Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 6 January 2015

Austerity and Economic Hyperbole

Chris Dillow thinks that talk of policies leading to disaster is overdone, which is surely true. However he also says “I don't think the claim that austerity has depressed economic activity is a counter-example here.” I disagree.

Consider the UK first. The OBR thinks that GDP growth was 1% lower in both FY 2010/11 and FY 2011/12 as a result of austerity. There are good reasons for believing that is a conservative estimate, but let’s use those numbers for now. They also think the impact of austerity in later years was small (remember Plan A was abandoned in 2012): others would argue that the effects of earlier measures might be more long lived, but again let’s ignore that possibility. In normal times if you reduce growth by 1% the level of GDP will quite quickly recover to the path it would have followed before the shock. However that usually happens because of monetary policy, and we are not in normal times when interest rates are at their Zero Lower Bound. So the impact of these two growth shocks on the level of GDP might be quite persistent. We know that GDP only started growing again in a consistent way in 2013, so it would be reasonable to assume that austerity caused the level of GDP be 2% lower in both 2011 and 2012. If we stop there (which is another very conservative assumption), that is a cumulative loss of GDP of 5% (1%+2%+2%).

Now if 5% of GDP does not seem a lot to you, it may be because it is easy to get punch drunk with figures about economic growth. Or maybe everything seems small besides the impact of the Great Recession, although in 2009 UK GDP fell by a bit less than 5%. But 5% of resources that have been completely wasted (because the unemployed disliked their forced leisure time, and firms’ capacity was idle) is a bit less than £100 billion, which is about £1500 for every man, woman and child in the country. If £1500 does not seem much to you, that probably says something about how well off you are.

If I think about the two other major UK macroeconomic disasters in the last 45 years, Thatcher’s monetarism and ERM membership, it is much harder to suggest that sums of this magnitude were wasted. Monetarism did bring inflation down quickly. This could almost certainly have been achieved in a more cost efficient manner, but it seems unlikely that the efficiency gain would have been as high as 5% of GDP. In other words, a recession may well have been required to bring inflation down. In addition during the ERM crisis large sums were lost defending an overvalued exchange rate, but in terms of the direct losses made by the Bank of England, at least someone else got that money, and maybe some of it is being returned right now! On neither of these occasions is it clear that anything like 5% of GDP was wasted. More generally, I would find it hard to think of another Chancellor (or any other minister for that matter) who clearly wasted a similar amount.

Numbers for the Eurozone are worse still. If model simulations are to be believed, we are talking about cumulated losses of around 10% of GDP and counting. I noted the continuing large output gaps in the Eurozone here. (I'm not aware of any model simulations that look at US growth without austerity, but I am sure they must exist.)

Finally remember that these output losses are completely unnecessary. Nothing of any importance has been gained as a consequence. So as far as austerity is concerned, I think strong language hyperbole is justified. 

   

14 comments:

  1. The First Law of Rough Justice: Self-inflicted wounds are always the most painful.

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  2. How does 1% lower in 2011 and 2012 turn into part of your 1% +2% +2% calculation?

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    1. 1% less growth in 2010 reduces the level of GDP by 1%. Add another 1% less growth in 2011 reduces the level of GDP in 2011 by a total of 2% compared to the no austerity case.

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    2. Simon. A while back you did a graph of GDP actual to a log trend extrapolation. Have you updated it? The area between the two lines is GDP lost. Economics Help has an update but uses a linear trend line for teaching purposes I expect. http://www.economicshelp.org/wp-content/uploads/2014/01/real-gdp-growth-00-14-trend-line-600x566.jpg

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  3. " I think hyperbole is justified."

    Clearly.

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  4. Is it fair to say that the austerity in the UK was at least partly a just pretext for chopping back bureaucratic overgrowth? The macroeconomics might be collateral damage from that. Of course genuine valuable public services were also damaged as collateral damage.

    I'm a fan of having a mixed economy that makes ample use of the state sector whenever it can do the job better than the private sector. But I did get the impression that New Labour took their eye off the ball and we had office blocks mushrooming up that were full of people at best basically just sending emails to one another for the hell of it. Sadly they also ended up being obstructive to those who were actually trying to do something useful.

    I worry that there is a phenomenon where if someone gets a pointless job, they need to move up the career ladder by employing a dozen more people working under them, beavering away, coming up with pointless forms or whatever. Those dozen people then each themselves need to employ a dozen underlings and so on. Its a tragedy of the human condition.

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    1. Thats some price to pay to "chop back bureaucratic overgrowth"!
      If this were true it would have been easier and far less costly to the economy to target those areas where there is "bureaucratic overgrowth", and thus avoid most of the collateral damage the UK suffered. It really does appear to be a purely ideological pursuit of a much smaller state sector.
      Interestingly the kind of jobs you describe seem to be increasingly common in large private sector organisations where more 'paperwork' and increasingly ingenius ways of creating more non-productive work for employees is now the norm. However, unlike for the public sector, there seem to be few calling for this private sector bureacratic overgrowth to be culled, with the inevitable huge job losses that would result.
      (I'm all for cutting unecessary bureacracy, whether in the private or public sector, but it seems to be on the up).

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    2. Simon, I totally agree that "wide moat" private sector companies and also third sector not-for-profits fall prey to the same phenomenon.
      Have you seen "On the Phenomenon of Bullshit Jobs" by David Graeber?
      http://strikemag.org/bullshit-jobs/

      I guess it is very hard for central government to do the micro-management needed to root out the phenomenon. I suppose cutting funding across the board was a way to force some rationalization further down the line. Of course the problem is that people need the jobs they have. They will desperately keep their empire of email senders and ensure that the ambulance drivers or whatever lose the jobs.

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    3. Can't agree with the way the contribution is expressed. Plenty of policy areas where public expenditure needed. Social care and health especially. Avoiding bureaucratic expansion is a separate debate and New Labour's managerial and constitutional initiatives in local government, as an example best value and scrutiny committees, were not helpful.

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  5. Given this staggering (and unnecessary) waste of economic resources thanks to Osborne's austerity policies, quantified (conservatively) in your post above, the 2014 Budget Report findings similarly confirms the negative economic effects of the "drag from fiscal consolidation" on the UK economy, and also confirms the abandonment of Plan A in noting "the pace of structural fiscal tightening was rather less than it had been in previous years" and “the shift from very heavy fiscal restraint to almost no fiscal restraint in 2012, 2013 and 2014” had “lifted a headwind”, surely Cameron and Osborne should be reminded of these fact and figures very publicly every time they speak of their competence at managing the economy - and thus their macro-economic incompetence?
    Afterall, these are not Labour's figures, or those of their favoured economic think-tank. They are the findings of the government's own fiscal watch-dog - the OBR, and the findings of the cross-party group of MPs in the official Treasury Committee report of the 2014 Budget.
    www.publications.parliament.uk/pa/cm201314/cmselect/.../1189.pdf

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  6. Is that an estimate of the impact of austerity relative to doing nothing? If so, is it possible to estimate the impact relative to some kind of positive intervention? (Martin Wolf said, “It is impossible to believe that the country cannot find public investments unable to generate positive real returns.” http://blogs.ft.com/martin-wolf-exchange/2013/05/23/austerity-in-the-eurozone-and-the-uk-kill-or-cure/ ).

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  7. Sorry, by this time I can only throw up my hands at the kind of reasoning which takes "austerity" and 'stimulus" as monoliths. Sure, I can accept that the 1% loss in growth might be persistant. But why assume the make-up in growth from stimulus must be persistant? Surely it depends on the type of austerity and the type of stimulus. Martin Wolf's comment cited by Paul is the key: you need to consider the real returns for cuts and the real returns for stimulus. If macroeconomists had deigned to worry about the micro details, then they might have been able to get a lot more political support.

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  8. To bring inflation down, the Thatcher govt should have implemented and aggressively raised land taxes, combined with cuts in other taxes. This combined with privitasation would make the economy more efficient.

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  9. Simon: You say that "bureaucratic overgrowth" seems to be increasingly common in large private sector organisations where more 'paperwork' and increasingly ingenious ways of creating more non-productive work for employees is now the norm.

    What is your basis/evidence for this claim?

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