I have decided to abstain from twitter conversations to protect my own wellbeing, but I made an exception for Andrew Sentance recently. The issue was the extent to which the 1981 fiscal tightening was equivalent to 2010 austerity. It was clear this needs a post to clarify things. In the charts below, I compare how various fiscal magnitudes compared to the year before financial year 1981/2 (blue) and financial year 2010/11 (red) in terms of percentages of GDP. (To be precise, the blue line subtracts X in 1980/1 from all subsequent years, where X is the share of some fiscal magnitude in GDP, and the red line subtracts X in 2009/10 from all subsequent years. Source OBR public finances databank)
The 1981 budget was a tax hike, that prompted the famous letter from 364 economists denouncing the budget. However notice that the tax hike was mostly reversed within two years. In contrast the tax hike in 2010 (higher VAT) was smaller as a percentage of GDP but it was not reversed.
With total spending we get a different picture
Under Thatcher the share of total spending in GDP stayed pretty constant. That does not mean there was no tightening, because with a large increase in unemployment we might have expected a rise in spending as a share of GDP (a point Andrew makes). But nevertheless the contrast with 2010 is stark. Public spending was the main component of fiscal tightening under Osborne.
Here we can see some tightening under Thatcher, but once again it was quickly reversed. Under Osborne the cuts grew over time, and by the end were twice as big as anything attempted under Thatcher.
These components can be combined by looking at net borrowing.
The Thatcher fiscal contraction was largely reversed within 2 or 3 years (almost completely reversed if we looked at cyclically adjusted figures). Osborne’s contraction grew steadily over time. It would also be a mistake to conclude that in the first two years Thatcher’s 1981 contraction was as equally severe as Osborne’s. Tax increases have a much lower impact on demand than cuts in public investment or government spending more generally.
So 2010 was not the first time a government had chosen to cut public spending in a recession, which is the reason I added the word ‘sharply’ in my tweet. It was also not the first time a UK government had attempted fiscal tightening in a recession, as 1981 shows, which is why I specifically talked about public spending in my original tweet. But perhaps the most important difference between 1981 and 2010 is longevity. Thatchers fiscal tightening in 1981 was largely reversed by1983: tightening did not just stop but it was followed by fiscal expansion. In 2010 tightening continued year after year. It is no surprise that the recovery was so weak.
Indeed, if you define an economic recovery as growth above past trends, which there is a strong case for doing, there was no recovery from 2010 onwards. Using the same definition there was a recovery after 1981, but it began in calendar year 1983. The temporary fiscal consolidation of the 1981 budget did delay the recovery for nearly two years, but partly because that consolidation was reversed the recovery eventually came. Of course monetary policy played an important role in both periods (the size of the interest rate cut was similar), but the cuts were slower under Thatcher and there was no Quantitative Easing either.
While 1981 was nothing like as bad as the austerity of 2010, it was a serious macroeconomic mistake which undoubtedly caused considerable hardship for many. It also played an important role in creating the conditions, in the mind of many Conservatives, for 2010. Conservative politicians and particularly the Institute of Economic Affairs told a false story, a story where the economists who wrote the 1981 letter were wrong and Thatcher was right. Because they kept on telling their story as if it was true some media commentators began to believe it was true. I’m sure this played some part in sustaining austerity in 2010.
The invisible bond vigilantes argument that sustained the Tories since 2009 seems to be faltering, given that Trump is increasing US borrowing to over 110% and they don't seem to find that ineffective.ReplyDelete
Well, it's the usual simple story: given a fixed inflation target, G Osborne kept the real economy in semi-recession, to ensure that the BoE would be "forced" to pump up the asset markets to counter that with "wealth effect" spending. He even stated this tersely:ReplyDelete
“A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.”
But that of course is not "austerity", but redistribution from people long labour and short assets to people long assets.
Very well put indeed. And with rates so low; QE.Delete
Please continue to post new blog article links on Twitter. I need that reminder to check.ReplyDelete
The UK economy of 1981 was very different to the UK economy of 2010.ReplyDelete
The 1981 economy still had a large domestic consumer goods sector and other manufacturing. A spending cut in 1981 causes large multiplier effects as the UK consumer goods sector cuts back shutting factories laying off workers so amplifying the effects of the fiscal shock.
The UK economy of 2010 is already importing most consumer goods. A fiscal contraction causes a reduction in imports or a change in the mix of imports. The factories are already shut so that feedback loop is reduced.
The lesson here is with a post manufacturing service economy it takes a bigger fiscal shock to drive the economy into recession. Also it will take a bigger fiscal expansion, or a more carefully targeted fiscal expansion to generate some reasonable growth.
1981 was a worse economic mistake than 2010. If 1981 had not happened the structure of today's UK economy would be stronger. It would have a bigger manufacturing sector. The 2010 austerity was a terrible and unnecessary economic mistake, but it leaves the structure of the UK economy unchanged. The real damage was done under Thatcher and Blair.
In today's UK economy the factories that will open to supply increased demand will be located in China.
Shouldn't it be Howe/Lawson versus Osborne, or Thatcher versus Cameron? Or are you claiming that Thatcher had more direct involvement in the budget than Cameron did? (In the latter case, it's perhaps hard to tell Cameron and Osborne apart, given how well they got along with each other.)ReplyDelete
This question is not directly related to this post but I wanted to ask you since you have written extensively on fiscal rules and golden rules in particular. A common argument in the early 2000s against golden rules that exclude net investment was that net investment is hard to measure because public capital depreciation is hard to estimate. What do you think? Is it true? Or was it true in the early 2000s but now we are better at estimating depreciation? Or was it never true?ReplyDelete