Author: Alan Shipman

Did the Chancellor outwit his critics - or out borrow them?

Updated Monday, 18th August 2014
Despite a fragile recovery, with earnings stagnating, Alan Shipman warns we may be facing an indefinite period of austerity.

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A cartoon illustrating Conservative MP George Osborne and Labour MP Ed Balls in their underwear. George stands with his hands on his hips and says "Oy! Ed! Gerroff my clothes!" while Ed takes George's jacket and replies "Well, George, you borrowed my Plan B so I'm borrowing your suit!".

So strong is the recovery unleashed by George Osborne, a year before the election, that plenty of economists are keen to explain why it’s too good to be true. Many point out that it’s been the slowest recovery on record, with national output (GDP) taking 6 years to return to its 2008 peak. As UK population has risen during that time, GDP per capita – a rough indication of attainable average living standards – has only just edged up above the level at the start of this parliament

The Coalition has succeeded in getting people into jobs, but these generally have lower productivity (output per person) than before – even though over 400,000 were displaced from public employment on the grounds that they’d do more useful work in the private sector. Low productivity means that many more people are needed to produce the same GDP as 2008, and that their average pay must also be lower – confirmed by sharp falls in real earnings since 2009/10.

Other reasons to downplay the Chancellor’s achievement include the continued reliance on service-sector growth, with the manufacturing recovery already stalling; the consequent failure of exports to grow as fast as imports, worsening an already wide trade deficit;  and the concentration of demand growth on consumption, with business investment still 15% below its pre-crisis level.

Sound criticisms, or sour grapes? If the recovery a year from now looks equally strong and better balanced (as the IMF among others is forecasting), the line of attack may well reverse. Osborne will be hailed by those who currently assail him – as one of the great Keynesian chancellors, who used public finances to steady the economy when the private sector was too debt-ridden or doom-laden to turn it around.

Austerity Keynesianism

He was supposed to do the opposite. Before and after his arrival at the Treasury, Osborne promised ‘expansionary contraction’: reviving the economy by rapidly re-balancing the Budget, so that the private sector could productively invest money that the public sector might otherwise borrow and consume. His shadow, Ed Balls, was cast as the Keynesian spendthrift, proposing a much gentler path of spending cuts and tax increases. Balls was unable, within a standard TV soundbite, to explain how a wider deficit now could lead to narrower deficits later. Osborne’s ‘Plan A’, pledging immediately lower borrowing through unprecedented public spending cuts, appeared to be the only game in town.

Osborne promised in 2010 that he would eliminate the government’s deficit (spending minus taxation) by 2015. In contrast, his Labour predecessor Alistair Darling had planned only to halve the deficit by 2015; and Balls had demanded an even slower rate of decrease. It was a three-way argument about debt reduction strategies. Osborne, on behalf of the Coalition, argued that cutting the deficit sooner would eliminate it faster, capping public debt at a much lower level than his rivals would achieve. The two Labour strategists argued that higher deficits in 2010-14 would lead to lower deficits in later years, by sparking a quicker recovery in GDP and therefore in tax revenue. On their projections, this would lead the long-run public debt no higher, and so achieve the same stabilisation at much lower social cost.

Mid-term assessments suggested the Chancellor had clearly won the argument. A 2011 analysis by the highly respected Institute for Fiscal Studies showed that Osborne’s plan would lead to an earlier, lower peaking of public debt than Darling’s, provided he managed to deliver the promised budget tightening. Balls’s ‘Plan B’ was thus pronounced dead, even before the longest recession came to an end.

But the end-of-term verdict will be sterner, as can be gauged by comparing Darling’s plans from March 2010, Osborne’s replacement plan from June 2010, and the actual outturns to date as Osborne’s plans are put into action.

Public sector net borrowing, % of GDP

 

2010-11

2011-12

2012-13

2013-14

2014-15

Darling, 3.10

11.8

8.5

6.8

5.2

4.0

Osborne, 6.10

10.1

7.5

5.5

3.5

2.1

Actuality, 3.14

9.3

7.9

7.3

6.6

5.5

 Sources: Budget March 2010; Budget June 2010; OBR Economic & Fiscal Outlooks March 2012, 2013, 2014

Osborne’s actual deficit (public-sector net borrowing) was lower than Darling’s projected deficit in 2011, but has been progressively higher in each subsequent year. Instead of closing the deficit, he hasn’t even halved it as Darling planned. It will be fewer than four percentage points lower than in 2010, if the Office for Budget Responsibility (OBR) is correct in its latest forecasts. The man who castigated Balls has actually followed his advice.

The Chancellor’s defenders vehemently reject this suggestion. They argue that Darling’s projections were over-optimistic on economic growth – which in March 2010 was forecast by the Treasury to rise back above 3% in 2011 and 2012. Labour would never have achieved this, they argue, with the banks still fragile and the Eurozone falling into recession. 

The Shadow Chancellor’s defenders are equally incensed by the comparison: if George Osborne really stole Ed Balls’ clothes, he got the abandoned pantomime outfit. Osborne fell short of Darling’s targets, they argue, because he cut public spending too far too fast, and choked off the GDP growth that would by now be achieving meaningful deficit reduction. Their ammunition lies in the fact that GDP was recovering well in 2009-10, and then headed downwards again from 2011-13, exactly as austerity’s detractors predicted. It’s hard to blame this on the Eurozone when Balls’s Treasury team had kept the UK out of it, and when Germany and France had regained their pre-2008 levels of GDP within five years.

According to his critics, Osborne has ended up with Plan B borrowing levels in 2014-15 because he refused to consider them in 2010-11. The chance to boost growth with counter-cyclical public borrowing has been lost. Indeed, because it is characterised by frozen or falling incomes, the recovery now under way is not producing the usual rise in tax revenue. So the deficit stopped falling earlier this year.

With the budget not now expected to re-balance until late in the next parliament, the Chancellor appears to be a late convert to ‘modern money theory’, which suggests that public debt is still a long way below the level that might drag down growth or become unsustainable. He’s delivered the growth that his opponents said was impossible. But only by running bigger deficits than even they believed were necessary, and forcing four more years of austerity which weren’t envisaged in either Plan A or Plan B. 

This blog post is part of Society Matters. The blog seeks to inform, stimulate and challenge our understanding of this changing world and of our humbling role within it.
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  • picture of Alan Shipman

    Alan Shipman

    (Department of Economics)

    Alan returned to research and teaching on the economy after it crashed in 2008, having (mis)spent years as an emerging-markets analyst, consultant and business journalist. Lucky enough to have been taught economics when capital ...

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