Covered: The economy, Conservatives
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mbrella: What’s wrong with the government’s present austerity measures? Andrew Baker: You have to ask what they were intended to achieve. The answer to that question is to cut the deficit. It is not possible for any coalition minister to open their mouth without pronouncing on how they’re “cutting the deficit”. Virtually every time they’re asked a question on policy they begin with this. Of course they’re doing no such thing, because cutting a deficit is not within the gift of any government. What happens to the deficit is a function of how the economy as a whole reacts and responds to government policy. Whether there is growth. And of course if there’s no growth, as we are currently seeing, the deficit won’t get any smaller. Which means that all the pain being inflicted through the cuts is completely and utterly pointless in terms of meeting the initial stated objective.
U
a situation where households are paying down their debts, corporations and banks are paying down their debts, and government is now paying down their debt. And they are all doing the same thing at the same time, meaning the entire economy craters. Have a look around you. And in a global economy, if all the leading governments try this at the same time, which they are, things get even worse. We have synchronised simultaneous public and private austerity. The upshot of this is that none of the conditions required for spending cuts to work as measures to stimulate growth, actually apply at this moment. U: So the government is going too far? AB: Spending cuts, on this scale, in the current circumstances, show a shocking lack of appreciation of economic context. There are recorded instances of governments cutting spending and it leading to growth. But in every instance where this was successful, the economy concerned was at – or close to – full output. The Treasury currently estimates the United Kingdom is six per cent below its potential output. Never before have spending cuts worked when output is so much below potential. This is a giant economic experiment and it’s being attempted in the name of a political gamble. Namely, if the government can say this is a public debt crisis, rather than a private debt crisis, they can blame it on Labour for leaving the public finances in a poor state, and this is their best chance of getting re-elected. In other words, all of this is politically driven, but the economic reasoning behind it is extremely flimsy indeed.
Hopeless George U: So cutting spending isn’t the answer? AB: It’s all very well cutting spending, but if that simultaneously reduces GDP, or the size of the economy, the deficit expressed as a percentage of GDP will remain pretty much unchanged. The government hoped that cuts would trigger growth. This is called ‘growth-friendly fiscal consolidation’, based on three avenues to growth: First, you cut government spending and that creates the space for a lowering of interest rates, because there is less money circulating in the economy, so it should allow borrowing costs to be lowered. But interest rates are already rock-bottom, as set by the Bank of England, so that avenue isn’t open. Second, if you cut government spending, citizens expect that this will create the basis for tax cuts in the future, so will to start spend more now in anticipation of lower future taxes. But because of the discourse the government have created about the chronic deficit, nobody really has rational expectations of future tax cuts, at least in the medium term, so that avenue isn’t open either. Third, the final avenue relates to a phenomenon called ‘crowding out’. When the state gets too big, the private sector is crowded out. If the government is borrowing from its citizens and the markets, that is money citizens aren’t spending and isn’t being lent to private companies in the form of investment. So if you cut government spending, private investment and spending will actually increase. Unfortunately, we have just been through a massive banking crisis. Large parts of the private sector, including the banks have huge debts, so they are de-leveraging, or trying to pay down their debts. They are not investing. So we have
U: Weren’t they necessary? AB: No. First, the UK is not Greece. It was not on the verge of bankruptcy. Neither historically, nor comparatively is total UK public debt anywhere near record levels. It’s actually only about 60 per cent of GDP. In the past, in Britain, and in other countries currently, it has been and is above 100 per cent of GDP. The reality is the amount of interest the government was paying to borrow only ever went just above three per cent. The danger zone for most countries is when it goes above six per cent and heads towards 10 per cent. The UK was a long way from that. Osborne seized on the Greek case, but no reputable economist took the Greek analogy seriously. Rachel Lomax, who used to run public spending at the Treasury and is a bit of a deficit hawk, described the comparison as absurd. The key thing is the UK has its own currency and sets its own interest rates, making a debt default more or less impossible. The government’s debt is mainly British-owned (mainly pension funds) and it is denominated in sterling. This was not the case for Greece and Ireland, where foreign banks had massive exposure. In other words we owe the money to ourselves. All of this meant the government was under much less pressure from the markets or the ratings agencies to cut spending than it would admit. The Standard & Poor [Index] never said they were about to downgrade the UK’s rating, they simply issued a circular, where they said they might have to review the situation at some point in the future if the annual deficit continued to grow. Again, Osborne opportunistically seized upon this to make political capital and point the finger at Labour. U: What should the government have done? AB: Probably kept fiscal policy broadly neutral. Made some targeted investments in strategic industries. Talked up the prospects for the economy and crossed their fingers and hoped for the best. But that wouldn’t have necessarily been good politics. Ultimately, current economic strategy is a game of chance driven by political expediency. What they could have done was put in place a new independently monitored and genuinely counter-cyclical fiscal constitution based on some simple rules.
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illustration: Devashish Guruji, www.idrewthat.blogspot.com
Umbrella talks to Professor Andrew Baker from Queen’s University in Belfast, who dismantles Chancellor George Osborne’s current economic policies