Dangerous voices are what the British Prime Minister called those who criticised austerity in a speech on Thursday. In response one of those dangerous voices, Martin Wolf, became shrill in Friday’s FT ($). After noting the observation by Jonathan Portes that public investment could currently be financed very cheaply because UK long term real interest rates are so low, he writes “it is impossible to believe that the government cannot find investments .... that do not earn more than the real cost of funds. Not only the economy, but the government itself is virtually certain to be better off if it undertook such investments and if it were to do its accounting in a rational way. No sane institution analyses its decisions on the basis of cash flows, annual borrowings and its debt stock. Yet government is the longest-lived agent in the economy. This does not even deserve the label primitive. It is simply ridiculous.”
Ridiculous it is, but as a piece of spin, the focus on reducing debt works as long as the Euro crisis lasts. I was puzzled at first by the phrase ‘dangerous voices’ in the Prime Minister’s speech. Why focus on the act of saying, rather than the content (as in ‘dangerous advice’ for example). Maybe it is just a little Freudian. They are dangerous voices, not because the advice they offer is dangerous, but because they offer a persuasive alternative to the dominant macroeconomic spin. Let’s start with that spin.
It is good politics to say that “there, but for austerity, go us”. I doubt very much that the government actually believes what it says, but the spin is too good to abandon. Why can I claim that the government does not believe what it says? Because, if debt was the constraint, the government would have tried balanced budget fiscal expansion. Balanced budget fiscal expansion is the growth plan that does not conflict with (and probably helps) the debt problem. Sure, long term supply side reform is good too, but we need demand stimulus now. See, for example, Ian Mulheirn here, or indeed the IMF. I’ve explained the logic many times, and Pontus Rendahl gives a nice theoretical account of why this works (and a new model) here.
If the government really believed that the markets would not let them borrow to expand, but wanted to do something nevertheless, then this is the obvious way out. So why have they not taken it? One answer (there are others) is that the short term lack of growth in the economy, and rising unemployment, is not actually a big problem for the government (or at least the major part of it). It is consistent with their five year strategy. The prime aim of this strategy is to shrink the size of the state, and the need to reduce debt provides an obvious public justification for this. Balanced budget expansion goes in the wrong direction, at least for a time.
But the government wants to get re-elected. Here the calculation might be as follows. First, the recession has not hit the Conservative’s political base hard, so in the short term there is no overwhelming internal pressure to change policy. Second, by the time of the next election in 2015, economic growth will have returned, and the macroeconomic spin will be “we said it would be hard, but growth shows the policy has been successful”. Some economists will complain about the output gap, but that will get lost in argument over what the size of the output gap really is. Others will point to average growth over five years, but then the well tested line about clearing up the mess we were left will come back into play.
In terms of macroeconomic spin, I think it is a pretty good strategy. Good spin is simple, and plays off real events. So the line “we have to reduce debt quickly because otherwise we will be like Greece, or Spain” works, while the response “but the Eurozone is special because member countries do not have their own central bank” is too technical to be an effective counter. In contrast the argument that Wolf and Portes put forward above – why not invest when it’s so cheap to borrow – is effective, which is why it is dangerous. So of course is “austerity is stifling growth”, as long as growth is negative or negligible. However, come 2015, the spin “we have done the hard work and the strategy has worked” will accord with (relatively) strong growth, while talk of output gaps and lost capacity will have less resonance. True, unemployment will still be high, but not many of the unemployed are Conservative voters, and the immunising spin about lack of willingness to work can be quite effective.
Will the strategy, and the associated spin, work? The risk that growth will not be respectable in 2014 must be low: by then consumers and firms should have adjusted their borrowing and wealth sufficiently such that growth can resume. If there is a chance that it might not be, I expect to see some measures in next year’s budget that do not conflict with the overriding ideological objective, such as incentives for firms to bring forward investment. The fact that the main fiscal mandate involves a rolling five year horizon means there is always room for such measures.
The Office for Budget Responsibility, that very positive innovation by the current government, will in all likelihood be pointing to the need for continuing austerity, because the earlier absence of growth will have (or appear to have) reduced capacity through hysteresis effects. I suspect that this was not in the original game plan. However I also doubt that it will be a fatal flaw either. Indeed, while austerity may be becoming unpopular now, do not be surprised to hear the following bit of spin in 2015: “Austerity laid the foundation for our current growth, so we need to stick with it to ensure growth continues”. As you can see, I think the connection between macroeconomic spin and macroeconomic reality is pretty tenuous. Please someone convince me that I’m being too cynical.
 Some argue that the “Labour isn’t working” advert in the 1979 election was effective. However high unemployment did not prevent Mrs Thatcher being re-elected. Perhaps unemployment is more of a problem for Labour than Conservative governments?