Austerity and the UK economy

During the recent row over tax credit cuts the Conservative government’s austerity policy came under some scrutiny. However, this only touched the surface when it comes to the true effects of fiscal consolidation measures over the past five years in the UK. This article examines those effects, as well as how the coalition government changed its austerity policy after 2012. Furthermore, it evaluates the recovery of the UK economy and the contrast between media coverage and economists’ opinions.

Facts and figures

The facts about austerity measures in the UK under the coalition government are unequivocal. The Office for Budget Responsibility (OBR) estimated that, controlling for other relevant factors, the coalition government’s austerity program reduced economic growth in the UK by 1% of GDP in both 2011 and 2012. In practice, this means a reduction of output of 5% of GDP, or £4000 of resources lost per household. Perhaps most surprisingly, this fall in output was expected by economists. If the government reduces spending, aggregate demand is negatively affected, which reduces output. In normal times, spending cuts can be partially offset through cutting interest rates to boost investment. However, when the austerity measures were introduced, interest rates were already close to zero, so conventional monetary policy was powerless.

Ostensibly noticing how the spending cuts were damaging the economy, the coalition government changed its “long-term economic plan” after 2012. Spending increased, deficit reduction targets were delayed and the economy recovered accordingly in 2013. Yet the coalition government insisted that the recovery vindicated austerity, while in fact the opposite is true. It should also be noted that this recovery is nothing special, as it has only averaged 2% at an annual rate. That makes the current recovery the slowest one since records began. Furthermore, as the recovery has not compensated for the lost output due to austerity measures, one can hardly call this a true recovery. Additionally, austerity negatively impacted employment until 2012, and productivity has virtually stagnated over the past five years. From the above it is clear that austerity hurt the UK economy, while growth picked up as a result of less austerity.

An alternative reality

However, it is hardly unexpected that a Conservative-led coalition government would pursue such tough fiscal consolidation measures to reduce the size of the state. More remarkable is the paradigmatic shift of public debate concerning the economy. There is a consensus among the establishment of the two major political parties in UK that tough austerity measures are both sensible and necessary, while in fact they are neither. This point of view came into vogue around 2010 in the UK and other parts of the world, notably in the US and in Germany. However, after 2012 most economists, as well as most countries’ press and politicians agreed that austerity was a grave mistake.

Faced with this indubitable conclusion, what rationale can possibly be offered for fiscal consolidation? I believe the answer is twofold. Firstly, in 2010 the coalition government cleverly tapped into the fear among the electorate that the UK would suffer a fate similar to Greece if it did not adopt tough austerity instantly. Clearly this is a ludicrous comparison, because the UK never defaulted on its debt nor was it close to doing so in 2010. Furthermore, unlike Greece, the UK has an independent currency. A country with a floating exchange rate and a credible central bank simply does not face the risk of a liquidity crisis turning into a solvency crisis. Additionally, fiscal consolidation was intended to convince consumers that public spending is under control, thus raising confidence. This argument has been discredited by the fact that no correlation was found between the austerity and expectations of economic prosperity. If anything, the main effect of the austerity paradigm on the electorate has been the creation of increasing distrust of any politician who denies that drastic deficit reduction is necessary. Secondly, another device the Conservative Party employed to stress the need for austerity was an analogy between the national economy and an individual household. It was argued that, like a household, a government should balance its books. However, this comparison does not take into account the vast influence a reduction in government spending has on aggregate demand, which is something that does not apply to a single household.

A strikingly painful example of how ingrained the need for austerity is in the UK’s public sphere is Labour’s abstention from the vote on the 2015 Summer budget that included harsh austerity measures. The Conservative Party and the right-wing media have effectively established an unfounded austerity paradigm that is not only falsely discrediting the last Labour government, but also continues to imbue the electorate with a ridiculous view of what fiscal responsibility is. The rigidity of public discourse regarding the economy reflects one of two possible developments in the UK: either politicians and the media are clueless when it comes to macroeconomics, or austerity has become such a significant lie that nobody dears to speak up about the dangers of austerity for fear of losing credibility in the public sphere. Shadow Chancellor John McDonnell’s recent opposition to the “fiscal responsibility” charter is an encouraging sign of public debate moving in the right direction.

Overall, it is clear that austerity harmed the UK economy, and that it only recovered once the fiscal tightening policies were relaxed. The even harsher austerity package planned for the next five years, combined with a lack of general understanding of its likely effects creates a potentially dangerous situation for the UK’s economic stability.

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