Austerity had to be done - but did it lead to Brexit? Posted by David Smith at 09:00 AMCategory: David Smith's other articles My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt. When looking for the real-world impact of the events of a decade ago, people who had never heard of Lehman Brothers then, and may still not have heard of them now, will be able to tell you two things. One is that stagnant productivity has gone in hand with stagnant real wages; in both cases the worst performance not just for decades but for centuries. The other is austerity. I shall leave productivity and wages for another day, though there is always something new to say. There is also something new to say on austerity, particularly in the context of the
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Austerity had to be done - but did it lead to Brexit?
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
When looking for the real-world impact of the events of a decade ago, people who had never heard of Lehman Brothers then, and may still not have heard of them now, will be able to tell you two things. One is that stagnant productivity has gone in hand with stagnant real wages; in both cases the worst performance not just for decades but for centuries. The other is austerity.
I shall leave productivity and wages for another day, though there is always something new to say. There is also something new to say on austerity, particularly in the context of the Commission of Economic Justice report published a few days ago, and championed by Justin Welby, the archbishop of Canterbury.
It is easy to forget just how much the events of the autumn of 2008 transformed, for the worst, the economic and fiscal outlook in Britain. The Treasury’s March 2008 budget, under the title “Stability and opportunity: building a strong, sustainable future”, was six months after the run on Northern Rock and in the same month that Bear Stearns, th4e US investment bank, hjad to be bailed out.
The outlook, however, was expected to be barely clouded by these events, with growth predicted of 2% in 2008, 2.5% in 2009 and 2.75% in 2010. The budget deficit would be 2.9% of gross domestic product in 2008-9, 2.5% in 2009-10 and 2% in 2010-11.
If you don’t want to know the score, look away now. This was when the then Labour government insisted it was meeting its fiscal rules and the policy of the Tory opposition, crafted by David Cameron an d George Osborne, was to “share the proceeds of growth” been tax cuts and higher public spending.
The earthquake that hit the economy and the public finances rendered such talk obsolete. The growth numbers turned out to be very different. The economy shrank by 0.3% in 2008 and 4.2% in 2009, making it the biggest post-war recession, before a modest return to growth, 1.7%, in 2010. The deficit, government borrowing, went off the scale, with figures of 7.3% in 2008-9, 9.9% in 2009-10 and 8.5% in 2010-11. Over those three years, borrowing was a staggering £319bn higher than the Treasury expected in March 2008.
Unlike now, the differences between the parties on the appropriate response to this were small. Tories were un happy with the idea of a short-term fiscal stimulus to ease the impact of the recession at a time of already high government borrowing. But the fiscal stimulus, largely in the form of as temporary Vat cut and ideas like a “scrappage” scheme for old cars, was quite small.
Both main parties were agreed that there was no alternative to deficit reduction – austerity - through a combination of tax hikes and public spending cuts. Tory austerity under Osborne was intended to achieve its goals of eliminating most of the budget deficit more quickly, and Labour would have relied on tax hikes (including the 50% top rate it announced before leaving its office). But there was no serious political disagreement that, faced with a budget deficit of 10% of GDP (higher on initial figures), there was no alternative but to act.
There were, of course, plenty of noises off among economists arguing against austerity, and that the appropriate course for a weakened economy was for the government to spend , more, rather than less. I never argued, as some did, that austerity itself could provide a stimulus, by lower long-term interest rates. But I did think there was no alternative.
Under austerity the economy continued to grow and, after a short-lived rise, unemployment fell. The private sector created seven times as many jobs as those cut by the public sector and today we have the lowest unemployment rate since the mid-1970s. There were scares about double-dip and triple-dip recessions, particularly around the time of the eurozone crisis in 2011-13 but the economy trundled along and avoided such traps, gaining strength from 2013 onwards.
It could have been done better. Voters were prepared for austerity in 2010, and a short, sharp shock. Dragging it out, and handing some of the money back with tax cuts such as raising the personal allowance, cutting corporation tax and freezing fuel duty meant that austerity fatigue was bound to set in. Achieving spending cuts by slashing capital spending – infrastructure – was short-sighted.
The long view on austerity also has to take in its impact on the referendum. There is credible evidence, notably in a recent Warwick University paper by Thiemo Fetzer, ‘Did Austerity Cause Brexit?’, that cuts in welfare spending in particular influenced the referendum outcome. Fetzer’s research suggests that without these cuts, support for leaving the EU could have been as much as 10 percentage points lower. And in the context of austerity it was harder to argue that EU migrants, despite being net contributors to the public finances, were not putting pressure on public finances.
The context set by austerity – and weak productivity and wages – also lay behind the Commission on Economic Justice report, published under the auspices of the left-leaning Institute for Public Policy Research (IPPR). It would be easy to rubbish this report – archbishops and economic policy are not usually a happy combination – and I was invited on to a couple of radio programmes to do so.
But it is true that there is an air of dissatisfaction about the economy, even nine years after the last recession and with low unemployment, and some of its diagnoses are spot on. Britain has invested too little; at the bottom of the 30-plus members of the Organisation for Economic Co-operation and Development for investment, public and private, as a percentage of GDP from 1997-2017. Within that, too much bank lending goes into housing rather than productive investment.
We also have too big a “long tail” of low-productivity businesses, and too little competition in many markets. A proper industrial strategy, rather than the damp squib the government has come up with, is indeed needed. So is action to transform skills. Increasing housing supply, particularly that of social housing, is vital.
Many of the Commission’s ideas, however, should remain firmly on the drawing board. It may be true that businesses have not responded to corporation tax cuts by increasing investment but increasing the corporation tax rate to 24% (from 19%) is not something you would want to do when Britain needs to maintain its attractiveness to inward investors.
Nor would you want to increase Britain’s overall tax burden, currently the highest for 30 years, to the levels of Germany or Denmark in order to increase public spending. Government receipts look to be close to a natural limit of 37% of GDP.
It is good that a debate is taking place on improving Britain’s economic performance, and the IPPR report is part of that debate. But it is also important that ideas are rooted in reality. There is more to reform, too, than turning the clock back to an era when unions were more powerful and a national economic (development) council helped steer the economy.
As for austerity, the worst is probably over and there has been a welcome increase in public investment. But the Treasury, starting to make preparations for next year’s spending review, is in ni mind to turn on the taps.