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.”

 

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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. Continue reading

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?

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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. Continue reading

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.

UK debt reduction: how can ‘Spreadsheet Phil’ do it?

Money-poundsLast week the UK government’s new Chancellor of the Exchequer, Phillip Hammond, known to some as ‘spreadsheet Phil’, gave his first Autumn Statement to parliament. This outlines the state of the UK economy and the government’s finances, and announces new policies on government tax and spending.

The forecasts of the Office for Budget Responsibility for the UK economy’s likely trajectory over the next few years were somewhat gloomy, and laid much of the blame for this at the door of the decision to leave the EU, or Brexit. Growth will be slower, investment weaker, and public borrowing and debt higher than otherwise.

I will avoid reiterating details regarding the Autumn Statement that were covered in last week’s press, and instead focus on the potential for debt reduction and overall economic performance over the next few years, which the government is trying to manage and improve upon: the Prime Minister wants an economy that ‘works for all’. Fine aspirations indeed. Continue reading