Austerity: Amplifying Private Sector Failure

I debate austerity with one of its architects

London’s Prospect magazine invited yours truly and Lord Nick Macpherson, who for many years was the top economist at the UK Treasury, to their offices for a debate about austerity. It was quite feisty, as you can imagine…

Below you will find an excerpt from the debate. Alternatively you can listen in full to Prospect’s podcast here.

First, scan this from Aeron Davis’s book on the Treasury, Bankruptcy, Bubbles and Bailouts - in which he describes Britain’s austerity programme under Chancellor George Osborne, overseen by Nick Macpherson.

 ‘The most aggressive austerity programme of any G7 country’ was initiated with a mix of 80% public spending cuts and 20% tax rises. It began with an emergency 2010 budget in which £6.2 billion of cuts were announced. Later spending reviews and budgets set out how £115 billion of further cuts were to be phased in over the course of the Parliament. This resulted in an average 25% budget reduction per Whitehall department, local council funding cuts of almost a third, and an £18 billion slice off the welfare budget. It included the loss of over 600,000 public-sector jobs, a public-sector pay freeze and a block on civil service hiring. In consequence, government spending as a percentage of GDP was cut from 45% to 40% over five years, a percentage reduction that Thatcher took eleven years to implement. P. 105.

Over to Prospect magazine’s editor, Alan Rusbridger.

Was austerity worth it? We put the question to two economic heavyweights

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.