular decisions. Let’s acknowledge too that the decade nevertheless saw stable inequality and falling material deprivation. But the idea that the past decade is a slam-dunk macroeconomic victory for opponents of deficit reduction is bizarre.
The Coalition government inherited a massive 10pc of GDP deficit that credible bodies said wouldn’t dissipate with recovery. All agreed borrowing at that level was unsustainable in the medium-term. The debate was on the timing, speed, and scale of cutting it.
Former chancellor George Osborne’s June 2010 deficit reduction plan had three rationales. First, develop a credible plan to avoid a funding crisis that would see borrowing costs spike. Second, stop debt-to-GDP rising ahead of the next recession or age-related budget pressures. Third, give more space for monetary policy to support demand. Alongside a deficit reduction plan weighted towards government spending cuts rather than tax rises, this would, evidence suggested, give the best chance of a strong private sectorled recovery.
Critics of austerity got one thing correct: the bond vigilantes were never going to arrive. The UK is not Greece or Argentina. We haven’t properly defaulted on our debt for hundreds of years, despite it rising to well over 200pc of GDP at times. Our prosperity is partly down to our government’s predilection to keep its financial promises, and unlike individual Eurozone economies, we have our own central bank.
On the other two counts, however, the austerity proponents were right.
Restraint then has granted more financial freedom now. And while Theresa May and then Boris Johnson have increased spending on the NHS, police, and infrastructure, there is no plan to “reverse austerity”. The debt path will be much lower than it would have been without cuts, which helps now given the Covid-19 tidal wave and spending pressures from an ageing population.
Macroeconomic effects – on aggregate demand, inflation, and unemployment – are where the austerity advocates won in practice, but not in debate. Austerity’s critics claimed fiscal tightening would lead to sustained elevated unemployment, with “scarring effects” on workers’ skills that would then worsen future growth prospects.
In fact, macroeconomic support through low interest rates and QE led to inflation not far undershooting its target for the decade, while unemployment fell rapidly, driven (as predicted) by the private sector. An all-time record employment rate was achieved by 2015.
True, real GDP growth was abysmal, leaving a lost decade in living standards. But this was driven by sluggish productivity growth, averaging just 0.3pc per year, a striking reversal from the 2pc growth seen between 1997 and 2007. To claim austerity caused this, however, is a speculative theory for which there is little to no economic evidence.
Yes, some extra well-targeted investments in, say, transport might have improved productivity a bit. But this impact of government spending would not occur instantaneously. In fact, government net investment was actually higher in the 2010s than the 2000s, despite higher productivity growth in the latter.
The idea other spending cuts were responsible for permanently poor productivity growth is far-fetched nonsense. Do we really think higher civil service pay, more generous welfare benefits, and yet more spending on a historically unproductive health sector would have led to a surging performance?
History suggests otherwise. Productivity growth fell marginally under Labour when public service and welfare spending starting rising sharply. A large body of evidence also shows large public sectors are a drag on growth, suggesting we avoided an even weaker performance by spurning a bigger government.
Some say we could have “run the economy hot” through more aggressive overall macroeconomic policy (fiscal and monetary) to try to eliminate underemployment and encourage firms to invest to meet higher demand. This would have required, however, a change in the Bank of England’s mandate. Since inflation at times was already well above the Bank’s 2pc target, it would have had to run a tighter policy if the government had simply borrowed more, choking off private activity.
At best though, any extra activity stimulated by more aggressive policy rules pales into insignificance compared with the impacts of weak productivity, driven in part by the early oil price shock, the financial sector’s post-crisis weakness, and then the political uncertainties surrounding Brexit. The true mistake of the last decade was insufficient political interest in supply-side policies on tax, planning, competition, and energy to compensate.
Given the budgetary impacts of the pandemic, it’s crucial we learn the right macroeconomic lessons from the 2010s. The idea that sluggish growth could have been avoided by borrowing more is ascendant. But it’s wrong.
George Osborne, the former chancellor, tried to control the deficit in 2010 with stringent austerity measures