The Failed Austerity Experiment in the UK

Philip Arestis and Malcolm Sawyer

A general election in the UK is set to be held in May 2015, which will mark the end of a five year period of Conservative-Liberal Democrat coalition government. This government set in 2010 as its prime policy target the elimination of what they have tended to refer to as Labour’s deficit and “clearing up the mess.” In an “emergency budget” introduced just over a month after coming into power (June 2010), Chancellor of the Exchequer George Osborne introduced some emergency cuts amounting to £6 billion—which can be compared with a deficit of over £150 billions. Initial plans were put in place to come close to eliminating the deficit over the lifetime of the Parliament, reinforced by the Spending Review of October 2010. These plans were based on “expansionary fiscal consolidation” arguments, along with a number others. “The most urgent task facing this country is to implement an accelerated plan to reduce the deficit. Reducing the deficit is a necessary precondition for sustained economic growth. To continue with the existing fiscal plans would put the recovery at risk, given the scale of the challenge. High levels of debt also put an unfair burden on future generations. …The Government has therefore set a forward-looking fiscal mandate to achieve cyclically adjusted current balance by the end of the rolling, five-year forecast period” (HM Treasury Budget 2010, emphasis added).

It was not only that the budget deficit was to be largely eliminated over a five year period, but that it would go alongside a booming economy with the output gap (between actual output and potential output) closed. The ability of the government to achieve a close to balanced budget and a closed output gap was validated by the newly established and “independent” (of government) Office for Budget Responsibility. This was accompanied by forecasts that investment and exports would recover and grow rapidly, and this would in effect enable the budget deficit to decline and the economy to grow.

It is now evident that the budget deficit has declined from 11 percent of GDP in 2009/10 to the 5 percent forecast for the current financial year 2014/15. But the target of eliminating the deficit will be widely missed—an intended (in 2010) surplus on current budget of 0.3 percent for 2014/15 has resulted in a 2.7 percent of GDP deficit (current forecast), and an overall public sector net borrowing intended to be 2.1 percent of GDP is currently forecasted to be 5.0 per cent. And currently the OBR is forecasting elimination of deficit in 2018/19 after further severe cuts in public expenditure. But it is clear that it has not been through a lack of public expenditure cuts that there has been a failure to meet the deficit targets. In 2010, “the government projected that in 2014/15 its total tax revenues would be £700bn. In fact, they will be £646bn, according to the OBR. Public spending, on the other hand, has behaved almost exactly as forecast. In 2010, the government projected that its spending would be £738bn in this financial year. The Treasury is to be congratulated on its capacities as national book-keeper in chief. The actual figure is £737bn …. It is not runaway public spending that is causing borrowing to stay stubbornly high, thus triggering the extreme shrinkage of the state: it is the hollowing out of the tax base”. (Will Hutton, “Forget austerity—what we need is a stronger state and more taxation,”). The failure of real wages to grow and more generally the lagging growth leads to a failure of tax receipts to grow.

The level of national income (GDP) in the UK has recently reached its pre-crisis peak, and GDP per capita is still below the peak. In the pre-crisis period, growth had averaged around 2 ½ percent per annum, and hence GDP is some 15 percent below where it would have reached with pre-crisis growth. Since 2010, when fiscal policy switched towards austerity growth averages less than 1.1 percent per annum (2014Q2 over 2010Q2). Austerity has gone alongside slow growth, much below previous rates, at a time when cyclical recovery could have been expected to have annual growth at and above average.

There are two clear lessons to be drawn from this episode. The first is that the budget deficit is not under the immediate control of the government, and the fate of the budget deficit depends heavily on what is happening in the private sector, particularly with regard to investment, consumer expenditure, and exports. It means that setting budget deficit targets without an assessment of whether their achievement is feasible is foolhardy, and without building in contingency arrangements when the private sector’s behaviour leads the government to missing the deficit target. Yet governments seem to persist in doing so. The UK coalition government set off basing their deficit targets on the assumption that there would be rapid growth of private sector demand.  When private sector demand did not grow as forecast, deficits did not fall as scheduled.

The second is that “expansionary fiscal consolidation” does not work—adopting fiscal austerity does not lead to economic recovery. In the UK case, the budget deficit programme was heavily geared to expenditure cuts rather than tax rises on the basis that favoured expansionary responses to austerity. It is, of course, difficult to say what would have happened in the absence of austerity. The monetary policy framework with ultra low interest rates and the quantitative easing should have favoured investment, although the general world economic climate was not favourable for exports although the exchange rate was favourable and imports grew to outpace exports. It is difficult, though, to believe that any expansion can be ascribed to the impact of fiscal consolidation, and its supposed favourable effects on confidence and investment.

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