Another voice: Against austerity
Jonathan Portes 5:32pmHere's the latest in our Another Voice series of posts, which give prominence to viewpoints outside the normal Coffee House fold:
You can't help but notice that the UK economy isn't doing too well. Part of this is down to international developments, sure. But part – as Mervyn King said in his letter to George Osborne last week – is the result of "fiscal consolidation", aka spending cuts. The IMF's assessment, published a few days ago, shows both why debt has risen (lower tax revenues) and what is happening now (sharp contraction):
And there's much more contraction to come:
So why keep on contracting if it is affecting economic growth? Clearly, the Prime Minister thinks that this is exactly what is needed. Yet, in doing so, he shows that he as learnt nothing from the
history of the Great Depression. That history, and conventional economic wisdom, tells us exactly what we should be doing – and it is not what Martin Wolf describes in the FT as "kamikaze tightening". The public sector needs to support demand, not reduce
it, until such time as the private sector – households and firms – again has the confidence to spend and invest.
The government's response is that without tightening, interest rates would be rocketing upwards. But there are two problems with that argument.
The first is the implicit suggestion that low long-term interest rates are the result of "confidence" in the government's fiscal plan. As I have written before, this is simply nonsense. Low long-term interest rates in the UK reflect not economic confidence but its opposite – the view of financial markets that the economy is weak and getting weaker. The fall in rates has been strongly correlated with falls in UK equity markets and falls in sterling. Neither is exactly a mark of "confidence". As Coffee House's own Fraser Nelson puts it, "if low borrowing costs were a precursor to economic success, Japan would have been booming long ago".
The second problem is the claim that – while fiscal consolidation may not be driving the current low level of interest rates – a reversal would lead to such a market panic that interest rates would rise sharply anyway. With fiscal consolidation, they say, the UK is a "safe haven"; without it, we're Greece. But comparisons of the UK to Greece miss the point. As Simon Wren-Lewis has explained, the situation of the UK is completely different:
"There is a straightforward reason why the current debt crisis is largely confined to the euro area, which can be summed up in one short statement: these countries cannot print their own currency."
This is a fundamental point. Investors in gilts know that the UK has the power to print unlimited quantities of sterling. So the chances of them not being repaid are vanishingly small.
Moreover, we have a floating exchange rate. So if foreign investors sell gilts, the pound falls; at some point it falls to a level where it becomes attractive again. So there are natural
adjustment mechanisms to bring us back to equilibrium.
But these adjustment mechanisms do not apply to countries that borrow in foreign currency – as effectively is the case for the eurozone. Here, when deficits go up, investors may
rationally fear default, because governments cannot print money. And the currency can't fall to make it more attractive to invest in government bonds.
So interest rates go up, leading to increased interest payments, and higher deficits – so the risk of default further increases. A spiral towards default can develop even if, before the whole
cycle started, the government was perfectly solvent.
So it doesn't take much to tip a country from a vulnerable position into a crisis. This, arguably, is what is happening to Italy and Spain (Greece, which is clearly insolvent and has been for some time, is a rather different case). But it can't, and won't, happen here.
All this is set out in much more technical detail by Paul De Grauwe here.
Rather than compare ourselves with Greece, we should take more notice of Denmark — like us, outside the eurozone with their own central bank and currency. The Danes have just elected a coalition, headed by the Social Democrats, who campaigned on a platform of "more spending on schools and hospitals, policies Rasmussen [the outgoing centre-right Prime Minister] warned will jeopardise Denmark’s AAA credit rating". Sound familiar?
And the thing is, it seems to working out okay for Denmark. Danish ten-year bond yields are hovering around the 2 per cent mark, down about half a percent over the last two months. So, they're lower than the UK's, and they've fallen faster. Danny Blanchflower has the details here.
Even the IMF seems to have woken up to this point. A year ago, the Fund bought Osborne's position hook, line and sinker, saying (without a scrap of evidence) that, "The consolidation greatly reduces the risk of a costly loss of confidence in fiscal sustainability". In sharp contrast, they now argue that, "if activity were to undershoot current expectations and risk a period of stagnation or contraction, countries that face historically low yields (for example, Germany and the United Kingdom) should also consider delaying some of their planned consolidation."
What has changed? If abandoning the plan would have risked a loss of confidence then, why wouldn't it now? After all, the medium term figures look worse, not better. The answer is that the Fund's current position is based on economics rather than ideology.
There is a legitimate debate about the optimal pace of what is – over the medium term – a necessary fiscal consolidation in the UK. But the UK is not insolvent; it is not close to insolvent. Anybody who compares the UK to Greece is simply scaremongering, and there is no need to take them seriously.
Jonathan Portes is Director of the National Institute of Economic and Social Research
Previous
Nick
October 10th, 2011 5:46pm Report this commentThe whole assumption of this article, is that the government accounts are accurate.
They aren't. They have applied the Bernard Maddoff book of accounting to make pension debts disappear.
Richard Nabavi
October 10th, 2011 5:51pm Report this commentWhat a spectacularly stupid article!
Citing Denmark is hardly supportive of the argument. Quite the opposite, in fact; they are a prime example of sound public finances, having run a surplus during the good years, and even now having a budget deficit which is well under control: 3.8% of GDP in 2011, and 4.6% forecast for 2012, compared with the utterly unsustainable 11% which the UK government inherited.
Of course it would be delightful if we were in Denmark's position, and could afford a bit of a stimulus in the bad times thanks to good husbandry in the good times. But we're not, and pretending that we are in the lucky position Denmark is in is, frankly, daft.
Stephen
October 10th, 2011 5:52pm Report this commentSo you use Martin Wolf, Simon Wren-Lewis, Danny Blanchflower and your own article from the New Statesman as "proof" of your argument.
Listing a bunch of Labour supporters who have been so wrong on economic matters doesn't help you.
Right On
October 10th, 2011 6:08pm Report this commentGreat, more Keynsian nonsense.
The solution being suggested is simply not workable. There is a seriously depressed level of economic activity as the private sector contracts and individual spending reduces due to the country begining to stop spending as much (the public rather than the government).
Propping up GDP with more public spending is total folly and may create the appearance of growth but it's illusionary - the private sector could take many years to adjust to a realistic level, and many people will need to reset their living standards minus large debt spending - the only choice is to take the pain and get the public finances under control. Couple that with a supply side growth strategy and the private sector will recover in time. Keep spending and you'll create a zombie economy.
Oh and surely we can stop rehashing the Great Depression arguement - public spending did not end the Great Depression - spending may have create the same illusionary growth for a very short period but it stagnated until the war. Huge deferred demand and millions of deaths seen off the last Great Depression.
TomTom
October 10th, 2011 6:13pm Report this commentPoor old Cameron has no idea what a Liquidity Trap does to interest rates and why it is devillishly had to reverse a Liquidity Trap. The difference between a Current Account and a Deposit Account is not very clear nowadays, save that one ties up money in an insolvent institution.
Cameron & Osborne are heading for a bust and very crowded streets of angry "Occupy" protesters, especially in January as City bonuses entrench Reward for Failure; Punishment for Success Culture of Modern Britain.
Liquidity Trap - think about it Cameron, it has really steep sides and a deep bottom
Rhoda Klapp
October 10th, 2011 6:24pm Report this commentOK, usual moan about the concept of another voice taken as read.
So, anxious to know just how reliable NIESR is as an economic source, I repaired to their website. I looked up their annual report for 2006, last full year before the recession hit. I was interested to find out whether they saw it coming. Wadda you think? Next!
Nikc
October 10th, 2011 6:25pm Report this commentAnd another point. Government spending was up in real terms last year.
Recession gets worse.
Causal link.
Government is consuming so much money that very little is left for productive investment, and what little is, is taxed at 50%. The real something for nothing society.
No input by the government, no risk by the government, no work by the government, 50% of the profits and none of the losses. No wonder people are investing overseas.
Hugo Chav
October 10th, 2011 7:42pm Report this commentIt is not Austerity that is killing the economy, it is Inflation.
This has come about from a weak pound, ZIRP, QE and Tax Increases.
Government spending is c.50% of GDP, which is an absurd number in a hyper-competitive world.
As we approach currency wars the Pound Sterling is going to come under extreme pressure due to our horrific debt dynamics. Our standard of living will take a bad plunge.
The best option in 2007 was to nationlise the bust banks with the setting up of a bad bank like Sweden did. It was absurd to bailout the bank debt holders. We should have cut public spending and set free the private sector with deregulation and tax cuts, for that is where the real wealth is created to pay down debt.
Our current strategy is leading to inflation, which hits the poor and elderly hardest, and the decline of our currency and thus our standard of living.
We need a Thatcher or Volcker type figure to rescue us from the debt junkies and money printers who currently reside in the Labour, Conservative and Liberal parties.
We are totally stuffed, within four years our debt dynamics will be approaching 100%. With twin deficits the markets will not show us no mercy, either a bond or currency collapse awaits us.
daniel maris
October 10th, 2011 8:25pm Report this commentPerhaps we need more of those Danish wind turbines which everyone tells me are economic suicide. :)
This is a good article, as it highlights the issue of confidence. Osborne's stupid policies, based on scaring the Great British Public into extremely cautious behaviour. As Japan shows, it can be difficult to get out of the rut once you are in it.
We need to stop the assault on the public sector, on pensions and working conditions.
Yes, there need to be job cuts and pay restraint. But the government has gone way over the top.
We need to invest in domestic industries that reduce imports. Wind energy, insulation and solar power are good examples. As are additional agriculture, recycling, and numerous other initiatives.
We need to get people off welfare. The best way would be to start with a job guarantee for all young people under 25. Such a scheme would almost pay for itself and have tremendous social benefits.
Nick
October 10th, 2011 9:09pm Report this commentTo Keynes, excessive saving, i.e. saving beyond planned investment, was a serious problem, encouraging recession or even depression
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So we look at the the current level looking for that excessive saving that is causing the recession and what do we find?
Yep, savings levels at an all time low.
Nick
October 10th, 2011 9:12pm Report this commentWe need to invest in domestic industries that reduce imports. Wind energy, insulation and solar power are good examples. As are additional agriculture, recycling, and numerous other initiatives.
No, that isn't the condition.
We need to invest in any industry that generates a profit that is more than the interest costs.
So lets let Wind and Solar loose. No need for a subsidy. It's so good its going to make a profit without forcing the customer to pay over the odds, isn't it? No, quite.
Green companies need to be taken off welfare.
Nick
October 10th, 2011 9:14pm Report this commentThis is a good article, as it highlights the issue of confidence. Osborne's stupid policies, based on scaring the Great British Public into extremely cautious behaviour.
Of course. It's rational. Why invest when the government takes 50%, and none of the risk?
What's the foreseeable future? Higher taxes, because they aren't cutting spending, they are increasing it in real terms.
What's a good strategy for an individual to cope with this?
Archibald
October 10th, 2011 10:00pm Report this commentFraser, I like this series, but you first invited Jonathan on here as part of a 'Right to Reply'. Now he's 'Another Voice' but there isn't actually a voice on the other side. Will you be giving yourself a 'right to reply'?
It's great to have different views from the Spectator, but you seem to be having more and more 'different views' (all four non-CH bloggers are centre-left to varying degrees I'd say) and not many 'views'. Can't you get just one right-leaning blogger, it's surely not much to ask, so we have a proper debate.
Also, 'right to reply' is far better than 'different voice' - give us two sides to an argument to chew over. Don't get me wrong, I like Jonathan's offerings, but let's have proper debate please - it's the prospect of this that had people outside London eager to hear about your Europe debate, I'd have thought that would have underlined 'right to reply' as the way to go - even if you get a voice from the right in rather than do it yourself.
Baron
October 10th, 2011 10:35pm Report this commentRight On, sir, you are right on.
daniel marries, sir, you aware how the statisticians treat the contribution of the public sector to the GDP? It’s equivalent of what it costs us, if we were to borrow £100bn, push the money into the public domain, GDP growth would look quite healthy, our future bleaker than bleak, we’ve done it in the past (financed from tax receipts, borrowings), now pain, do we want more of it?
and this:
Keynesian policies cannot work in a country that runs massive trade deficit, they cannot boost employment either if the country has opened its borders to unchecked immigration.
Nickle
October 11th, 2011 12:33am Report this commentdaniel marries, sir, you aware how the statisticians treat the contribution of the public sector to the GDP?
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That's why the best measure is tax receipts divided by tax rate. It can't be fudged.
outsider
October 11th, 2011 3:39am Report this commentHugo Chav is right Mr Portes. Mr Osborne's policies are failing not because of cuts in real public spending. They are failing because of cuts in real incomes as a result of inflation, induced by the Bank's American style policies operating in a country where the exchange rate is key for inflation.
Real average earnings are down 4 per cent over the past three years even against the CPI and of course earnings do not allow for people who have lost their jobs, annuitants et al. Inflation = falling real incomes = weak demand.
The Chancellor parrots the notion that a small rise in interest rates will drive millions from their homes when in the real world most mortgagees will be able to freeze their monthly payments.
You are right that the wildly exaggerated warnings of austerity, made to please the markets, undermine confidence still more. But growth will not come from ever more borrowing, whether by state or consumers, because people know it is unsustainable and rationally expect it to bring more pain for living standards later.
Douglas McWilliams
October 11th, 2011 9:26am Report this commentSorry to confuse with a few facts. But the only fiscal consolidation so far has been the VAT rise. So writing about 'fiscal consolidation (aka spending cuts)' is simply wrong.
What a load of bankers.
October 11th, 2011 10:55am Report this commentDetlev Schlichter - 10/10/11:
When this crisis started in 2007 and intensified throughout 2008, it was often labelled a “crisis of capitalism”. You don’t hear that so often anymore. Granted, there are still the occasional lapses, sadly even by economists, but the longer the crisis goes on and the longer the spotlight remains on money and banking, the more it dawns on the public just how much the present financial architecture is evidently defined not by the “invisible hand” of the market but the controlling hand of the state. When yet another round of bank “recapitalization” is announced, presumably at taxpayers’ expense and thus driving home the point once more that the banks are above the fray of normal and fallible capitalist enterprise, and when the salvation for our debt-laden economy is declared for the umpteenth time to be sought in yet more debt-funded government spending, or in yet another injection of more money created under state monopoly by the central bank and handed to the public as an apparent incentive to take on yet more debt, the public is beginning to wonder if policy makers have not lost the plot, and if we should not fear the ‘stimulus’ more than the unchecked market.
Why are we in this mess?
“Undercapitalized banks” is code for banks that lent too much. How can banks have lent too much, and obviously have done so for years, decades even, and have done so the world over in the most enduring and persistent credit binge in history, when they are all under the control of the state central bank, which in a paper money system has the monopoly of printing (unlimited) bank reserves and administratively setting short-term interest rates, and thus controlling lending conditions? Is this not properly called state failure, rather than market failure?
TomTom
October 11th, 2011 3:06pm Report this comment"Keynesian policies cannot work in a country that runs massive trade deficit, they cannot boost employment either if the country has opened its borders to unchecked immigration"
Too True !
Y = C + I + G + (X - M) and PQ + MV
and don't let them forget it !
daniel maris
October 11th, 2011 7:46pm Report this commentNick -
You say:
"We need to invest in any industry that generates a profit that is more than the interest costs."
Superficially that sounds attractive but I think it is misguided.
Take a look at much of our financial services sector. The sector is not nearly as profitable to our country as a whole as would at first sight appear. The main reason is that they suck in huge numbers of people from abroad - people who add to the infrastructure costs of our crowded island (or at least the crowded south east corner) and push up the cost of housing and transport.
Not only that but it unbalances our economy, attracting the brightest and best of our citizens into that sector.
Then we have seen that it is the sort of industry that is subject to huge swings which,through the banks has saddled us with huge debt.
Putting a green energy infrastructure in place is expensive, but it (a) creates plenty of jobs for UK citizens across the country, not just in the south east (b) provides plenty of continuing employment for UK citizens (c) helps our balance of payments (d) long term reduces energy costs (e) delivers energy independence.
Obviously I am not arguing against profitable private enterprise, but I am saying don't rely on it to deliver everything you want and need.
Incidentally I am saddened that the government is going to impose on us the nuclear option - we are making a hugely expensive mistake building this new generation of nuclear power stations. If you don't want green, go for LNG. Whatever you do, don't opt for the failing nuclear power industry.
Jonathan Portes
October 12th, 2011 9:08pm Report this commentLet me respond to at least some of the comments.
Richard Nabavi is right that Denmark’s deficit is less than ours. But in saying that the deficit is “unsustainable” he is placing his own judgement over that of the markets, who are charging interest rates that are exceptionally low by historical standards for long-term UK government borrowing – just as they are for Denmark, the US, Japan and so on. If he thinks they are wrong, he can always follow the advice of Niall Ferguson, Bill Gross and so on and short sell gilts – but so far he’d have lost an awful lot of money if he had.
Stephen thinks Martin Wolf (and presumably Fraser Nelson, who I also quoted approvingly) are Labour supporters. Who knew?
Right on thinks pain is necessary. In this he is taking the David Cameron line, and that of the Treasury circa 1931 or so. Like most empirical economists, I just don’t see why unemployment/low growth –resources not utilised simply because government can’t or won’t manage demand in line with potential supply – is necessary. It is an admission not just of failure but of incapacity, which is worse.
Rhoda Klapp seems to think that NIESR’s failure to predict the financial crisis (five years before I joined) means that our macroeconomic modelling isn’t worth taking seriously. There is a serious point here – I disagree but don’t have the space for this complex argument. But if she thinks we should only listen to those who have a claim to have predicted the crisis, then we’d be following the advice of people who want much more radical action, both on fiscal policy and elsewhere, than I’ve argued for here. Nouriel Roubini, to take the best known example, would go much further than I am, and be far more damning about the UK’s current contractionary policy.
Douglas McWilliams thinks there have been no spending cuts. This is simply wrong; there has been a significant discretionary/structural tightening, much of it through reduced spending. He should check his facts.
Finally, Nick talks about pension debts; this doesn’t really make a lot of sense. Government has lots of future obligations – pensions, but also health (anyone really think the government will reduce NHS spending in real terms). This is not a debt; it is a priority call on future tax revenues. The question – and it is an important one – is not the present value of future pensions or anything else, but whether tax revenues will be sufficient to pay for public spending over the medium to long term. This is largely irrelevant to the optimal short term fiscal stance.
As always, it's been a pleasure, and thanks to Fraser and Peter.
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