When I
wrote this recent post
on the impact of austerity in the UK, I was slightly nervous about the numbers.
I suggested that the 2011 and 2012 cuts in spending on goods and services alone would have reduced GDP in 2012 by
between 1.25% and 2.5%, but this was a back of the envelope calculation using
simple aggregates and static multipliers, and it left out the impact of
important tax increases and transfer cuts. However luckily we today have a
rather more systematic analysis
from Dawn Holland and Jonathan Portes at NIESR. This adds in the impact of tax
increases and transfer cuts, and comes to a figure of over 4% for the impact of
2011 and 2012 austerity on UK GDP in 2012.
Now at this
point I should declare an interest of sorts. Holland and Portes use the Institute’s
global econometric model NIGEM. I built the
first version of this model. However that was so long ago, and I’m sure
that the improvements subsequently made by Ray Barrell,
Dawn Holland and others mean that nothing is left of my original construct.
What is especially
interesting about the NIESR study is that they also do the analysis for the
Eurozone economies. If we extend the calculations to 2013, Greek GDP in 2013 is
over 13% lower as a result of 2011-13 austerity, Portugal’s GDP nearly 10%
lower and Spain’s 6.7% lower: UK GDP is ‘only’ 5% lower. Now a cut in average
incomes of 5% or more is a big deal, and it is why I keep saying
that the welfare costs of these measures dwarf other considerations. But we
know that this pain is not evenly spread: many people are not much affected by
austerity, while others are receiving much larger cuts in their incomes.
The key
point, which the NIESR study also puts numbers to, is that this pain is not in
any way inevitable. It comes because austerity is being undertaken when
monetary policy can do very little to counteract these effects. In more normal
times, which means once the recovery is sufficiently underway such that
interest rates begin to rise again, this scale of austerity will have a much
smaller impact on GDP. In principle, its impact could be completely offset
by monetary policy. So the argument that these large income cuts are
inevitable because debt has to be brought down at some point is simply wrong.
However the
NIESR study does miss one thing out of its calculations. Nowhere is there a confidence
fairy that will magically persuade the private sector to spend because
government debt is coming down. (As the NIESR study shows, the debt to GDP
ratio actually rises because GDP falls by more than debt, but hey that’s a
detail – GDP will recover one day, probably.)
Now
to believe in fairies you need pretty good evidence, and that is just what we
do not have. A few economists think
they saw some in the data, but that is not enough - nothing like enough - to
justify inflicting this scale of pain on so many. (Others, of course, saw nothing (e.g. pdf).) Unfortunately too many people just wanted to believe in the confidence fairy. Normally we find those who really do believe in 'real' fairies either rather amusing or rather strange. Unfortunately some of those who believed in the confidence fairy were put in charge of running our economies.
