Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 22 March 2015

Controlling the past

In his novel 1984 George Orwell wrote: “Who controls the past controls the future: who controls the present controls the past.” We are not quite in this Orwellian world yet, which means attempts to rewrite history can at least be contested. A few days ago the UK Prime Minister in Brussels said this. [3]

“When I first came here as prime minister five years ago, Britain and Greece were virtually in the same boat, we had similar sized budget deficits. The reason we are in a different position is we took long-term difficult decisions and we had all of the hard work and effort of the British people. I am determined we do not go backwards.”

In other words if only those lazy Greeks had taken the difficult decisions that the UK took, they too could be like the UK today.

This is such as travesty of the truth, as well as a huge insult to the Greek people, that it is difficult to know where to begin. Let’s start with the simple statement of fact. According to OECD data, the 2010 government deficit in Greece was 11%, and in the UK 9.5%. The Prime Minister is normally well briefed enough not to tell outright lies. But look at this chart you can see why the statement ‘virtually in the same boat’ is complete nonsense.

General government financial balances, % GDP: source OECD Economic Outlook
The real travesty however is in the implication that somehow Greece failed to take the ‘difficult decisions’ that the UK took. ‘Difficult decisions’ is code for austerity. A good measure of austerity is the underlying primary balance. According to the OECD, the UK underlying primary balance was -7% in 2009, and it fell to -3.5% in 2014: a fiscal contraction worth 3.5% of GDP. In Greece it was -12.1% in 2009, and was turned into a surplus of 7.6% by 2014: a fiscal contraction worth 19.7% of GDP! So Greece had far more austerity, which is of course why Greek GDP has fallen by 25% over the same period. A far more accurate statement would be that the UK started taking the same ‘difficult decisions’ as Greece took, albeit in a much milder form, but realised the folly of this and stopped. Greece did not get that choice. And I have not even mentioned the small matter of being in or out of a currency union. 

From the Prime Minister, let’s move to Janan Ganesh, FT columnist and Osborne biographer. He says that Osborne’s secret weapon is his “monstrously incompetent adversaries”. If only the Labour party had “owned up to its profligacy in office during the previous decade” it would have more authority in the macroeconomic debate today. I have written a great deal on this, but actually you can get the key points from the chart above. If you have a target for government debt which is 40% of annual GDP, and nominal annual growth is around 4%, you want to aim for a deficit of 1.6% of GDP. Labour clearly exceeded that, which is why the debt to GDP ratio drifted up from 30% of GDP in FY 2000 to 37% in FY 2007 (OBR figures).

A mistake? Yes, particularly in hindsight. Profligacy - absolute nonsense. The debt to GDP ratio in FY 2007 was below the level Labour inherited, which does not sound like a profligate government to me. Nor does a deficit in 2007 that is only about 1% above a long run sustainable level signal profligacy.

What blew the deficit was the recession. Ganesh acknowledges that, but says “there was no excuse at all for pretending that a recession was never going to happen “. This is pure hindsight stuff. In 2007, the consensus was that the UK was close to balance in terms of the output gap. It is only subsequently that some have tried to suggest, rather unconvincingly, that 2007 was really a global boom. So Labour was not pretending anything.

But why this urge for Labour to apologise for what is a relatively minor misdemeanour which had no major consequences. [1] Because it plays to the Conservative narrative: their version of history where Labour was responsible for the mess that the Conservatives had to clean up. Labour has been forced by mediamacro to buy into the deficit reduction narrative enough as it is: asking for more is just self-serving political nonsense.

As I explained here, it is really important for the coalition parties to sustain this narrative, because without it Osborne’s record looks pretty awful. When people realise that this poor record was not an inevitable result of ‘Labour profligacy’ or any other mess Osborne inherited, and that to focus on reducing debt was a choice rather than a necessity, then the responsibility becomes clear, and support for yet more sharp austerity quickly disappears. [2]

As for the phrase ‘monstrously incompetent’, I really wonder what world Ganesh lives in. When I look back at Chancellors of the past, I see few candidates for this label, and Brown and Darling are not among them. However what term would you use for a Chancellor that freely chose a policy of premature austerity, and as a result lost every UK adult and child resources worth at least £1,500? That unforced error does sound like something worth owning up to. 

[1] The worst that can be said is that, had Labour kept debt at 30% of GDP, they might have felt less constrained in 2009 and undertaken greater countercyclical fiscal action. But George Osborne argued against the countercyclical fiscal actions Labour did take in 2009! 

[2] That is of course an unsubstantiated conjecture, and the following is not meant to be evidence, because its a small and unrepresentative sample. In a previous post I mentioned a debate that Prospect magazine organised between myself and Oliver Kamm. I hadn’t realised until someone pointed it out (along with a rather biased editorial in that same issue), but readers get a chance to vote after reading this debate on whether ‘austerity is right for Britain’. At time of writing, we had 17% voting Yes and 83% voting No.

[3] HT Ari Andricopoulos


  1. Dear Simon,
    Thanks for the very interesting, as always, post. Let me set out the counterfactual to make sure i understand your argument.

    1. You acknowledge in the article that up till the financial crisis public sector borrowing was “too high” relative to some cyclical adjusted yardstick, although you do not describe as it so high to be “profligate”.
    2. As I understand it, your view is that when the financial crisis hit and interest rates then reached the lower bound, the government should have run an expansionary fiscal policy.
    3. Let me make sure I follow what your alternative proposal is, and here i am putting words in your mouth, so i could be wrong: I presume it would be to (1) expand fiscal policy until the economy recovers and (2) then go for austerity.
    4. For this to work, one has to have two ingredients i think. First, a model of the economy where fiscal policy is effective at the lower bound. Second, the government has to have sufficient credibility that this path will be stuck to. (And perhaps a third ingredient: namely, credible reform of finance).
    5. So again, in the spirit of my testing my understanding of your argument, let me make the case against the alternative proposal (and tell me if you have discussed this in your blog and I have missed it):

    1. On credibility, would people believe the promise of future austerity when the government could not rein in spending even in one of the most plentiful times in economic history i.e. the mid 2000s? You say it was not profligate, but might the signal have been very poor for credibility?
    2. The political dimension to credibility. Maybe you have discussed it, but I think all would agree that the 2009 expenses scandal was a catastrophic disaster for trust in politicians of all parties ( I have not looked at the opinion polls but I presume trust fell sharply). I don’t think that helped the credibility of politician’s future promises.
    3. I think Janen Ganesh makes the point that when the financial crisis hit the future tax take from financial services, which was a substantial fraction of corporation tax, would have had to been revised drastically downwards. This by itself would have necessitated some austerity and, perhaps, more importantly, banking reform.
    4. You argue that Labour have mistakenly signed up to austerity due to pressure from misguided opinion. Let me try an alternative: Labour is almost entirely funded by unions and unions have now essentially disappeared from the private sector. To the extent that austerity falls on the public sector, that makes Labour’s credibility pretty difficult to establish
    5. A similar argument holds to the extent that the Conservatives are funded by financial services: again, that makes credible future promises that might hurt finance very hard to establish.
    6. Finally, what would an expansionary fiscal policy have bought? By 2009 we had had a decade of falling public sector productivity growth on every quality-adjusted measure. I don’t quite see what would a promise of a (even temporary) period of rising spending would have bought in terms of a real output increase.
    In sum, especially because of the expenses scandal, I just wonder if political credibility had been lost and hence the only option was an non-political institution where credibility still resided, namely monetary policy.

    Thanks again for the great public good provision of your posts!
    Jonathan Haskel, Imperial College

    1. Thanks a lot for this. There is a lot here, so let me start with credibility. You do not say credibility with whom. Do you mean financial markets? The only credibility that a government that borrows more requires is that it will pay the money back. I see nothing in the data or in theory to suggest that the UK in 2010 was anywhere near losing that credibility.

      One of the problems with the credibility argument is that it applies to any increase in debt at any time. So it should apply to 2009, when the UK, US and Germany were all 'following my proposal', as you put it. Are there any increases in the deficit about which it would not apply? When Osborne stopped reducing the deficit in 2012, why did he not instantly lose credibility?

      I'm also very puzzled by your (6). Are you suggesting that if the money for repairing schools had not been cut, schools would not have actually been repaired. That if the money for improving flood defences had not been cut, no additional flood defences would have been built?

      However I have a lot of sympathy for your last point, although I get there by a different route. Delegating monetary policy is thought to be a good idea because we trust a delegated authority to do the right thing rather than go for some political advantage. What austerity has shown us is that we cannot trust governments to come to monetary policy's aid when interest rates hit a lower bound. So we need to give monetary policy additional tools so that it does not require this aid.

    2. Dear Simon, thanks for your very patient reply to my incoherent ramblings. I suppose what I am searching for is a theory of how governments establish credibility among borrowers. How do I think about whether trust in politicians, or the change in course in 2012 that you point out affect credibility or not? Thanks again for your reply, Yours, Jonathan

    3. Dear Jonathan

      I think this is an interesting question, even if it is not relevant to the UK position in 2010. I think it is about the relative costs of default vs higher taxes/lower spending, plus an assessment of the policymakers 'type' (i.e. their preferences). Given this, immediate deficit reduction does not signal very much, if it just involves easy cuts (investment being the standard example). I have argued before that if a policymaker wants to signal that they are a 'never default' type, they should immediately make cuts that incur the greatest political cost to them. In Osborne's case, when I was asked by one of his advisors what he should do to demonstrate maximum deficit cutting credibility, my advice was to raise inheritance tax rates.

      Yours, Simon

    4. Dear Simon, thank you, this systematic way of thinking about it is very helpful to me: on reflection, I guess that reforming politician's expenses is likely small beer. One final thought: I wonder where reforming finance (to the extent it has been done) would fit as a signal of "type"? Thanks again, Jonathan

    5. That's an interesting point..

      There does seem to be a political element. Any party of the left or even center is repeatedly told that it must do things - like austerity, tax cutting, privatisation, etc - that alienate its core vote, purely in order to 'show economic credibility'.

      Whilst parties of the Right can undertake quite reckless economics - like cutting corporation tax and the highest rate of tax, guaranteeing the 'Triple Lock' on pensions, adopting a softly-softly line on tax avoidance.. with barely a murmur. It's not just a UK thing, either.

    6. I love the suggestion to Osborne to raise inheritance taxes. It has the benefit of being both economically sensible and also, in the context it was said, very funny.

    7. This comment has been removed by the author.

    8. @ JOnathan HaskeL: About your ramblings concerning "credibility", read a macro textbook and look at the interest rates for public debt. Public debt is in high demand.

      About supposedly decline of public sector productivity, show some data. Otherwise it is just right-wing "market always good, government always bad" idelogy.

  2. Simon,

    Actually I suggest David Cameron has a point of sorts, though for reasons which a way above his pretty little head. It’s this.

    Internal devaluation in uncompetitive EZ countries is painfully slow to work. To that extent, it’s desirable for a periphery country to cut its deficit (i.e. impose a bit of austerity) AS SOON AS the first signs of lack of competitiveness appear. That way it might have to endure say ten years of mild austerity rather than three years of catastrophic austerity with bailiffs from Northern Europe knocking at the door.

    You yourself suggested recently that mild austerity might bring internal devaluation as quickly as catastrophic austerity, and I suspect you might be right.

  3. This is the Coalition's grand lie, one which the Lib Dems bear almost as much culpability for letting this sort of nonsense exist as the Tories do for saying it.

    Ultimately, judging from their City donations, the Tory government is a front for the inconvenient truth that the City was given massive freedom under the Labour government and are now repaying that party and the country by arguing that the City could not help itself in its behaviour and government should in some unspecified way have stopped them lending far too much and paying themselves overblown commissions on each harmful transaction pre-2007.

    So much for the Tories' supposed belief in self-reliance and self-control.

    Krugman blog February 5, 2010 'The Spanish Tragedy' gives OECD Government debt as % of GDP for each member country on a single graph for 1997 when Labour came to power and for 2007 when the subprime crisis hit.

    In that graph you'll see that the UK is next door to Spain, and Krugman blog followed that up September 11, 2011 in 'The Spanish Prisoner' (before the ECB became more than a glorified inflation target) showing the divergent government borrowing rates as Spain's soared and the UK's became soporific - the Spanish government was in surplus in 2007, but the UK, like Germany, was in a slight deficit.

    Cameron is a Machiavel.

  4. Simon, I admire your patience, but I am not sure why you choose to give any quarter to the revisionist nutters and those who would humor them. Why would UK debt rising from 30% to 37% of GDP between 2000 and 2007 be considered at all relevant to the discussion, never mind a mistake (and never mind that the increase is, I believe, essentially fully accounted for by a corresponding rise in the "mistake" of public sector net investment). And then there's the (on-going) episode you neglect to recall: Cameron and Osborne claiming credit for the the (world-wide reserve currency country) tumble to the ZLB. Confidence! As for Jonathan Haskel's story that the 2009 expenses scandal (wha-what?) and Labour and Tory party financing is what explains and justifies the Tory economic mismanagment, all I can say is that it apparently takes a lot of education to offer up such a confused narrative.

    1. I think allowing the debt/GDP ratio to rise was a mistake, but mainly in hindsight. I do not think the idea that it is OK because public investment increased will work, because public investment before the Great Recession never really got much above average levels during the previous conservative government, and it is not at all clear that the stock of public capital as a share of GDP was rising.

    2. Allow me to try and clarify my point. Whether it was a "mistake" or not in hindsight is largely an academic point that by rights ought to be disassociated from discussions of macroeconomic policy related to the Great Recession circa 2010 to present - what is the point of your post, yes? As for your reply about the trajectory of public investment, that is another interesting conversation, on the same terms unrelated to current concerns. I was only noting that data I have seen can attribute the rise in debt to this account, and, if true, this puts a twist on the "mistake" story (that, again, ought to be out of bounds in any case).

    3. In general I agree - the issue has virtually no relevance to post 2010 policy. But this post was partly about Ganesh's claim that Labour had been ‘monstrously incompetent’, and it is relevant to that.

  5. yes the labor government had to run up the debt a little because they couldn't tax the rich, even though they are making more money than ever before in history

  6. I used to enjoy reading Ganesh and thought he was quite sharp and perceptive. I have since come to the conclusion – partly as a result of reading your blog – that he is an ideologue impervious to empirical evidence. So thank you for laying out this case clearly and carefully.

  7. This has missed out the main difference: the UK is sovereign in its own currency and the only constraint on spending is inflation whereas Greece is not.

  8. "If you have a target for government debt which is 40% of annual GDP, and nominal annual growth is around 4%, you want to aim for a deficit of 1.6% of GDP"
    No. This would require households to go further and further into debt. In a country with a trade deficit like the UK you want to aim for a structural deficit same as the trade deficit. The sectoral balances are quite clear on the matter.
    Or better off just abandon the rules that require governments to issue bonds £-£ for their deficits and just credit bank accounts and not borrow the money back afterwards as there is no point in it and it is corporate welfare.

  9. This vague stuff about credibility sounds like Krugman's confidence fairy. Trying to read the mind of markets is perilous. Markets like growth. In a demand slump unemployment is the first beast to slay. At Zlb that's fiscal stimulus. And why would you worry about the pound? The Euro is in tatters. China may have a real estate bubble and manipulates its currency. The dollar is overpriced.

    As for the Greece comparison, that's like when Ted Cruz says there's no climate change cause he saw snow in New Hampshire. As with all right wing clowns, take them seriously. It can always get worse.

  10. 1) Who the hell assumes 4% real growth is sustainable in even the medium term for a rich country? Not that Labour would have been terribly profligate if you had instead assumed a 2% real growth rate but still, it's necessary to look to numbers with some understanding of what they actually mean (perhaps there shouldn't be "pure" economists, make the education some kind of extended master degree after a bachelor degree in engineering or physics) and when you do that 4% real growth is simply unrealistic except for the very short term in a rich country (you need very high (skilled) immigration, revolutionary new technology or both to sustain such a growth rate). In the long term that extra 0.8% deficit will start to matter (though the Torries wouldn't have done any better).

    2) There were large booms in 2007, maybe not in the UK but the huge UK financial sector was certainly entangled in them abroad (directly or through exposure to complicated financial "products"). With a huge financial sector like that you have to expect volatile GDP and tax revenues. So again, you have to expect that 4% to be a temporary high and base your government budget on longer term averages.

    1. OTOH 4% NOMINAL growth is somewhat plausible (though still on the high side until we get to really smart AI, fusion power, etc...), I should've read more carefully.


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