Fiscal tightening in UK recessions: 1981 and 2010 compared

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) 

First consider public sector receipts.

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.

It is worth looking at one component of spending: public investment.

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 Tory party lost its way from 2010, not 2016

“I have had it up to here with the Conservative party.” So writes a one time editor of the Spectator, Matthew d'Ancona. It is a good read: for example

“A chilling populism is now creeping into the language of mainstream Toryism: the language of treachery, snarling tribalism and impatience with anything that smacks of prudence, compromise or caution.”

He is talking about Brexit of course, and he is entirely right. What he misses, in my view, was that this problem did not begin with the EU referendum, but six years earlier, with the Tory ‘modernisers’, Cameron and Osborne.

I think d’Ancona gets to the heart of the problem when he writes

“By tradition, the strongest claim the Tories have had to office is a belief that ideology should be subordinated to reality. Even Margaret Thatcher – the most explicitly ideological of Conservative prime ministers – was ousted to stop the poll tax and to salvage Britain’s relations with Europe.”

Thatcher began neoliberal hegemony in the UK and a lot of the policies she introduced were popular, at least at the time. Her revolution was introduced with some caution, and when her caution ran out she was deposed. That caution, at the level of senior ministers or the party, had gone by 2010. The clearest indication of that is austerity.

Sound public finances, which d’Ancona says he supports, should never apply in the middle of a recession. We have known that since Keynes. As a result, in every post WWII economic downturn the government has focused on recovery and not the rising deficit. The single exception before 2010 was under Margaret Thatcher in her infamous budget of 1981. But that austerity was very different from 2010 for three reasons, in ascending order of importance.

1. The deficit was not targeted for its own sake, but in a failing attempt to hit a money supply target.
   
   
2. The deficit was mainly reduced by raising taxes rather than by cutting spending, which is more demand friendly. 2010 austerity preferred spending cuts to tax rises.
   
   
3. The austerity experiment was short lived and quickly reversed.

I do not want to minimise the damage done by the 1980/2 recession. My point is just that Thatcher and her ministers saw that monetarism was not working and they ditched it. Not soon enough but it was reversed. To use d’Ancona’s words, ideology was subordinated to reality.

The contrast with the austerity that began in 2010 is clear. As I never tire of saying, almost every first year economic undergraduate around the world is taught that in a recession you stimulate demand. Nowhere do the textbooks talk about worrying about the resulting deficit at the same time, because that implies austerity rather than stimulus. Unlike Thatcher, in 2010 there was no runaway inflation. The debt funding crisis that Coalition politicians were so fond of telling us about was a figment of a few City economists’ imaginations.

By 2012 it was obvious that austerity was a huge mistake. The recovery was nowhere in sight, and a key reason for this were large cuts public sector investment. It is no good complaining about the Eurozone crisis when you are cutting spending while interest rates have fallen by as much as the MPC dare. That is a schoolboy error. An imminent funding crisis implies rising interest rates on UK government debt, but by 2012 those rates were falling. The majority of academic economists who predicted that austerity would damage the recovery had been proved right. But did Cameron and Osborne change their policy, as Thatcher had done, and switch to fiscal stimulus? Of course we know they did not. Reality did not get a look in.

In economic terms austerity was the most damaging aspect of reality denial by the 2010 Tory based government. I calculated that austerity cost the average household £10,000, but the true figure may be much more if we allow for the damage austerity did to the supply side of the economy. It is certain that cuts to social care and the NHS cost lives: it is just a question of how many thousands of lives we are talking about. Austerity represented political deceit at its worst. Voters accepted nonsense pushed by the government about its credit card, and this allowed Tories to achieve an ideological goal of a smaller state which was otherwise unpopular.

If that was not bad enough, austerity also helped sow the seeds of Brexit. When people in communities that had been left behind voted for Brexit they said things couldn’t get any worse, and they said that in part because of austerity. But this was not the only grand deceit of this Tory led administration. They established a target for immigration that they had no intention of meeting because they knew the damage meeting that target would do. But their rhetoric that immigrants were responsible for the ills caused by austerity was a major reason that Cameron lost his referendum. A Prime Minister who had falsely told the nation why it was essential to reduce immigration had no answer to those who pointed out it could not be completely controlled because of Freedom of Movement.

Cameron did not just make a mistake in allowing a referendum in the first place. Through his ruinous policy of austerity and his demonisation of immigrants he ensured that referendum would be lost. d’Ancona is right that Europe brings out the worst in the Tory party. It shows how Tories can elevate ideology and party above the interests of the country. But that did not start in 2016, but with the destruction it has sown since 2010.

The politics of ignoring knowledge

Simon Tilford has a post where he explores the roots of Brexit in a kind of UK exceptionalism. He argues that “the underlying reason [for the Brexit vote] is the hubris and ignorance of much of the British elite, not just the eurosceptics among it”. I want to expand on that. I do not think this ignorance and hubris is confined to the UK’s role in the world. It also extends to an attitude to knowledge of all kinds, and I suspect it is possible to date when this began to the revolutionary zeal of the right under Thatcher.

The Thatcher government that gained power in 1979 were going to do away with what they saw as Keynesian nonsense, and run the economy using money supply targets. Treasury civil servants produced a forecast that said their policy would lead to a recession, and this turned out to be what happened. The forecast when it was made was dismissed by the politicians in government as the product of outdated civil service advice reflecting a failed consensus.**

It is of course the prerogative of politicians to reject a consensus, particularly if there is a reasonable minority of experts who think the consensus is wrong. It is what happened next that was the problem. Monetarism was a monumental and predictable failure, but Conservative politicians and their supporters spent considerable effort and resources turning this failure into a triumph of Thatcher over an establishment civil service and academic economists. One example is the letter from 364 economists objecting to a deflationary fiscal policy in the 1981 budget. The right, and in particular the IEA, have successfully cultivated a belief that this letter was wrong when in fact it was right. The recovery (using the term as it should be used) was delayed by over a year by the 1981 budget. More generally the view was that social scientists or civil servants were probably antagonistic to the neoliberal project and could safely be ignored. They were, in Thatcher’s words, not one of us. [1]

The reality was that the Thatcher and later Major governments did subsequently often take note of what experts were saying, but the myth on the right prevailed. Before the Conservatives regained power in 2010, they thought very little of going against the advice of the majority of economists over austerity, although to be fair they were later supported in this by senior civil servants and the governor of the Bank of England. Policy based evidence replaced evidenced based policy. But this was the relatively sane wing of the party, as we discovered during the referendum campaign.

We know the EU referendum campaign largely ignored experts, whether they were economists, lawyers or experts in international relations. What I think surprised many is that the Leavers fantasy was not just a device to obtain votes, but actually reflected what the Brexiteers believed. Since the referendum the government has clung to the fantasy, and ignored or dismissed all the advice it was getting from its civil servants. (In two cases dismissed meant sacking or resignation.) As Steven Bullock says, the EU side are in despair that the UK has yet to work out a realistic position on many issues. Because large parts of the UK public, relying on the right wing press for their news, still believe in the fantasy, some in the main opposition party think their best strategy is to ape their opponents.

As a result, we are in a strange bifurcated world. One part consists of pretty well anyone who knows anything about the economics, politics or legal aspects of Brexit. They realise how hard Brexit will be, know how much damage it could do, and by and large think it will be disastrous for the UK. (Experts tend to recognise and respect knowledge in other areas.) The other part lives in a different world, the world of the media and politicians, where everyone still lives the fantasy.

In this respect, we are no different from what is happening across the Atlantic. Angus Deaton notes the tragic irony that in the year the great nobel prize winning US economist Ken Arrow dies, the Republican administration is ignoring one of his great achievements, which was to show why a simple market in healthcare will not work. The only ‘expert’ this Republican administration seems to recognise is Ayn Rand. If it is successful in replacing or sabotaging Obamacare, millions will lose coverage and thousands will die as a result. The experts (such as the CBO) who predict this are accused of inaccuracy by a White House that cannot even be bothered to check its spelling of 'inaccurately'.

May holding Trump's hand shortly after he became president was indeed symbolic. Those who justify ignoring experts often talk about them as ‘unaccountable elites’ who have ulterior motives in giving the advice they do. In reality ignoring expertise means dismissing evidence, ignoring history and experience, and eventually denying straightforward facts. It leads to the politics of barefaced lying, such as asserting that a new trade agreement can be negotiated in little over a year. [2] This disdain for knowledge is not a prerogative of the right: you can find it on the left among those who say, for example, that all social science is inherently value laden and therefore political. (Ironically often dismissing mainstream economics as a buttress of neoliberalism, the same economics that the right are so keen to discredit.) The difference is that that the knowledge dismissing right have power in the UK and US, and so we are suffering the consequences of their evidence-free politics.

[1] Sir Keith Joseph tried to abolish the Social Science Research Council.

[2] It seems finally that the government has accepted a reality that was obvious months ago to those who listened to experts. 

**Postscript 21/07/17 As Sasha Clarkson reminds me, one of that group now spends his time denying climate change.

When is an economic recovery not a recovery?

This post may seem to be unusually pedantic, but please be patient

What do we mean when we say the economy is recovering from a recession? Do we mean it has started growing again, or do we mean it is returning to its pre-recession trend? Brief research suggests there is no standard definition, but Wikipedia is clear it is the latter:

“An economic recovery is the phase of the business cycle following a recession, during which an economy regains and exceeds peak employment and output levels achieved prior to downturn. A recovery period is typically characterized by abnormally high levels of growth in real gross domestic product, employment, corporate profits, and other indicators.”

The second sentence is crucial here. All economies grow on average: they have a positive trend growth rate. An economic downturn (or worse still a recession) involves the economy dipping below trend (or in a recession not growing at all). Typically whenever that has happened in the past, most economies make up for the growth they lost in the downturn, by growing more rapidly than trend once the downturn is over. This had certainly been true for the UK. We expect economies to grow over time because of technical progress, so it seems almost obvious that a recovery must involve above average growth until we return to something like an underlying trend.

Imagine a 5,000 metres race. Suppose an athlete trips and stumbles, leaving the main pack behind. If 5 minutes later I said the athlete was recovering, would you think this meant that they were getting back to their previous pace but still well behind the main group, or that they were getting back in touch with the main pack? I suspect you would think it meant the latter, and you would call a complete recovery when they were back within the main group. If you think about the main group as the underlying trend path of the economy, then a recovery in growth means getting back towards this trend path.

For this reason I would define a recovery from recession as above trend growth, and I think most macroeconomists would do the same. Here is recent quarterly growth in UK GDP per head.

The red line is the pre-crisis trend growth rate. You can see from this that only 2014 could possibly be called a recovery, and even that is a bit of a stretch. The UK is far from unique in this respect, but unlike other countries the UK economy has a pretty clear and unchanged trend growth rate since the 1950s. Until now that is. This global lack of recovery begs many important questions, which those who read economics blogs will be very familiar with: has the financial crisis had a permanent negative effect on productive potential, was the pre-crisis period really a disguised boom, are we suffering from secular stagnation, what role did austerity play?

Yet all of these important issues are sidelined in popular discussion if we misuse the term recovery, and instead describe any positive growth after a recession as a recovery. This is not a problem for economists, who tend to talk numbers, but it does matter for the public debate. I cannot help feeling that calling any positive growth after a recession a recovery also adds to a sense of disconnect people have, particularly when (as in the UK) there has really been a recovery in employment, such that productivity has been virtually flat. People ask how come there has been a recovery and yet my wages are still so much lower in real terms than they used to be?.

When the underlying trend may have slowed or shifted, then it becomes difficult to know what is or is not a recovery, but that is no reason to misuse the term. When we are talking about the past, then things should be clear. Here is the same data for 1981.

It is obvious from this data that the recovery from the 1980 recession only really began in 1983. The two previous years saw as many periods of below trend growth as above trend growth: given normal growth, the economy was effectively standing still. Unless, of course, you have a political point to prove. In 1981 the Conservative government of Margaret Thatcher raised taxes substantially in the Spring Budget, despite just seeing 5 quarters of falling output per head. They increased taxes after falling output because they wanted to reduce the budget deficit. 364 academic economists quickly wrote a letter denouncing the policy - a Brexit like majority at the time.

In 2006 Philip Booth of the Institute of Economic Affairs wrote this:

“The economic recovery that the 364 said would not happen began more or less as soon as the letter appeared.”

This sentence has been repeated time after time by right wing economists and politicians: so often that it is now repeated as fact by BBC journalists. It has become what I call a politicised truth: something that is false but is perceived to be true by journalists who talk to politicians but not academics. And the statement that the recovery began as soon as the letter appeared is simply false if you use the term recovery properly: the recovery began a year and a half later. Had fiscal policy not been tightened in the 1981 budget, the recovery might have begun earlier than the end of 1982. In that sense, the economists were vindicated by subsequent events.

In 2010, George Osborne was warned by many academic economists - almost certainly a majority at the time - that embarking on austerity so soon after the recession was folly. But, just as in 1981, he wanted to reduce the deficit. It is not difficult to imagine that as he pondered these warnings from academics, he thought to himself that Margaret Thatcher got the same advice in 1981 and everything he had read said the advice was wrong because the recovery started immediately after taxes were increased. He would have been emboldened to do the same, with what we now know were disastrous consequences. Just two years later, GDP per head had lost another 3% or more relative to trend.

This is partly a story about the dangers of propaganda that you begin to believe yourself. But it is also about the potential ambiguity of one single word: recovery.