Austerity Confusion, or why the Tories are trapped by austerity

What do we mean by an end to austerity? There seem to be two meanings being used currently. The first, used by Conservative politicians in particular, is equivalent to what economists call fiscal consolidation: cutting spending (or raising taxes) in order to reduce the deficit (as a share of GDP). However when Labour say they will end austerity, I think they mean something even simpler: to stop (and reverse) cuts to government spending as a share of GDP.

The confusion has been compounded by two factors. First, Conservative Chancellors have mainly used cuts to spending rather than tax increases as part of their austerity programme. Second, they have also justified cuts to spending that were needed to finance tax cuts (corporation tax, inheritance tax etc) as austerity, which is a clearly not fiscal consolidation and is simply a reduction in the size of the state.

How do I know Labour do not mainly mean ending fiscal consolidation when they talk about ending austerity. Just look at their GE2017 manifesto. That involved various increases in current spending financed entirely by higher taxes (including corporation and inheritance taxes). This manifesto, which helped gain them such rapid popularity in the GE2017 campaign, was a proposal to increase the size of the state.

I explore in a shortcut piece for the London Review of Books how this ambiguity is a serious problem for the Conservatives. Even if they ended austerity completely (made no further attempts to reduce the deficit), Labour would be able to offer a much more attractive fiscal package to the voters because Labour are prepared to undo the tax cuts the Conservatives have made over the last seven years. 

How do I know such a package would be attractive? Here I reproduce my favourite chart from the latest Social Attitudes survey that I talk about in the LRB piece.

The ‘neoliberal’ line is in yellow at the bottom. In 2010 nearly 90% either wanted to keep the size of the state the same or increase it. It is why the Conservatives were forced to use what I call deficit deceit - pretending cuts to the size of the state were about cutting the deficit - to pursue neoliberal goals (see my last post). By using deficit deceit to reduce the size of the state, when concern about the deficit was bound to wane, the Conservatives have condemned themselves to current unpopularity as voters realise what they are losing.

Why didn't this stop the Conservatives winning the 2015 General Election? Here is a YouGov poll that explains why.

In 2015 more people blamed Labour that the Conservatives for spending cuts. This was translated into views about economic competence because the Conservatives, with the help of mediamacro, made reducing the deficit the key variable in judging economic policy. We are now in a period where this narrative still has an influence but it is no longer enough to win an election. The Conservatives dare not throw it away because many voters still believe it. They have become trapped by their own austerity policy and the reduction in the size of the state that went with it..

The austerity story in extensive form

My London Review of Books article is now available online. It is much longer than the normal blog post, so it allows me to put together a lot of points in one place. It tells the history of the macroeconomic policy response to the Great Recession. How in 2009 policy responded in the right way (in terms of direction if not magnitudes), but how in 2010 it all went very wrong with the move to austerity. It is told from a UK perspective, but similar stories can be told for the US and Eurozone. It says why austerity was a mistake, and how both politicians and most of the media have tried to avoid this conclusion.

Besides length, the other main difference is the effort I have made to write clearly for non-economists. (Whether I have succeeded you can judge, but to the extent I have the editorial team at LRB deserve a lot of the credit.) Of course I would like to do this all the time in my posts (unless I signal otherwise at the beginning), but I’m acutely aware that I often fail. Mostly it reflects lack of time. I try to always do one read through thinking how would a non-economist interpret this, but as anyone who reads through their own work knows, if it is something you have just written it is quite difficult to be objective. My ‘post the next day’ rule helps here, but I do not always stick to that rule! (Occasionally jargon can be descriptive: ‘automatic stabiliser’ and ‘lender of last resort’ spring to mind from the article.)

Writing a piece like this also makes it clear how difficult macroeconomics in particular is. Everything is, at least potentially, connected. To tell the story of fiscal austerity you do not only need to talk about the impact of spending cuts on demand and output. You also need to talk about monetary policy, and therefore Quantitative Easing. Not just to discuss potential monetary policy offset, but also why the Eurozone is different, which means talking about the relationship between short term interest rates and interest rates on government debt. I do this all the time when writing academic papers of course, but for a non-academic audience the rules for what you include and what you leave out have to be different.

The hardest thing is to switch off the academic part of me which is saying: you really should cover that, or that is a very imprecise way of making that point. For example in the LRB article I did not go into a discussion of whether, because UK inflation was high in 2011, interest rates might have increased if there had not been austerity. That discussion you can find in detail in my NIER article, but I decided including it in the LRB discussion was both unnecessary and distracting. However I did mention helicopter money (by request), because a natural question for a non-economist to ask is why the central bank is creating money to buy financial assets rather than giving it directly to people? (Actually that is a pretty good question for an economist to ask as well!) What I wrote was that financial assets can be sold again when the recovery is complete if the bank judges that there is too much money in the economy, but that of course begs the question of whether there are other means of reversing helicopter money. You just have to stop somewhere, and leave important issues out.   

The other thing that struck me writing both the LRB and NIER articles was how little depends on the benefits of hindsight. When I did my analysis of fiscal policy under Labour, the major criticisms did reflect subsequent events: in particular that the fiscal rules should have aimed for a gradually falling debt to GDP ratio. With the Coalition, the key mistake was obvious at the time. What has come with hindsight are in a sense details, albeit important ones: exactly why the Eurozone was special, the motivations behind the policy, and mediamacro. However I think the more interesting comparison, from a UK perspective, is between macroeconomic policy under the Coalition and the 1979 government under Margaret Thatcher. That would be an article I would like to write sometime.