How UK deficit hysteria began

Laura Basu has a good book just out on UK media coverage of events from the Global Financial Crisis (GFC) until 2015, which I have reviewed for Open Democracy. Among other things, it tells the story of how what Mark Blyth calls the ‘biggest bait and switch in history’ happened in the UK. Laura argues that it can be dated almost exactly to the Budget of April 2009.

That the right wing press would start talking about the horrors of the rising UK deficit is no surprise. Osborne had decided in the previous year to oppose the Labour government’s stimulus measures because he saw in the rising deficit a way to beat Labour. The puzzle is why a broadcast media, ever conscious of balance, pushed the same line, even though it was clearly advantageous to one side politically.

The following story is mine, not Laura’s. Before the GFC, the way that the broadcast media covered budgets had become quite formulaic. Each budget would present estimates of the deficit over the next five years, and with the help of the IFS commentators broadcasters would discuss not only what tax changes had been announced, but also what might be implicit in the projections. No doubt this framework suited journalists well, because it allowed easy analogies with households. If the IFS felt that the projections were over optimistic and therefore fiscal rules might be broken, they said so and that became one of the budget talking points. The state of the economy was hardly ever discussed, because the Bank of England seemed to be doing a pretty good job of keeping things stable.

That all changed with the GFC, when monetary policy ran out of reliable levers to manage the economy. However journalists wouldn’t know that from the Bank of England, who tended to talk as if Quantitative Easing was a close substitute to interest rates as a monetary policy instrument. They would know it from academic macroeconomists, but journalists were generally too busy to make the effort to talk to them. For whatever reason, they did not fully appreciate how much the world had changed as a result of the GFC.

So when in the budget of April 2009 the Treasury showed the full extent of the deficits that the recession (and to a smaller extent the government’s stimulus measures) had created, journalists behaved exactly as they would have done before the GFC. Compared to deficits seen before the financial crisis, the numbers were indeed large. But crucially, because the Treasury estimated that the GFC had reduced the trend level of GDP, fiscal savings were necessary as a result. When these took the form of efficiency savings, the IFS were rightly skeptical.

So the coverage was all about higher taxes and lower spending, and whether they would be enough to close the record deficit. At no point in the subsequent discussion does anyone ask whether the current deficits are large enough to create a strong recovery. The growth forecasts are taken as given, and only their fiscal consequences are discussed, as if the former had nothing to do with the latter: an assumption that is only appropriate if monetary policy is in complete control of the economy. The government’s line that these deficits were necessary to ‘support’ the economy was almost entirely ignored.

Furthermore, the issue of whether the markets would purchase all this extra debt was already being raised. This is City speak, seeing a recession as involving more government debt and therefore perhaps higher rates, rather than understanding that the recession was caused by more saving and less borrowing so there would be plenty of new savings to buy the additional debt.

In other words the broadcasters had a framework for commenting on the budget which was appropriate before the financial crisis, but totally inappropriate after it. What they should have been asking is whether the Chancellor had done enough to ensure the recovery that was forecast, or whether perhaps larger deficits might be needed. In retrospect, that was exactly the right question to ask.

At the time, the reason for these deficits was clearly spelt out by the IFS as well as the Treasury. "The Treasury's assessment of the fiscal damage wrought by the current economic and financial crisis is breathtaking," said IFS director Robert Chote. "It will require two full parliaments of mounting austerity to repair." But in a telling indicator of things to come, the headline paragraph loses the bit about the GFC. As Laura’s book shows, it became so easy for a media prone to amnesia to forget about the financial crisis and blame everything on Labour profligacy, as after a time most voters began to believe. But the fundamental mistake was focusing on the deficit as a problem rather than as an instrument designed to produce a strong economy. The mistake came from the media’s inability to see how the GFC had changed the macroeconomic rules of the game.

Budget accounting tricks

One of the problems with fixed date deficit (or in this case surplus) targets is that they encourage playing around with the public finances to hit the target. Generally, but not always, this involves making a saving today by shifting costs into the future. Privatisation is an obvious example. It may be justified if the net present value of the sale is positive, or if privatisation really improves efficiency, but all to often it is a device to meet a short term target.

As Jolyon Maugham shows clearly, Osborne has done his fair share of such tricks, and not just in the latest budget. I have nothing to add, except a thought on where this should take us. There are two roads not to take. The first, which is taken by many on the right, is to say that the Chancellor should have imposed more ‘real’ cuts to meet those targets. The second is to suggest that really the Chancellor is doing sensible macro after all, but is just trying to disguise the fact.

What accounting tricks show is that the target itself is nonsense, and not that the Chancellor should try harder to hit them. While these tricks should clearly be exposed, there is a danger that by focusing too much on them, we inadvertently legitimise the target they are designed to achieve. What they show is how difficult the Chancellor now finds it to cut public spending any further. I do wonder sometimes at the mindset of those who write that Osborne has failed because he did not cut enough to meet his targets. Have they internalised the anti-Keynesian propaganda so much that they actually believe it?

For the same reason, these accounting tricks do not show that Osborne is relaxing austerity in the way I and others have argued should happen. The planned decline in public investment is real enough. There were plenty of cuts in the budget, and while disability cuts as proposed have now gone (is this a record for the speed of reversal of a budget measure), they may simply return repackaged. The savage cuts to ‘unprotected’ department spending remain, as does the myth of protection itself. The Chancellor used tricks not because he had a change of heart, but because he ran out of options. Nor do cuts in capital gains tax or higher rate tax bands make for much of a fiscal stimulus, as they fall on groups who will tend to save much of it.

The Chancellor is culpable for sure. But his mistake was not to use accounting tricks, but in putting at the centre of his budget strategy a politically inspired target which makes no economic sense whatsoever.     

Lack of accountability

In 2007 the Pitt review told us that climate change was going to greatly increase the incidence of record breaking bursts of rainfall in the UK. The Labour government responded by substantially increasing their spending on flood defences in the spending review which ended in 2010/11.

The coalition government reversed those increases, leading to sharp falls in spending on flood prevention. Five years and many costly floods later, George Osborne has finally admitted he was wrong by announcing a substantial increase in money for flood defences. After being told by the government, one flood disaster after another, that they were doing everything that was possible, they have now decided that maybe it would be a good idea to spend more.

A bigger mea culpa you could not find. Yet if you google “austerity flooding”, it is still my blog post that comes top. When the floods hit around Christmas in 2013, no one seemed to want to connect the two. The government seemed immune to criticism, and successfully directed any culpability to the Environment Agency (who could not answer back). Even with the latest floods, outside the pages of the Guardian or Independent there was little criticism of earlier spending decisions. Yes Labour were slow out of the blocks in attacking the government, but are we really in a media world where if a senior politician does not talk about something it becomes a non-subject?

Chris Dillow asks why Osborne is not given the scorn and derision he deserves. As ever he gives many possible answers, but to many people one factor above all explains what is going on. It can be summarised by the following chart from the IFS, looking at who wins and who loses from this latest budget.

As I noted in my last post, Osborne felt he had to produce a budget like this for reasons that have only to do with who will be the next leader of the Conservative Party. Yet many will conclude that he (almost) gets away with it because it is in the interests of those who control the media to let him get away with it.

While there is undoubtedly some truth in this, I do not think this is quite the killer explanation that some suppose. Another important factor is that we have been living through a period in which the need to cut spending to reduce the deficit has entered the national consciousness as not only an undeniable truth, but an imperative that dominated all other concerns. So strong was that conviction that it helped win the Conservatives an election, despite the fact that they pledged to make the deficit worse by cutting taxes. Osborne had successfully characterised himself as the politician brave enough to ‘make the hard choices’ required to fulfil that imperative.

But as I have argued before, this belief that what George did and continues to do on cuts is an undeniable necessity is a product of the events of the recent past, rather than some immutable idea that the nation will forever hold. The most significant part of Iain Duncan Smith’s resignation letter is the following:

“I am unable to watch passively whilst certain policies are enacted in order to meet the fiscal self-imposed restraints that I believe are more and more perceived as distinctly political rather than in the national economic interest.”

So a plea to political journalists and commentators. Forget the spin that this resignation is all about the EU referendum (which, like all good spin, has an element of truth) and focus on this sentence. The idea that with his cuts George was and is only doing what had and has to be done is crumbling, and you do not want to be the last to notice. Start holding our government to account, not just for benefits cuts but also for the damage caused by flooding, and above all for the dire performance of the UK economy relative to the past.

It’s the politics, stupid

Those looking for any kind of economic logic from yesterday’s budget will look in vain. The budget had one goal, and only one, goal - the election of George Osborne as David Cameron’s successor. Now that mayor of London Boris Johnson has come out in favour of leaving the EU, a position also favoured by the majority of Conservative Party members who will elect the next leader, Osborne has a real fight on his hands.

Once upon a time Osborne could have actually played the prudent Chancellor role for real, but those times are gone. Getting the deficit down no longer appears (to the media and Conservative MPs and party members) the overriding priority it once was. So it has to be tax cuts designed to benefit most those in the upper quarter of the income distribution, plus yet more cuts to corporation tax. (As I noted in a piece for The Independent, the OBR’s downward revision to expected productivity growth suggests the extra dynamism these cuts were meant to induce stubbornly refuses to materialise.)

That is why a Budget where the main external news was a deterioration in the outlook for the UK economy, and where the centrepiece is a (ludicrous) target for the budget surplus at a fixed date, could end up being all about tax cuts. (Apart from the new sugar tax, which is welcome and long overdue.) It is achieved by a combination of more cuts to welfare (the disabled) and spending. Yes there is a lot of creative accounting as well, but when those chickens come home to roost you can be sure that the response of this government will be how public spending has become unaffordable and more cuts are required.

Cut taxes, and use the deficit as an excuse to cut spending. For the Conservatives it has proved to be a winning formula, and Osborne intends to milk it for as long as mediamacro lets him get away with it.

Another good rule with this Chancellor, apart from it is always about the politics, is that whatever phrase he keeps repeating tells you where he thinks he is vulnerable. Hence 'long term economic plan' to cover decisions made to achieve short term political ends. That is why the current slogan is ‘putting the next generation first’, because everything Osborne has done so far has achieved the opposite. The slogan is not meant to signal a sudden change, but just to distract from more of the same. Climate change? He failed to raise fuel duty, and more. Public investment? As I say in The Independent, lots of talk but the OBR numbers tell us he plans in this parliament a level of net public investment almost 25% below the level in the previous parliament. The rhetoric may be enough to win the votes of (generally old) Conservative party members, but the next generation will not thank him for it.     

When to be optimistic on growth

I’m afraid I did not respond to requests to talk directly about the debate over Gerald Friedman’s numbers. I think I can only cope with that kind of thing one country at a time, and there were better people on the case. But I suspect a key to seeing your way through the wider debate is to know when to be optimistic about economic growth, and when not to be.

Martin Sandbu, channeling Narayana Kocherlakota, is quite right that we should not discount the possibility that economic growth could be unusually strong over the next decade or two. There is a significant chance that some of the slowdown that has appeared to have occurred to trend growth since the Great Recession might be reversible, partly because many hysteresis effects are also reversible. Inflation may not respond positively to strong growth as it has done in the past.

That possibility is high enough that it should have a big influence on monetary policy, for reasons I and others have outlined many times. The cost of needlessly throwing away potential resources is much higher than the cost of small overshoots of an inflation target. For that and other reasons the Fed’s decision to raise rates - and the MPC's decision not to cut them - was a mistake, as is continuing austerity.

Does that mean we should hard wire this optimistic view into budget projections? Essentially no, because budget projections should be based on your central guess of what is going to happen rather than any best case scenario. Almost every politician thinks they have the magic ingredient that will lead to strong growth. There is nothing wrong in that, but they should hope for the best and plan for the ordinary.

Doing this imposes a discipline on the electoral process that is essential to stop some politicians pulling the wool over voters eyes. If a politician or party wants to go with optimistic numbers, then the debate should be about how reasonable those numbers are, so voters can see what is going on. A world where these things are not debated is a world where everyone promises the moon and no one is any the wiser.

Where the discussion can get confused is if we put these two things together, and note also that fiscal stimulus involving additional investment would be good for the world right now. But that should and is argued for without pretending that it can all be paid for with the taxes that will come rolling in as it happens. There is a rock solid case for paying for extra investment - investment in its widest sense including human capital - by borrowing, because future generations benefit from that investment. When real interest rates are as low as they currently are, you have to be ignorant, duplicitous or slightly mad to say otherwise.