Alan Rusbridger, editor of Prospect: Before we discuss austerity, maybe Ann can set the scene by telling us some of the context around the financial crash of 2008?
Ann Pettifor, macroeconomist: Well, what caused the crash, it seems to me, was the deregulation of the financial system, and the unsustainability of the credit that had been issued at very high real rates of interest and that was ultimately not repayable. People often refer to the American housing market as being the cause of the crash, but the real cause was the issuance of credit to those who couldn’t afford to repay, especially when interest rates rose.
At the time, the world’s total debt was about 250 per cent of global GDP. Today it’s about 350 per cent. In that sense, it’s still unsustainable, and it’s still going to precipitate a crisis, which is why I think Nick and I will share a commitment to the stabilisation of the public finances. I don’t believe in excessive deficits and very high levels of debt.
Alan: Nick, the policy that we now refer to as austerity was implemented on your watch. What was austerity, and why was it necessary?
Nick Macpherson, former Treasury permanent secretary: Well, the financial crisis took a huge amount of productive capacity out of the economy. What we found ourselves looking at back in 2009 and 2010 was a future where the economy was going to be about 15 per cent smaller than we had expected, and we had spending commitments that reflected a view of future growth that was no longer sustainable. So, something had to give. In 2010, the government ran a deficit of 10 per cent of national income. In those circumstances, it’s not that you need to suddenly return the budget to balance, but you do have to be able to demonstrate that you’ve got a plan to get the deficit down to a credible level in the medium term.
The initial response to the crisis was, quite rightly, to support the economy—Alistair Darling cut VAT as chancellor. But by late 2009, he was focusing on a plan that would cut the deficit in half over a four-year period. An election then took place. George Osborne wanted to adopt a more ambitious approach, but, crucially, he was determined to use spending reductions rather more aggressively and, at the same time, to not increase tax as much as Darling had planned. The term austerity, which I suppose harks back to the 1940s and the years of Stafford Cripps [Labour chancellor from 1947 to 1950], rationing and so on, has different meanings. David Cameron and George Osborne used it to mean cuts, but they made a virtue of it.
Alex Dean, managing editor at Prospect: Was it a matter of political choice who bore the burden of the cutbacks?
Nick: We could have done it in different ways. There are two issues here. One is, if you are going to reduce the deficit, how do you do it and who bears the cost? It’s fair to say that, at that time, the less well-off in society perhaps bore a greater burden than was desirable. There was definitely a case for the better-off taking more strain. But the other issue is, is fiscal consolidation sensible in principle? There’s been a huge debate since 2010 about how, by seeking to reduce the deficit too quickly, the government reduced economic growth. I actually don’t believe it did affect the performance of the economy much. What affected the economy was the eurozone crisis in 2011 and 2012. The disruption in our main market, namely Europe, did have an effect.
Ann: What was happening is that real earnings had collapsed by 2012, and that had domestic causes, so I think it’s a bit unfair to blame it on the eurozone crisis. I think you’re exactly right, Nick, to describe Osborne’s policies as political choices—George Osborne was one of the most political chancellors we’ve ever had—but you don’t go far enough.
The fact is that underpinning his political choices was an awful lot of economic theory, around “expansionary fiscal contraction”, for example, which says that by cutting spending you help the economy expand. And it was argued by very distinguished economists, so I don’t just blame the politicians. I think the big problem is with the economics profession, which convinced the politicians that government spending can’t do much to expand the economy. Darling and Osborne bought into the idea that when the economy as a whole plunges, then the government must reinforce that by cutting spending, when actually that is the moment for the government to intervene to revive the economy. When the government decides to amplify the failure of the private sector by contracting the public sector, then you’ll get the sort of sustained slowdown that we’ve had since 2009.
Nick: Where I disagree with Ann is that, while real wages have indeed stagnated for a long period, in practice there’s very little that the public sector can do about that. The stagnation, in the end, reflects productivity changes in the wider economy. The government could have spent more in 2010, but I don’t think it would’ve made much difference to the performance of the economy. The independent Office for Budget Responsibility estimates that the benefits of the Keynesian “multiplier” are quite low.
Alex: That’s the idea that you get more back than you spend, because public spending boosts growth?
Nick: Yes. The thing about Britain is that we’re a very open economy. Keynesian interventions can work well where the economy is relatively closed. In the United States, those sorts of interventions can have quite a sizeable effect. In Britain, the spending tends to go into imports, and it may benefit the Bavarian car industry, but it doesn’t seem to do huge amounts of good for Britain.
Nick Macpherson: I wonder whether cutting the benefits of the poor is terribly good economics
Where I would agree with Ann is that it’s worth looking at the balance of both spending cuts and taxation. I also wonder whether cutting the benefits of the poor is terribly good economics, because the poor tend to have a higher propensity to consume, so their money is put to good economic use. But I still don’t believe that had we, let’s say, run the deficit at 5 per cent a year higher through that period, it would’ve made much difference to the performance of the economy. Indeed, we’d now be stuck with even more debt than we currently have.
Ann: I really have to disagree with you on the debt. For me, the debt and the deficit are a consequence of economic inactivity: they are what we get when we have a weak economy, high unemployment or very low incomes. If people were paid higher wages, they would pay more taxes, tax revenues would rise and the books would be balanced.
And can I just say that I deeply resent the attribution of government “tax and spend” to Keynes. I think it’s a way in which he is denigrated, saying that the Keynesian response to a crisis is for more government spending. He never wanted the economy to be in crisis in the first place. The reason we were in one in 2008 was because we’d neglected Keynes, who argued that to stabilise the economy and the budget it is necessary to manage and regulate the financial sector. Very deliberately, Wall Street and the City of London took over and were pulling the major levers of the economy, effectively setting market rates of interest, exchange rates and so on. When governments lose hold of those levers, that’s when they’re in trouble and can be left exposed to the vicissitudes of the market.
Nick: There’s a problem that all governments face, which is that there are always inflexion points where, if you borrow too much, you suddenly find that the cost of borrowing begins to go up.
Alex: As happened with Liz Truss?
Nick: Until Liz Truss and Kwasi Kwarteng came along, there was an assumption that when governments got into fiscal difficulty, you simply devalued your way out of trouble and the pound took the strain. And so, for quite long periods, interest rates seemed immune to what governments did.
But the Truss episode is a reminder that there are inflexion points where the markets can lose confidence in the government. If you’re in the Treasury, that is your biggest fear. You don’t want to go there, because once you’ve lost credibility the price is very high. One of the reasons why Jeremy Hunt had to tighten policy so much in last year’s Autumn Statement is because he had to convince the markets that this moment of madness was temporary. So there are costs to letting your deficit and debt rise at too fast a rate. And we are still paying the price: the 15th March Budget was more restrictive than it would have been had Truss never become prime minister.
Ann: So what you are saying, Nick, is that actually the markets are governing us and running the show? Now, I’m highly critical of what Truss tried to do, mainly because her spending was about tax cuts for the rich, and they were unfunded and that was unsustainable, no question. I think the markets were dead right about her “mini-budget”. But the fact of the matter is that the most important interest rate—the base rate—is not ultimately determined by the markets. A powerful central bank like the Bank of England can just step in and—hey presto!—market rates can be pushed down.
Ann Pettifor: If people were paid higher wages, tax revenues would rise and the books would be balanced
I don’t think we should use the Truss episode as a way of saying, “Sorry, but we must give up trying to do something about our economy because the markets won’t let us.” That’s the kind of defeatism that economists are often guilty of.
Nick: The difference between Britain and other countries, or certainly other countries that run large deficits, is that the British people tend, like the governments they elect, to over-consume, under-save and under-invest; therefore, something like 30 per cent of our national debt is in the hands of overseas investors. As [former Bank of England governor] Mark Carney once put it, we rely on the kindness of strangers to fund our debt, and so we do have to be sensitive to what those investors expect in terms of macroeconomic policy.
It would be nice if we didn’t have to rely on the markets, but in the end governments have to demonstrate that they can live within their means.
Ann: I don’t disagree with you. I think it’s a tragedy that we have put ourselves in the position of being dependent on the kindness of strangers. But I disagree with you about investors. Investors want what you and I want: a prosperous economy, not what we have had since 2010, which is an economy that is gradually sinking into the mud, with virtually no growth, with cuts to real incomes, and with a worryingly unskilled workforce.
Economists blame productivity, but it seems to me that productivity is a fig leaf. The fact is that we have low levels of productivity because we have low levels of investment. The government has to invest to encourage and support the private sector. In the event of the private sector losing confidence in the way it did in 2008, that’s when governments have to step in. And austerity was about saying, “No, governments should consolidate the crisis by cutting even further.”
Alan: Thirteen years since the coalition came to office, austerity is particularly biting at the moment. It feels as though the state has been hollowed out. With the benefit of hindsight, was it wise to have cut the public services so deeply back then, Nick?
Nick: In determining policy, you need to look at the underlying pressures on the state. This is the period when demographic pressures have finally come into play. We’ve got an ageing population that’s putting more demands on the health service, more demands on social care; successive governments have implemented a triple lock on the state pension. I’ve always thought that this country needs to have an honest debate about the size of the state. If you want to have a European-style welfare state, you probably need to have European levels of taxation. Taxes are going to have to rise because all the pressures on spending are upwards, and somewhere, somehow, government is going to have to find some way of funding that.
Nick Macpherson: I think vanity projects like HS2 are a rather inefficient form of investment
Ann: But you see, this is where we disagree, Nick—I think vehemently—in that you’re framing this as if taxes pay for public spending, as if taxes are paying for the state. But taxes are a consequence of investment and spending, they’re not a source of investment and spending. When I get a job, and work for a whole month, at the end of the month I earn my salary and only then do I pay taxes. If employment and wages fall, tax revenues fall massively. If the government works to increase employment, tax revenues will rise. It’s not rocket science. This idea that taxes pay for public spending is at the heart of austerity, and it’s the problem with austerity.
Nick: Well, I’m afraid that I don’t believe that you could pay for a European-style welfare state by taking out a loan.
Ann: No, but you pay for it by having a prosperous economy and full employment of highly skilled, highly paid people pouring tax revenues into the Treasury.
Nick: I’m very much in favour of full employment and I’m very much in favour of growth, but I don’t think the experience of the last 10 or 15 years indicates that public spending is the driver of growth. What is the driver of growth? Ultimately, competition, skills and innovation, which have very little to do with how fast public spending grows.
Alex: Can I just test you on that, Nick? Surely if the state spends more on, say, education, that boosts skill levels, and that boosts growth?
Nick: I fully accept that some spending is likely to improve productive capacity. Personally, at this time, I would be prioritising skills in particular. And protecting and expanding the share of public spending that went on productive investment through the post-crash period would’ve been money well spent. But historically, this country has had a chronic tendency to invest in the wrong things.
I think prestige vanity projects, such as the HS2 rail link from London to the north, are a rather inefficient use of investment resources. There are definitely things the government can do, but in the end what drives growth is not the size of the public deficit. It can have some impact in the short run, and I agree with Ann that, if you’re in a slump, there’s a case for using fiscal policy to support activity. But we are not in a slump. When we next have a general election, my guess is that we will be in circumstances broadly similar to those now. So whoever wins that election will need to have quite an honest conversation about how to pay for their spending pledges.
Alan: Ann, if you had been chancellor in 2010, what would you have done about public spending, and how different would the state look now?
Ann: I would have worked closely with the Bank of England. One of the tragedies of the Truss debacle was the sacking of [former Treasury permanent secretary] Tom Scholar on the one hand and the failure to talk to the Bank of England on the other. I would’ve worked with the Bank to borrow the money needed for the government to invest, and I would’ve made sure the government invested in employment-generating activity such as infrastructure projects—which could be, like HS2, delivered by the private sector but essentially funded by the public sector. My personal passion would have been to invest in projects that would’ve protected us from climate breakdown. I was part of the group that produced a 2008 report called “A Green New Deal”.
Ann Pettifor: From 2010 to 2022, the government could have borrowed at unprecedentedly low rates of interest
Alan: What about the existing structures of the welfare state, education and health? Would you have been able to get away with not cutting them?
Ann: Absolutely. I would’ve made a point of improving them, to drag the economy out of the slump.
Nick: I don’t agree with Ann on this. I think that if we’d have carried on spending as if the economy were a whole lot bigger than it was, we would have had to borrow a great deal. You have to actually go out to the markets and sell this debt. Now, if you could persuade the Bank of England to buy the debt—effectively, monetary financing in the short run—you could probably do that without affecting the cost of borrowing.
But that would almost certainly result in higher inflation, and the problem in these circumstances is that when debt starts rising, the cost of servicing it can go up markedly—as we have found in the last year, when debt interest has been by far the fastest-growing government programme. The problem in those circumstances is that debt interest then starts squeezing the resources that are available to spend on rather more constructive programmes, such as health and education.
Ann: But, Nick, throughout the period of 2009 to 2022, government could have borrowed at unprecedentedly negative real rates of interest. To point to just the Truss period is a little unfair. We had 13 years of exceptionally low rates.
Nick: I’m quite sure we could have borrowed a bit more during that period, but to do it on a scale of, say, 5 to 10 per cent of GDP a year would’ve raised questions about, “Well, where is the nation’s debt going?” British debt is highly trusted, and my concern is that we should keep it that way. In the end, every government has to be able to set out a credible plan around how it’s going to finance its spending. Now, it doesn’t all have to be financed out of tax; sometimes it might be financed substantially through borrowing. But the state’s got to be able to demonstrate that, over the next five years or so, it can maintain a broadly stable system of public finances. You cannot spend your way out of every problem.
Alan: At the moment, we’re teetering on the brink of recession, if not in actual recession. We’ve got public services that are on their knees. We’ve got strikes. Everything seems as bad as it could be, really. If you were back at the Treasury now, Nick, what would you be saying to an incoming Labour government?
Nick: The first thing I think any government’s going to have to do is to sort out the strikes issue. The fact is, this government is expecting public sector workers to take a bigger real wage cut than at any point in our lifetimes. Thereafter, if recession strikes, I’d be expecting the Bank of England to use interest rate policy to support the economy in the short run. The government should continue to invest in the nation’s infrastructure. It probably is going to have to spend more in the medium term, particularly on health and social care. I would be trying to persuade the government to come up with a tax policy that can fund the extra spending.
Alan: Ann, what would your advice be?
Ann: Well, further cuts to incomes are just not sustainable in macroeconomic terms, so I think that it would be a priority to raise incomes and to balance the budget through tax revenues generated by full employment of skilled and well-paid workers.
I always love this quote from Keynes. In a debate on the radio with [economist and industrialist] Josiah Stamp he said: “You will never balance the budget through measures which reduce the national income. The chancellor would simply be chasing his own tail—or cloven hoof!” Increase the nation’s income, and you will balance the budget. That was the case in the 1920s and 1930s, and it is the case now.
This transcript has been edited for length and clarity
