A very great deal has been written by economists and others recently about the wisdom of the UK government’s plunge into austerity mode in 2010. The consensus among economists, by far the most common view, is that during a recession, and especially when a country is sovereign in relation to its own currency (ie – it is not tied to gold, or the euro) a policy of government fiscal austerity is contractionary: it reduces GDP in the short-term, tending to prolong the recession.
One might be forgiven, however, having listened to the political and ‘corporate’ class, for believing otherwise. Why politicians and why many business people would wish to promote the opposite view can be argued. Certainly, text-book academic macroeconomics does not support this view. And what little published academic work there is which has been used to support the ‘austerian’ view has been discredited again and again. The reasoning of the ‘austerian’ politicians and business people seems therefore to be based either on ignorance (eg a belief that a whole economy must work like that of a firm or household) or else is based on the ideological view that ‘the state must be shrunk’ and any excuse for shrinking the state is good enough. The text-book macroeconomic academic consensus says that in a recession and when government debt is higher than it ‘should’ be, a sovereign government, like the UK’s, should definitely have a ‘credible’ proposal for getting the debt down in the medium to long term – but not aim to do so in the short term: because of the damage such a policy would cause and its hysteresis effect. One of many very recent blog posts covering this issue by a respected UK economist – Simon Wren-Lewis – is here.
In this post Simon Wren-Lewis politely and cogently argues with one of the few contrarian economists – Ken Rogoff – and takes him to task for forgetting the fact that the UK has its own currency and can thus ignore the risk of ‘market panic’ caused by high debt because it has the means to deal effectively with such a panic.
But more significantly a paper was recently published by the IMF which looks at how, and under what circumstances, government debt may be reduced by means of a policy of fiscal contraction. Basically, it shows that only 26% of fiscal consolidation efforts (defined as a large adjustment in fiscal balances ignoring interest rate payments) were successful when growth is below a country’s historical average. In contrast, when growth is above average, the success rate increases to 41%. I, personally, would not have said that even a 41% success rate was good – but that is another issue. Essentially, the paper says that in the relatively few instances where fiscal contraction worked when growth was below a country’s long term average a few very special conditions existed: a critical one of these conditions was ‘a lift from a depreciating exchange rate and solid export growth—channels that are largely blocked for many countries in the current environment of near-zero central bank interest rates and slow global trade’. The UK has certainly had a depreciating exchange rate – but there has been no ‘solid export growth’, nor could there have been, for pretty obvious reasons.
The fact that we now seem to be very slowly coming out of our recession in the UK is quite irrelevant. The point is that we still have a poor export performance, productivity is one of the lowest of the developed countries, and business investment has still not taken off. Indeed latest ONS data shows that UK business investment was 8.5% lower in the third quarter of this year than in the second quarter. No wonder productivity is low. But even if things were better than that, it would certainly not prove that the government’s policy has been successful. Eventually most recessions do end, no matter how badly managed – so the fact that it may have ended (or may not… if we are having a ‘dead cat bounce’) means nothing: the point is, it has been unnecessarily prolonged by ignorant mismanagement or, worse, a conspiracy to ‘shrink the state’. Being a lifelong believer in the cockup theory of history I do not use the word ‘conspiracy’ lightly.
No ideology in an advanced country should have been sneakily allowed to cause the misery of declining incomes (for the majority, natch), unemployment, under-employment and the cuts in social welfare for the least privileged that this one has. It will have long term effects which are very nasty – the polite term for this being hysteresis.
Edit 18 Nov 2013: Mr Carney says ‘glass half full’ – but with no increase of GDP *per capita* since 2010, still declining business investment and still no export growth, despite a heavily depreciated pound – this does not look like any kind of sustainable recovery to me… Just ordinary people digging into their savings and borrowing more. The game will be well up before the next election I think