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.

There is no mandate for No Deal

We are told constantly that the 2016 referendum gives our government a mandate for a No Deal Brexit, and that we would not respect democracy if we failed to leave. Both arguments are obviously false, yet they so often go unchallenged in the media.

The 2016 referendum was narrowly won by the Leave side. It does not matter how many people voted in that referendum, the margin of victory was narrow. What many Leavers would like you to believe is that this referendum requires the UK to leave the EU in some way or another. This is false. The referendum did not say that we must Leave the EU whatever the circumstances and whatever the cost or whatever leaving meant. None of those words were on the ballot paper, and they were not implicit either.

Just suppose the 2016 vote had led to the recession predicted by the Treasury. No recovery from this recession was on the horizon. Suppose too that Trump had not become POTUS, and Clinton said she had no interest in doing a trade deal with the UK anytime soon. Polls overwhelmingly suggest that Scotland would seek independence if we left the EU. Polls showed support for leaving the EU had dropped to less than 30%, and so on and so on. Are we really saying that despite all this, we still had to leave the EU because of a 52% majority in an advisory referendum. The realism of this example is irrelevant if you want to defend the idea that the referendum was like some kind of contract that had to be followed come what may. You certainly have no right to call it democratic, or the will of the people

The question was whether to Leave or Remain. As a result, not surprisingly people voted on the basis of what they thought Leave or Remain meant. So to see what people voted for, you need to look at what was discussed. In particular, the Leave vote will have been influenced by what the Leave side said. And almost without exception, no one on the Leave side mentioned Leaving without any deal at all. (Of course some Brexiters are now pretending they talked about it all the time - lying is second nature for these people.)

Normally when someone says that a government has a mandate for a policy, it is because that policy was in the manifesto presented at the election. The Leave side did not have a manifesto, and that was a fatal flaw in Cameron’s referendum. In the absence of a manifesto we have to base any assessment of what any mandate was on what the Leave side said Brexit would entail. And almost without exception the Leave side said it would involve a trade deal with the EU of some sort.

It is true that the Remain side talked about No Deal as an extreme case in the list of possible forms of leaving the EU. But when looking at mandates, we look at what the winning side said, not the losing side. The Leave side spent a great deal of time ridiculing Remain predictions as Project Fear, and that included ridiculing the idea that we would not get a deal with the EU. Some on the Leave side said it would be the easiest deal in history.

The reason why No Deal is the only Brexit option left standing is that militant Brexiters have done everything they can to get us there. They voted down alternative options their government proposed. It is militant Brexiters, not a majority of the public, that think No Deal is the only true form of Brexit. When Brexiters claim that voters were really voting for No Deal they should be laughed at, but instead our supine media lets it pass.

What about the idea that we have to leave with No Deal because otherwise democracy (the 2016 vote) will be betrayed. This is a favourite claim by Farage. The people who have in fact betrayed Brexit are Farage himself and fellow Brexiters. They have turned a vote for a Brexit involving a deal with the EU into something quite different.

Such a claim only gets mileage because, thanks to the Brexiters, parliament failed to agree on a deal. But such an outcome was implicit in the 2016 result. Because the referendum did not specify what type of Brexit should be attempted, we have no a priori reason to believe that any particular option would command a majority. Indeed with such a close victory the presumption must be otherwise, and the polls show this to be the case. Parliament’s failure to agree a deal simply reflects the fact that there is no majority for any particular deal.

The idea that we must go through with Brexit even though there is no majority for any form of Brexit is nonsensical. It is an illusion created by a flawed advisory referendum narrowly won which politicians foolishly said at the time that they would implement. Luckily no politicians is bound by the foolish promises that other politicians made.

Again a hypothetical example shows this point. Suppose a similar referendum had been held on the proposition to increase spending on the NHS by raising taxes, and it had been narrowly won. However polls also suggested that when you asked about specific taxes (should we increase NHS spending by raising income taxes etc) there was no majority to raise any specific tax. Should the country nevertheless go ahead and raise spending and choose some arbitrary tax just because of the original referendum result? It makes no sense to enact something that a majority object to on the basis of a flawed referendum.

So why do Brexiters get away with still talking about the will of the people when a majority clearly favours Remaining to any form of Brexit? Not because we cannot rely on opinion polls - Leavers will not allow any further vote to confirm the opinion polls! That in itself is a crystal clear indication that Brexit is undemocratic. Some even say that a further vote on a specific Brexit deal is undemocratic. In what topsy turvy world is a public vote to confirm a previous public vote undemocratic.

It is a world where Brexiters have control of most of the media, and where Brexiters and some of the people who voted for Brexit are desperate for some democratic justification for what has become an assault on pluralist democracy and evidence based policy. If you repeat something often enough you are in danger of believing it yourself. Once Tory politicians said at every opportunity that the previous Labour government was profligate, and because it went unchallenged people believed it even though it was obviously false. (Just look at the numbers.) Equally if no one contradicts you when you say we must leave with no deal because of a narrow referendum win where no one on the winning side talked about leaving with no deal, you can convince yourself to enact the biggest act of self-harm in modern UK history on an unwilling majority.

When Boris Johnson won the 2019 General Election

in November, many people were shocked. How could someone who had been free with racist slurs towards many minority groups, who had arranged for an opponent to be beaten up, who had been sacked twice for lying and yet had continued to lie frequently, who had been the worst foreign secretary in decades, and who had wasted a lot of public money on blunders as Mayor of London go on to win a General Election? That he became Tory leader in the previous July could easily be explained, given the nature of his electorate then, but winning a General Election was something else.

He had been elected as leader in part because the party saw him as the only person who could prevent Nigel Farage taking many votes away from the party. Essential to Johnson’s strategy to starve Farage of votes was to follow through on his commitment to leave with No Deal. After brief talks with the EU in which he tried unsuccessfully to change the withdrawal agreement, he reported back that the EU were being obstinate and obstructive, and therefore No Deal was the only way the UK could fulfill its promise to the people to Leave.

Parliament voted (narrowly) against leaving with No Deal, and instead instructed Johnson to seek an extension. He then obtained a six months extension to Article 50 to allow time for either a referendum or a General Election. He had, unsurprisingly, chosen a General Election, as his parliamentary majority (with the help of the DUP) was in danger of disappearing altogether.

By championing No Deal in the run up to the election, he managed to drastically reduce the Brexit party’s support. Those who favoured No Deal soon realised that it was pointless voting against a leader who was holding an election explicitly designed to get a mandate for No Deal. In contrast, the vote among those that were against No Deal was badly split.

As the election drew near Labour regained the lead among opposition parties because of its anti-austerity stance, its strong programme for economic reform and additional public investment. However the LibDem vote remained strong partly because many Remainers did not trust Corbyn on the Brexit issue. The unequivocal commitment by Labour not to try and renegotiate Brexit and instead support Remain as part of their manifesto came too late. Many also found it impossible to vote for a party that had been described as institutionally racist by the EHRC. Despite hopes based on 2017, the increase in Labour's vote during the campaign was modest, partly because the broadcast media gave a generous amount of time to the Liberal Democrats and also followed attack lines from the right wing media when talking about Labour.

Although the Remain vote far outnumbered the pro-No Deal vote, the split in the Remain vote was disastrous in the UK's FPTP electoral system. It led to the Conservatives beating Labour in nearly all Lab/Con marginals. Cummings did for Johnson what he had done for Vote Leave. In addition, the fact that Johnson had cut stamp duty and taxes for higher income earners, together with the slogan ‘vote Swinson get Corbyn’, limited the number of Tory Remain voters who defected to the LibDems. Once again the proportion of LibDem seats was far below their proportion of votes.

Recriminations began almost immediately. Those who voted LibDem blamed Labour for not replacing Corbyn as their leader. Labour blamed the LibDems for splitting the anti-Tory vote. Both were correct. It was Corbyn more than anyone who was responsible for creating and sustaining the LibDem surge at the European Elections by refusing to unequivocally support Remain, even though it would be impossible for Labour to get a soft Brexit through parliament. However those who voted LibDem because only the LibDems were the true Remain party had succeeded in destroying the Remain cause, and those who had voted LibDem because Labour was institutionally antisemitic had kept a party in power where almost half its members would not accept a Muslim as the country's Prime Minister.

With his enhanced majority Johnson took the UK out of the EU without a deal in December 2019. The year that had looked so hopeful for Remain when the UK failed to exit in March ended with the worst form of Brexit possible. 

How the lessons from austerity have not been learned

The UK and the Eurozone are both vulnerable to the next recession, but both politicians and central bankers think each other should deal with it.

I don’t want to talk about the likelihood of a recession in the UK, US or Eurozone. Forecasting is a (necessary) mug’s game, where there are just too many variables to make anything like an accurate prediction. It is worth outlining the risk factors, and Grace Blakeley does an excellent job here. Instead my concern is the vulnerability in both the UK and the Eurozone to the impact of a recession if it happens. This vulnerability was clearly illustrated by the mistakes made after the Global Financial Crisis, yet in many ways the lessons of that failure have not been learnt.

Most people know the story of austerity after the Global Financial Crisis (GFC). In the UK the negative impact of the GFC was so severe that even cutting interest rates from around 5% to 0.5% was not sufficient to counteract its impact. As a result the Labour government in 2009 undertook various fiscal stimulus measures. They, together with lower interest rates, succeeded in stopping the fall in output, but by 2010 the signs of a recovery were still fragile. The new Coalition (Conservative and Liberal Democrat) government decided to focus on the rising budget deficit rather than the recovery, and undertook a large fiscal contraction in what became known as austerity.

The consequence of UK austerity was the slowest recovery from a recession in centuries. Here is a nice chart from a recent report by James Smith of the Resolution Foundation, which clearly illustrates the extent of the weak recovery.

Employment eventually recovered, but at the cost of an unprecedented fall in real wages. James Smith gives some evidence to suggest that the reason employment got off comparatively lightly but wages suffered by much more than we might expect was the 2008 sharp depreciation in sterling. This allowed firms to respond to the recession by keeping wages low, whereas in recessions in which sterling did not fall firms resisted nominal wage cuts and so had to resort to cutting jobs.

The idea that austerity was essential to reduce the deficit is simply wrong. It undoubtedly was a large factor in the weakness of the UK recovery. The tightening of fiscal policy has continued until today, with the consequence that interest rates have had to stay low to offset this fiscal tightening. The net result is that instead of rates being near 5% as they were before the GFC, they are below 1%. As James Smith points out, interest rate cuts in previous recessions have ranged from three to ten percent. This means that conventional monetary policy has almost no room to counteract a new economic downturn if one came.

The Eurozone is in an even worse position. Their history is of two recessions since the GFC, the second of which was largely caused by fiscal tightening as a result of the Eurozone crisis of 2010-12. The last time core inflation in the Eurozone touched 2% was in 2008, and it is currently around 1%. (More details from Frances Coppola here.) Interest rates set by the European Central Bank (ECB) remain at their lower bound. If a new recession happened, caused for example by a disruption in trade due to Donald Trump, conventional monetary policy would be unable to do anything about it.

Of course central banks in the UK and Eurozone still have various unconventional monetary policy tools. But the clue to their reliability at ending a recession is in their name. They are unconventional because they have only been used since the GFC, so we have limited evidence on their impact. It is like having an accelerator on a car where how far you have to push your foot down varies from second to second. You will end up driving slowly, which in economic terms means a prolonged recession.

All this is now largely understood by central bankers. All have said in one place or another that they will be relying on fiscal stimulus to help counteract the next recession. The ECB needs fiscal stimulus right now to get out of the last one. Yet fiscal stimulus is in the hands of politicians and not central bankers, and many of the politicians and political parties that were crucial in implementing the austerity that hit the post-GFC recovery are still in power.

There is therefore a danger that the policy of fighting the next recession will fall between two stools. Central bankers will say, in their own quiet and politically sensitive way, that they are not equipped for the task, but politicians may be deaf to these messages and will once again start worrying about deficits that inevitably rise in an economic downturn. To say more, we need to differentiate between the UK and the Eurozone.

In the UK some may think that with a new Prime Minister the problem of austerity has disappeared. In order to get elected both candidates have promised all kinds of tax cuts or spending increases. But as I have argued recently, what we are seeing here is what economists call deficit bias: the tendency to borrow just for political gain. Worse still, if the borrowing is mainly for tax cuts (including tax cuts for the rich), there is a danger that it is part of a strategy called ‘starve the beast’, which involves increasing the deficit with tax cuts and then demanding spending cuts to bring the deficit under control.

The upshot is that a Tory leader wanting to spend and cut taxes to please party members provides no guarantee that they will undertake effective fiscal expansion in any future recession. Neither of the Coalition partners has apologised for the mistake of austerity, and we have no reason to believe that they wouldn’t do it again in any future recession. The only major party that has a fiscal framework that would automatically move to fiscal expansion when interest rates hit their lower bound is Labour.

In the Eurozone there is also too little recognition among senior politicians that fiscal stimulus is required when ECB interest rates are at the lower bound. This is why Eurozone inflation is still below target. The OECD point to a crying need for more fiscal stimulus. Germany in particular has a great need for additional public investment, but is restrained by a fiscal rule that is worthy of an economic stone age. Efforts to create a Eurozone budget that could act in a countercyclical way have also been blocked by politicians, despite support from the ECB.

We can hope for a change of political attitudes in both the UK and Eurozone, but central bankers should not be content with hope. They have been delegated the task of stabilising the economy, and if they fail to complete this task in economic downturn after downturn many will come to believe that delegating monetary policy to central banks was a huge mistake. In addition, it is not the case that all central banks can do when interest rates hit their floor is unreliable types of unconventional monetary policy.

A fail safe way for a central bank to bring a recession to an end when interest rates are at the lower bound is to create money and give it directly to citizens. It could also create money and give it to borrowers by subsidising borrowing rates. The former is called helicopter money, a term due to Milton Friedman, and would require cooperation from government. The latter has been undertaken by the ECB in the past (see Eric Lonergan here), and so could be done to a greater extent without involving government. In essence it involves cutting interest rates on borrowing to well below the lower bound, but keeping rates for savers at the lower bound, and funding the difference by creating money.

Central banks in most of the major economies have been happy to create money during a recession, but nearly always this money has been used by central banks to buy assets. The impact on the economy is then difficult to predict, because no one's income has increased and the interest rate for borrowing has not fallen significantly. Giving the money directy to people rather than buying assets would have a direct and more predictable impact in stimulating the economy, as Frances Coppola argues in her new book.

So why do central banks not do this? There are two major reasons. First, they worry that increasing people's income is the job of elected governments, although I would argue that it is central bank's job to stabilise the economy if the government does not. (See my article with Mark Blyth and Eric Lonergan for more on helicopter money.) Second, if they create money to buy assets, when the economy recovers they can if necessary take money out of the economy by selling those assets. If they give that money away they wil not have those assets to sell. However this problem could be dealt with by governments guaranteeing the supply of assets a central bank needs.

Besides these arguments, I think there is a third argument why most central banks have not proposed doing these types of measures in a major way, and that is conservatism with a small c. The problem is that, if politicians unprepared to undertake fiscal expansion in a recession remain in power, that conservatism may be very costly both to us and to central banks themselves.

Reaction to “There is only one alternative to Prime Minister Boris Johnson”

I anticipated that my last post would not be popular in many circles. I want to respond to some of the common themes from the responses in this post, but there was one reaction I was not expecting. First some background. Since the beginning of the year I have had an arrangement with the online edition of the New Statesman (NS) that my Tuesday post should be simultaneously published on my blog and in the NS. The arrangement was working well.

My last post was published by the New Statesman as usual. And then sometime later it was unpublished. The line my post took was not one the NS wanted to carry. I do not know the details of what happened but I can guess. The post was hardly extolling the virtues of Corbyn as Labour leader, but it suggested any attempt to get rid of him was both futile and would increase the chances of Johnson winning the next election. I don’t think that message was welcome.

Of course any publication has a right to chose what it publishes, and I have no quarrel with that. What was unfortunate was the implicit confirmation of the main concern in the post, which was that the non-partisan and even left leaning media with the support of the Labour centre really believes they can depose Corbyn using the issue of antisemitism. I gave in the post the reasons why I think Corbyn is unlikely to depart as a result of this pressure and any challenge is unlikely to succeed, and none of the responses to my post questioned this logic.

Among comments on twitter, the most offensive was to suggest my post was itself a product of antisemitism, along the lines that I didn’t care about Jews. By implication anyone voting Labour in the future is also antisemetic. The most moderate remark I can make about this kind of comment is that it gives the drive to remove antisemitism a bad name. The implication that you are antisemitic if you support a party accused of badly handling internal cases of antisemitism is an extension of a far more frequent argument: the idea that it was not virtuous to vote for Labour.

A common response was that it was morally wrong to support a racist party or party leadership. Of course Labour is not a racist party and I doubt very much that its leadership are antisemitic, but lets put that to one side until later. The problem with this argument is that you can make lots of other similar arguments. Is it morally right for someone to support a party that was part of a government that caused untold misery through austerity, and where neither of the possible future leaders have apologised for supporting austerity? Is it morally right to support politicians that voted for the hostile environment policy?

Voting should be about weighing the pros and cons of each party’s stance on different issues, and in a FPTP system it means also thinking about whether voting for some parties in your constituency is a wasted vote. It is very hard to rationalise voting or not voting on the basis of I couldn't possibly vote for a party that showed any sign of racism. Would you really not vote if a party that failed to deal with antisemitism adequately even if it meant that another party whose leader actually uses racist speech and has voted for racist policies would stay in power? This is not a trolley problem: it is part of being a good citizen to make this choice.

Another comment I received is that there are no degrees of racism. I think this is nonsense. Once again it is useful to compare the two main parties. Both leaders are accused of being racist. With Corbyn the evidence amounts to things like not recognising antisemitic tropes in a painting, not mentioning someones antisemitism in an introduction to a book, or being associated with antisemitic people as part of his support for statehood for Palestine. With Johnson we have someone who has compared Muslim women in a certain dress to letterboxes (and those are not his only racist slurs), and who has supported a racist policy: a hostile environment that saw the deportation of members of the Windrush generation. Are these really equivalent?

Or let us look at the two parties. The Labour party has been accused at operating an inefficient disciplinary process for antisemitism or worse, of leadership interference in this process. The Conservative party routinely lets those exposed of making racist comments back in after a few months of ‘re-education’, and has just voted for a leader who makes racist remarks because most members show racist tendencies (to put it too mildly). Are these really equivalent?

Going beyond the UK, is telling non-white Congresswomen born in America to go back home to the crime infested countries they came from the same as anything Corbyn has done? The thing about the antisemitism in the Labour party is it involves no policy against Jewish people and it involves no language by members of the Labour leadership team against Jewish people. Some Labour party members are antisemitic, but there is no evidence that this number is unusually high compared to the population at large. When people try to equate antisemitism within the Labour party to racism in the Tory party they ignore these points.

The most depressing aspect in comments on my post was the number of people who just talked about antisemitism within Labour as if it was the same as racism within the Conservative party. This lacks the key ingredient that is also lacking in the media’s response, and that is a sense of perspective. One of the cheap remarks made in comments was that I was equating antisemitism within Labour to Clinton's email server. This was obvious nonsense, as I was clearly using the Clinton case to show how the media as a whole can lack a sense of perspective, and when it does that it can have terrible consequences.

Perhaps the most common response in comments was that a choice between Labour and the Tories could be avoided by voting Liberal Democratic. Despite the arguments in my post, I was told that the era of two party politics was over. Let me make one final point. The disastrous events that we have recently seen in the UK started in 2010, with in particular an austerity government during the worst recession since WWII. For more than half of the 9 years since 2010 the Liberal Democrats were in power, and the two candidates for leader were both ministers in the Coalition government. Their actions and voting records speak for themselves. As I have said in the past, I think the UK needs radical change to ensure nothing like the disaster of the last 9 years happens again. Only Labour at present provides that. Simply returning things to how they were before 2010 allows what happened from 2010 to happen all over again.