It looks as if the UK government’s austerity drive to reduce the deficit in haste no longer has the objective of improving the economy. It has other objectives.
It looks this way because the excuses for austerity not apparently actually improving the economy are transparently weak. They boil down to ‘our main export markets are in a terrible state, the global economy is in a pretty poor state, other countries are in the same boat, so we are doing the best we can under highly adverse circumstances; but don’t worry – we are getting there, slowly – just look at our improving employment situation‘.
This is transparently weak because, for a start, it ignores the fact that our major companies are simply not investing. These companies do not need to borrow (or borrow much) to invest as they are generally sitting on large cash-piles. So while it is true that our SMEs may be experiencing difficulty raising funds – because the banks are still in a ‘delicate’ position – if our major companies were to be investing we would be seeing some real growth. But they are not, despite the once-alleged confidence building effects of the austerity policy. This is because they are fearful there won’t be enough demand to justify their investment in new products, new plant, new machinery. They see a lack of demand stretching into the future. This demand shortfall arises because consumers do not have the wherewithal or confidence to go out and spend. For some years now, their wages and salaries have not kept pace with consumer prices and they are nervous about their jobs. One major reason why their wages remain ‘stickily’ low.
But what about our ‘improving’ employment situation? Well, it’s true that private employment has grown and even outpaced the engineered decline in public sector employment. But at pretty low wage levels. And anyway, there is a marked decline in productivity associated with these employment improvements. More private jobs is not translating into more production and growth. Cheap labour is being hoarded by firms and hired, too, as a cheaper or less risky alternative to capital investment. And in the service sector much labour is being expended fruitlessly chasing more business which refuses to materialise because this is a negative-demand-led recession.
David Cameron, George Osborne and Nick Clegg are none of them stupid. Neither (now, at least) are they ignorant. They know all this stuff. So what is their stated excuse for not abandoning their policy of short term fiscal consolidation – though, of course, it is now not quite so short term because the end-of-this-parliament targets are definitely going to be missed, and the government has admitted it? When, instead, they could be borrowing – at what are actually negative real interest rates – in order to boost demand through increased capital investment in productivity-enhancing infrastructure, building works, school repairs, more housing, etc? All things which are really needed, and which would, much of it from the get-go, have significant economy-boosting effects. The stated excuse is that to be seen to be changing the austerity policy and embarking on a borrowing ‘binge’ when the national debt is ‘so large’ in relation to GDP would cause the bond markets to freak out. The markets would suddenly cease purchasing UK government bonds. And this would result in a rapid rise in market interest rates on the bonds significantly increasing the price of government borrowing in the future. Also, they claim, the UK would lose its AAA status because the government would have lost credibility in its perceived ability to reduce the deficit and ultimately the national debt. Um… well the credit rating agencies are going to do that anyway, and soon. Because, clearly, the government is failing in its endeavours to fix the economy, while the deficit remains stubbornly high, with debt still increasing in relation to GDP. GDP is still bumping along the bottom, if not actually decreasing, further exacerbating the debt-to-GDP ratio. Obviously the best way of actually reducing this ratio would be to increase GDP, the denominator in the equation. We really, really need growth.
There is also, of course, a major unstated reason for not changing policy: that no senior politician can be seen to admit they were wrong, as this would have a seriously deleterious effect on their personal credibility and future career path. Tough one that… Moral dilemma, eh?
So therefore the purpose of continued austerity is now no longer to fix the economy, but (i) to try to hold off a sudden rise in UK government bond interest rates (a sudden drop in demand for bonds) and (ii) to shore up policymakers’ personal credibility until ‘something turns up‘. This is just finger-in-the-dyke stuff. It can’t help but fail. Even more disturbing is that, actually, there is also a third reason (iii) that some Very Serious People, possibly including Mr Osborne – but if not, certainly people he rubs along with at dinner parties, perceive government debt as immoral. They do, too. They may give reasons for this, relating to future generations – reasons which don’t generally hold water. This is really ideological, emotional, not susceptible to argument. Oh, and a related fourth reason (iv) The belief that the state must be shrunk so that the well-off can keep as much of their income as possible and not be burdened by more than the minimal amount of taxation: purely ideological, this one, to put it politely.
So – there we have it: four motivations for continued sharp fiscal retrenchment – none of which actually relate to the reason we were given for front-loaded fiscal retrenchment at the outset: that this austerity would cause the private sector to invest and grow. This was the myth of ‘expansionary austerity’. A myth, by the way, cleanly, neatly and tightly debunked in an essay/paper from the USA’s Center for Economic Policy Research (CEPR) published some 7 months ago. Here (PDF).
Way back in 2010 Olivier Blanchard of the IMF clearly said ‘Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it’. That was in June 2010.
All this is not to say that the national debt is too low, or just right. The national debt is, by general agreement, even among KrudeKrugmaniteKeynesians, too high in relation to GDP. A credible plan for its reduction – and therefore reduction of the deficits which feed it – is definitely needed. But we do not have such a plan at the moment. Plan A has, indeed, been discredited. To be at all credible, a rational plan needs to be stated now, to be implemented when GDP does significantly turn up in what looks like being a sustained manner. Austerity in a time of growth may be a virtue. In a time of depression/recession it is definitely a self-defeating ‘sin’. As the IMF pointed out way back then.
1. How does our debt to GDP ratio actually look? Is it as bad as it is claimed? Well, it is not brilliantly good. But putting it into a historical perspective shows that it is not actually all that terrible, either. Here are some charts. So we need to do something to bring it down. But all that now-now-now panic was totally unnecessary. (EDIT: And long after this was originally written, a paper by Reinhart and Rogoff widely used to justify debt panic, has been thoroughly debunked for (i) sloppy use of Excel, (ii) deliberate exclusion of data that didn’t fit the thesis and, (iii) perhaps the greatest sin, assuming causality and ignoring the possibility of reverse-causality: high government debt results in slow growth, when it could equally be that slow growth causes high government debt).
2. Did the last government cause the sharp increase in national debt? Well, it did happen on their watch. But that was because of the extreme financial crisis caused by the meltdown of the banks, requiring an expensive bank rescue operation, and causing a sharp drop in tax receipts.
3. Could we have been in a stronger position when all this actually started? Probably. But Spain and Ireland were paragons of fiscal rectitude, and still got sunk by their banks (and the euro and the ECB – but that is another story). The UK was not particularly fiscally profligate before this all happened. The fiscal deficit of the UK was actually less than 3% of GDP at the time. Not so bad, as it happens. Similar to the USA and France. But, of course, if the banks had been better regulated… Well, that’s another story. And the blame for that can certainly be laid at the door of Gordon Brown. However, the Conservative party at the time was all for very light-touch regulation too.
There is one potential flaw in the argument that the government should switch course, and borrow for investment in beneficial infrastructure, etc, etc… But nah… That’s for others to elucidate… If they have some evidence, that is…
…Oh well, all right then. The potential flaw is that – although I do not believe it would happen, it is, theoretically possible that some muddled thinking on the part of some people in ‘the markets’, combined with herding, might result in either refusal to buy new UK government debt, or, if not immediate, a sudden rise in their yields (free market interest rates) as those who had bought the new debt (mainly banks) found that they could not sell it on at prices above or equal to what they had bought it for. In other words, if the UK government were to abandon current austerity policies and borrow for worthwhile capital-type investment to boost GDP (fiscal stimulus, yay!) interest rates on UK debt might possibly go stratospheric.
As I said, I don’t believe this would happen. But, if it did… what would happen then? The answer, from history, seems to be here. Nice charts and explanation from that KrudeKeynesianKrugman (KKK). So, not Greece, nor Spain, nor Ireland today. But but France in the 1920s. When an awful ‘bond vigilante’ strike actually happened. So France, which had started with an enormous post WW1 debt problem, recovered strongly. what a surprise! The effect of the sharp rise in French bond yields caused a sharp decline in the value of the franc (surprise? No). Resulting in increased exports (surprise? No). Some inflation eroding the value of the debt (but definitely no Weimar, note). And on to a full economic recovery. France boomed in the 1920s – until the Great Depression. But that is a whole other story.
Meanwhile here is a blogpost and chart chart snitched from Not The Treasury View (aka Jonathan Portes and NIESR) which says it all about the current recession, compared with previous ones.