For those who think I’m exaggerating when I say the
intellectual case for austerity is crumbling, have a look at Alan Taylor’s Vox column. His analysis is particularly nice because it
demonstrates two key problems with some earlier research. If you ignore the
endogeneity of fiscal policy, and you ignore the state of the economy, then his
study (joint with Oscar Jorda) replicates the ‘expansionary austerity’ result.
If you take account of these things, you get numbers much more consistent with,
for example, this widely cited IMF study (although their
analysis attempts to improve on that work). So (journalists please note) it is
not a matter of X says this and Y says something different: if you do the
analysis properly austerity is clearly contractionary in bad economic times.
Alan Taylor also uses his estimates to cost the impact of UK
austerity: GDP would be 3% higher today without it. Here the the relevant chart.
He warns that this number is “likely [to be] a biased underestimate of the effects of current UK austerity. This caveat is the zero lower bound, when fiscal multipliers are known to be much larger in both theory and evidence.” Controlling for booms and slumps makes sense for various reasons, but controlling for monetary policy is at least as important. That also means that the 3% should carry the health warning that if UK GDP had been this much higher, this might have raised inflation, which might have led the MPC to raise interest rates, by more than is implicit in their estimates. But these are all big ifs.
He warns that this number is “likely [to be] a biased underestimate of the effects of current UK austerity. This caveat is the zero lower bound, when fiscal multipliers are known to be much larger in both theory and evidence.” Controlling for booms and slumps makes sense for various reasons, but controlling for monetary policy is at least as important. That also means that the 3% should carry the health warning that if UK GDP had been this much higher, this might have raised inflation, which might have led the MPC to raise interest rates, by more than is implicit in their estimates. But these are all big ifs.
When I did a back of the envelope calculation of the impact of cuts in just UK
government spending since 2010, I came up with GDP being around 2% lower by
2013. As this ignored the impact of tax increases (e.g. VAT) and transfer cuts,
then this seems quite consistent with Alan Taylor’s 3%. So if we make that 1%,
2% and 3% for 2011, 2012 and 2013, that is a total cost of 6% of GDP so far.
Gross National Income was £1,557,503 million in 2012, and there were 26.4
million households, so that gives gross income of £59,000 per household. So the
6% figure implies that austerity has cost the average UK household a total of
about £3,500 over these three years. Although all governments like to give the
impression that they can have a big impact on people’s prosperity, few actually
do. These numbers suggest that the current UK government has managed to do so, but
unfortunately by making us all poorer.
The gross income per household you calculate seems to be high compared with the average income per household published by the ONS of less than half that level. Is your envelope too big?
ReplyDeleteI hate accounts that just quote total GDP figures in £ million, because they mean very little to even someone like me. The number I calculate is the household equivalent of average GDP per head. The numbers generally quoted for average household income tend to be median rather than mean, and will not include retained profits. There are probably other differences as well.
DeleteI think the 6% figure is also what the Coalition predicted May 2010 that the UK economy would have grown by now.
ReplyDeleteBut as Osborne said in the Times in 2006 "In Ireland they understand this. They have freed their markets, developed the skills of their workforce, encouraged enterprise and innovation and created a dynamic economy. They have much to teach us, if only we are willing to learn."
As someone generally on the austerity side, I think it's unfortunate that a few economists and many politicians have claimed or implied that fiscal consolidation can be immediately expansionary. Fiscal consolidation is a reduction of spending and in national accounts spending = income = production. There shouldn't be any debate about that. The debate should be over which route produces more growth over the longer run. No model can plausibly answer that question.
ReplyDeleteOne of the angles most overlooked is that austerity works best for smaller countries in healthier neighborhoods. The reason should be obvious - they hurt their neighbors less and are helped by them more. That doesn't mean that bigger countries should never do it, or that it should never be done during bad times. It certainly doesn't mean that opponents of austerity are proved right by the weak UK economy since 2010, which I think would have been weak with or without austerity.
Another important angle overlooked in the UK debate is the risk of sovereign debt crisis, which was very much part of the political calculation in 2010-2011 though no one in government wanted to say so. With one of the world's highest ratios of banking assets to GDP, and no one likely to offer it a bailout, the UK does need to tread especially carefully.
It is very difficult to see how the UK would default when you have a central bank operating QE. That means the UK does not need to 'tread carefully'.
DeleteDoesn't that totally disregard the impact on sterling ?
DeleteThe BoE may be able to support the gilt market until kingdon come but it has very limited control over the purchasing power of the currency and imported and potentially crippling inflation.
One thing that everyone seems to ignore is the possibility that *no* policy would have achieved much more than what the Coalition has. Since we are talking about GDP, the classic equation points to four components, and you can tick them off one by one. Consumption has been depressed because consumers are de-leveraging. Investment has been low because consumption showed no sign of recovery. Net exports have remained negative because our biggest export market is in something resembling a Depression, and because high employment in the UK has sucked in increasing amounts of imports.
ReplyDeleteThat leaves all the heavy lifting on Government Spending, so is that an Aha! moment. Would it be a really good idea to blow out the fiscal deficit to maybe 10%? How about a half million more civil servants? Maybe a few new Departments to remind us how to drink water and how to stay dry when it rains? Maybe a million PCs so that Civil Servants can write memos to one another on the topic of how to write memos about memos?
I'm not just being sarcastic here. I am suggesting that it is possible that the only way out of slow growth is to wait until "animal spirits" revive and we get growth in the wealth producing parts of the economy, not the wealth consuming parts.
To me, the exclusive focus on fiscal stimulus comes quite close to the MMTers and their enthusiasm for the Government as employer - or stimulator - of last resort. Of course it can be done. We all know it can. But is it really a good idea to take the economy back to the days of the Beveridge Report?
When the economy finally does pick up, and it is showing signs, I think we would prefer to have an economy that can still compete rather than one that has been even further distorted by Labour-lite Government spending.
Lost labour resources can never be regained...better to stimulate an economy than to use austerity measures. Everyone loses out in austere times but the unemployed lose out most.
ReplyDeletewhat if after 20 years of austerity, the economy hasn't recovered? what then? will there be a revolution if it hasn't recovered long before then? remember there was a lot of rumbling going on during the great depression. and that was after only 5-6 years. we cant repeat the long depression experience again as the world has changed a lot. we dont have >80% of the population involved in food production like we did before
ReplyDeleteEven if some austerity was necessary, its application has been far from even handed..Rent Arrears are ballooning because of the bedroom tax. VAT is both a regressive tax and deflationary...oh, and there have been TAX CUTS for higher earners..yip we're all in it together..but some are in it more than others!
ReplyDeleteI've written a bit on a Victorian perspective on the National debt, written 150 years ago and looking back another 150 years. I draw no conclusions, but Macaulay's view raised an eyebrow.
ReplyDeletehttp://eagleclawedwolfe.wordpress.com/2013/07/12/confounded-wise-men-and-dicing-userers-macaulay-on-finance-2/
Reviewing all these comments now from an end of 2015 perspective. Quite interesting how wrong many of the commentators have been.
ReplyDelete