The lessons we shouldn’t learn from the UK government’s fiscal U-turns

The UK government’s September ‘mini-budget’ is no more. The chancellor who delivered it has been sacked, and the Prime Minister is hanging on to her position by her fingernails, her authority withered and her humiliation almost complete. The new chancellor has reversed virtually all of the promised tax cuts, and has scaled back support for people’s energy bills. Further spending cuts are likely to be proposed in a couple of weeks. So far, the financial markets have been reassured, with the pound stabilising against the dollar and the price of gilts rising somewhat, though they are still lower, and interest rates higher, than before the mini-budget.

Regular readers of this blog will likely know that I am no right-wing libertarian when it comes to economic policy, and am therefore critical of Trussonomics, which is of course now effectively dead. In today’s post, I thought I would assess some of the wrong lessons that might be drawn in the UK and around the world from the evolving fiscal policy of the current Conservative government.

The UK is the new ‘sick man of Europe’: an interview with Duncan Weldon

For those of you interested in the current performance and prospects of the UK economy, here is an interesting and wide-ranging interview with Duncan Weldon, a former economist at the Trades Union Congress, and a former economics editor for the BBC’s flagship programme Newsnight. He now writes the Value Added newsletter. During the interview he discusses the UK’s poor performance in recent years, and how this has been impacted by government policies, as well as the international environment, including our evolving relationship with the European Union. He ends on a (sort of) optimistic note, in that the fact that UK productivity is some 20 percent behind that of countries such as France and the US means there is plenty of room for living standards to ‘catch up’ with those of more successful economies.

The hidden agenda of austerity

“Besides their supposed beneficial effects on inflation and the balance of payments, austerity programmes are commended for other reasons, too, and these may be the real basis for their popularity in business circles. For example, high unemployment and the increased likelihood of lay-offs certainly helps business maintain labour discipline. When sales are strong and labour is badly needed to maintain high levels of production, strikes and slowdowns are costly; labour is in a strong position. But when sales are slow, and inventories are high, so that production is not urgent, labour has no ground to stand on. In general, austerity forces people to think more about profit and loss, and less about environmental and social issues. In boom times, popular democracy will force business to curb pollution, restrict the dumping of dangerous wastes, improve unsafe working conditions, and the like, but in hard times no one wants to risk driving business over the edge and making things even worse.

In short, austerity has helped to banish the spectre of the 1960s – no more unbridled challenges to corporate authority, or angry demands for regulation and social accountability, perhaps most important, no more mass refusals of talented youth to start the scramble up the corporate ladder, preferring instead to ‘turn on, tune in and drop out’. In times of austerity the college-minded look to business school; everyone is glad of a job – if they are lucky enough to get one!…

Austerity promotes control; it strengthens authority and weakens labour. Expansion undermines authority; by creating prosperity it provides the weak and the powerless, the underdogs, with the resources to stand up to the system. Austerity supports the center, weakens the periphery, creates dependency and intensifies competition. It promotes innovation and cost-cutting, weeding out the weak and rewarding the strong, who therefore favour it. Austerity removes the state and popular forces from the marketplace; expansion both requires and promotes control over business by labour and popular sentiment.

Perhaps equally important, austerity favours finance over production. Austerity raises the earnings of finance at the expense of production capital; at the same time it weakens the position of the latter, by simultaneously shrinking their markets and raising their costs…

[I]t would seem that a policy of Expansion is clearly superior, and so it is from the point of view of the public. But this is not at all how it appears to business. For Expansion improves the bargaining position of labour, and not just over wages. After a long period of full employment, labour is likely to bargain to increase job safety, reduce pollution, re-design jobs to make them less repetitive, and generally improve the quality of life. What labour gains in these respects, restricting management powers, businesses of all kinds lose. Consumers and citizens may likewise be emboldened to demand regulation of dangerous or unsavoury business practices. Hence Austerity, by weakening labour, promotes the interests of both kinds of capital, whereas Expansion, by strengthening labour does both kinds of capital a disservice. From the point of view of business, austerity is indispensable in maintaining the freedom of business to do what it pleases with its assets.”

Edward J. Nell (1996), Making Sense of a Changing Economy, Routledge, p.120-2.

The Debt Delusion – Living Within Our Means and Other Fallacies

John Weeks has a new book out, The Debt Delusion, which takes a progressive line in debunking a number of what he terms the myths that surround fiscal policy.

Weeks is an Emeritus Professor of Development Studies at SOAS, and coordinator of the Progressive Economy Forum. He is heavily critical of austerity and proposes an ‘anti-austerity’ agenda on tax and spending for today’s policymakers.

Weeks has long been critical of mainstream economics in general, not least in his previous book for the layman, Economics of the 1%.

Summing up his proposed fiscal policy framework, he writes (p.182-3):

Austerity: 12 Myths Exposed

Social Europe has produced a booklet attacking many of the myths surrounding austerity. It is free to download here. Below is a short extract from the preface:

“Austerity: 12 Myths Exposed debunks commonly held beliefs in support of austerity as a solution to addressing stagnation and economic crisis. Austerity staples like ‘live within your means’, ‘Swabian housewife economics’, ‘public spending hampers private investment’ and the new authority of alleged maximum debt and deficit levels, such as the Maastricht criteria governing the eurozone, are tackled and taken apart. While this booklet does not provide a full recipe for the end of austerity, those who are looking for alternatives will find a range of arguments needed to clear the pathway towards paradigm change. One thing is clear: austerity is a tool of national and international financial interests – not a solution to the problems caused by them.”

 

Austerity, household debt and Brexit: the case for a weaker pound

What are we to make of the current performance and future prospects for the British economy and for the JAM (Just About Managing) households which the Conservative government proclaims to be trying to help?

According to recent figures from the Office for National Statistics (ONS), households, on average, became net borrowers in 2017 for the first time since records began in 1987. The savings ratio fell to its lowest annual level since 1963.

Household spending growth also fell to 1.7%, the lowest since 2011.

There was some better news on the current account deficit for 2017, which fell to 4.1% of GDP, also the lowest figure since 2011. And in the fourth quarter of last year, it fell to 3.6%. The improvement is at least partly down to the weakness of the pound and a stronger world economy boosting net exports and net earnings on foreign investments.

But the improvement in the current account is also being flattered by weaker growth in imports due to their higher cost reducing real household income and consumption growth. In an open economy, part of household income is inevitably spent on imported goods and services. A fall in the current account deficit can come from a reduced demand leakage into imports as well as increased growth in exports.

With the weaker pound and higher inflation reducing real household income, and interest rates still at very low levels, households are taking the opportunity to add to their already substantial levels of debt, rather than reduce consumption even further.

With the household sector spending more than its income, it is adding to the growth of aggregate demand, as credit acts as a net injection of purchasing power into the economy.

But with household debt already high, interest rates set to rise gradually, and real wage growth still negative, these trends will prove unsustainable. Although inflation has perhaps peaked, and real wages should start to grow once again, there is some way to go before the JAMs start to see a sustained and substantial rise in living standards.

Mark Blyth on some ‘Stupid Economic Ideas’

Professor Mark Blyth, author of Austerity: The History of a Dangerous Idea, does some debunking in this short video.

How austerity may reduce innovation

An interesting post from Simon Wren-Lewis on how sustained austerity can lower innovation and productivity growth. With the latter growing painfully slowly in the UK and other rich countries for a number of years, this is potentially important. As he notes, it may only explain part of the productivity slowdown, but it still highlights one of the negative impacts of austerity.

Put briefly, austerity weakens aggregate demand when it cannot be offset by monetary policy (as has been the case since the recession). This may create an ‘innovations gap’. Firms facing reduced demand for their products will slow down the rate at which they create or utilize new products, processes and technology via new investment, leading to weaker growth in productivity. This sort of investment would have ’embodied’ the new technology, but in its absence, the improvements will not take place.

Budget deficits forever?

Below is a helpful quote from post-Keynesians Wynne Godley and Marc Lavoie on fiscal deficits and full employment. I am sceptical, based on economic history, that full employment can be sustained for lengthy periods under capitalism, which Keynesians claim is possible given the right policies. However it usefully makes a nonsense of the oft-found obsession many governments have with austerity and ‘balancing the books’, as if the public finances are akin to those of a prudent household.

Yanis Varoufakis: why austerity doesn’t work

Yanis Varoufakis explains in the short video below why austerity doesn’t work. He uses the example of the UK economy, and leaves out the foreign sector (trade and investment), which does simplify things. I would argue that including the latter in the model is in fact vitally important to our understanding in the case of economies open to foreign trade and investment.

One reason for this is because a deflation which results from government austerity reduces the demand for imports from abroad, which negatively affects trading partners. Devaluing the currency can also have this effect, and is potentially an example of a ‘beggar-thy-neighbour‘ policy. The devaluing country may only gain at the expense of others, which can invite retaliation. This can take the form of competitive devaluation: if one country devalues, its growth might increase for some time, but if all countries do the same, the global benefits may be zero, while their distribution will tend to be uneven.

A small country open to international trade can adopt a deflationary fiscal policy and devalue its currency, in order to rebalance its economy away from domestic demand and improve its export competitiveness. This has often been the policy imposed by the IMF on developing countries in crisis as a condition of lending.  But if all countries deflate and devalue, the result will be a global recession.

This illustrates the importance in macroeconomics of analysing the world economy as a whole system, whose interacting parts can produce effects not obvious when looking at a single economy. This is an insight found repeatedly in the work of Michael Pettis, whose book The Great Rebalancing offers an original explanation for the Great Recession of 2008 and the likely global economic outcomes in the years ahead.