Less is more

Aus­ter­ity may be a dirty word, but it is too soon to write its obit­u­ary Ryan Bourne

The Daily Telegraph - Business - - Front Page - Ryan Bourne holds the R Evan Scharf chair for the pub­lic un­der­stand­ing of eco­nom­ics at the Cato In­sti­tute 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

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