For Osborne's policy to have succeeded would have required abnormally good luckby / July 17, 2017 / Leave a comment
Published in August 2017 issue of Prospect Magazine
Subjects can dominate the agenda one day, and then drop from view. Something of the kind has been happening to austerity. Two years ago nothing seemed so important to George Osborne as eliminating the budget deficit. In 2015, fresh from masterminding the Conservatives’ unexpected win, Osborne pledged himself to achieving a surplus by 2019-20 and announced further cuts of £12bn in welfare. Austerity, having been relaxed before the election, had returned with a flourish. Not only did the Chancellor claim that his austerity policies had produced economic recovery, but committed himself to an annually balanced budget for all time. No more nasty borrowing.
By 2015, the economy had started to grow with vigour: at 2.8 per cent in 2014 and then 2.2 per cent in 2015. The Office for Budget Responsibility forecast growth of 2.4-2.5 per cent in each of the next three years. It assumed that the British people would sensibly vote to remain in the European Union. On the basis of such prospects, there seemed little obstacle to the promised surplus—or the elevation of a successful chancellor to the premiership.
Then came the Brexit vote. Forecasts were revised drastically downwards, and Osborne was translated not to No 10 but first to lucrative jobs and lectures, and then the Evening Standard. The mood music abruptly changed. Theresa May reinstated “One Nation” Conservatism; her chancellor, Philip Hammond, abandoned Osborne’s targets. Yes, the deficit was on a “downward path,” but no one could say when it would be gone.
Still, there was no doubt in the mind of May that the voters would give her a thumping majority. But with Labour’s disturbing recovery and consequent hung parliament, growth numbers were revised down again. In the Queen’s Speech, the minority Tory government finally put “strengthening the economy” ahead of the commitment to “improve the public finances.” Not long ago, the whole Cabinet—Lib Dem and Tory—buckled under the weight of the deficit fixation. No longer. Today the Health Secretary is petitioning for an NHS bailout, while the Education Secretary argues that cuts to the schools budget are no way to prepare for a prosperous future. Damian Green, the deputy prime minister in all but name, has pushed student debt up the agenda, and even the Foreign Secretary has suggested that the country can afford to do without a rigid cap on public sector pay.
Lacking from this retreat has been any analysis, still less apology, regarding the difficulty encountered in trying to “balance the books.” Instead of analysis, there are unfortunate “headwinds.” Osborne’s was the eurozone crisis; Hammond’s has been Brexit. Bad luck is the standard excuse of any gambler, when his foolhardy bet fails to come off. But for the austerity policy to have succeeded would have required abnormally good luck.
I, along with a few other commentators including Martin Wolf and Larry Elliott, started to make the argument against austerity in 2010. Trying to balance the government’s books in a slump would, we warned, make matters worse. The private and public sectors could not simultaneously increase their saving. If they tried, the result would be to reduce overall spending, and then depress both public revenues and private incomes. The only way back to solvency was growth. It would not come about automatically; a pro-growth policy was required. Cutting public spending was the reverse of this.
“Recession and retrenchment have left discouraged workers, lost skills, broken banks”
The Treasury’s forecasters, and others including the International Monetary Fund, swept such arguments aside. Austerity in the budget, they claimed, was necessary to restore business “confidence.” Recovery of confidence would offset any dampening effect of retrenchment.
The cutters had one crucial argument up their sleeve—Quantitative Easing (QE). While they took money out of the economy, the Bank of England silently pumped it back in, buying up chunks of the national debt. The Bank injected £375bn between 2009 and 2012, equivalent to 23 per cent of the latter year’s GDP. These massive cash injections aimed to make the holders of government bonds wealthier, spurring them to go on a spending spree. Since everyone would notice the budget cuts, and no one would notice QE, the government would be able to claim that it was the cuts that were boosting the economy.
Alas, this was wrong too. QE proved an extremely leaky vessel. Keynes warned in 1936 that before we assert “that money is the drink which stimulates the system to activity, we must remind ourselves that there may be several slips between the cup and the lip.” One such slip is that people might hoard the money rather than spend it; another is that they might buy financial assets and property, rather than spend it in ways that increased output. Both things happened. Banks piled up cash reserves; investment only rose by 22 per cent during the Coalition years, as against a projected increase of 47 per cent.
In addition, QE gave money to the wrong people. The government was taking money away from the poor through benefit cuts, while the Bank was putting it back into the hands of the rich—asset owners. The rich have the option of hoarding while the poor normally spend everything they’ve got, and so the joint effect of contractionary fiscal and expansionary monetary policies was to reduce total spending, not increase it.
The mainstream economists at the IMF and the Organisation for Economic Co-operation and Development now recognise the harm of austerity. Simon Wren-Lewis of Oxford University estimates its cost at up to £8,000 per household. Real wages are still lower than a decade ago. Worse, the productive capacity of our economy has been damaged, setting the country on to a lower growth path into the future. Why? Recession and then retrenchment have left discouraged workers, lost skills, broken banks and under-investment.
All this has now become clear except to some members of the government. In June, Michael Fallon said: “We all understand that austerity is never over until we have cleared the deficit.” This is exactly the wrong way round. He should have said, “the deficit is never over until we have cleared the economy.” It may not be seemly to witness him engaged in open combat with cabinet colleagues who have, belatedly, realised that the austerity game is up. But better that ministers engage in unseemly discourse than blindly persevere with a failed policy. As yet there is no thought given to what comes next. The practical alternative to deficit fetishism has not been established. I will return to this pressing matter in the next issue of Prospect.