Sunday, April 12, 2015
On austerity, take economists with a pinch of salt
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Should you listen to economists during this election campaign? I say that in the full knowledge that it may encourage some to stop reading now, and that the excellent work done by economists at the Institute for Fiscal Studies and other bodies is rightly used as a check on the claims and counter-claims of the parties.

No, I ask because of a survey of mainly academic economists published a few days ago by the Centre for Macroeconomics, which is based at the London School of Economics but which also encompasses researchers from the Bank of England, Cambridge University and other institutions.

The survey asked two questions. One was whether the coalition’s policies had been good or bad for growth over the past five years. The second was whether the outcome of the election would make any difference to growth and employment over the next five years.

The answer to the first question was clear-cut. Two thirds of the economists questioned said that coalition policies – “austerity” – had been bad for growth. The answer to the second question was slightly less clear but the majority view was that the slower the pace of deficit reduction – the less the austerity - the better it would be for economic activity.

I know this survey because each month I take part in it, on a range of different questions. This one got noticed more than usual because of the timing and because it was picked by Robert Peston of the BBC. It was quoted during the televised party leaders’ debate.

I disagreed with the majority verdict. The coalition had been for good growth, I said, because it had pulled Britain back from the abyss and away from a fiscal crisis that could have been hugely damaging.

Sometimes it is said that fears of such a crisis were artificial and that a country with its own currency and central bank should not worry about such matters. But Britain has had more than here fair share of past crises. Attempting to spend our way to growth gave us the IMF crisis of 1976.

As for the next parliament, the most important question is not the relatively small differences in the pace of deficit reduction between the main parties but what the next government can do for the supply-side, for incentives, and for productivity.

I was not alone in saying the coalition has been good for growth. Several distinguished economists, including Patrick Minford of the Cardiff Business School, Nicholas Oulton of the LSE, Costas Milas of Liverpool and Jagjit Chadha of the University of Kent took the same view, and for similar reasons.
Minford argued that the coalition had achieved a balance between deficit reduction and destabilising the economy, Oulton that “austerity has been greatly exaggerated” and Chadha that “sound money” deficit reduction had created the room for aggressive quantitative easing by the Bank of England, alongside low long and short-term interest rates. Milas pointed to Britain’s respectable growth performance in recent years, particularly on IMF figures.

Indeed, the pattern of growth during this parliament was not, as is often said, that growth stopped as soon as the coalition started implementing austerity, roughly two-thirds of which it inherited from Labour. Growth in non-oil gross domestic product, the best undistorted measure of economic activity, exceeded 2% in both 2010 and 2011, only slowing to 1% in 2012 – the height of the euro crisis – before picking up again.

If I am honest, however, I would admit that in my response I was aiming off, as a counter to the inevitable large majority on the other side. If you ask a group of British academic economists whether austerity has been good or bad for growth, whatever the circumstances, the majority answer will be as predictable as if you asked them whether there should be more or less university funding. In that respect, most academic economic opinion has not moved much since 364 economists signed a round-robin letter in 1981 warning that Margaret Thatcher’s policies would deepen the recession. The letter famously coincided with the start of a long upturn.

The correct answer to the first question in my view, though it would not have made for an interesting survey, would have been for respondents to adopt the classic two-handed economist – “on the one hand, on the other hand” – approach. The coalition might have been good for growth, but it might not have been. It depends, and it depends on things we cannot possibly be certain about.

I cannot say for certain there would have been a fiscal crisis if austerity had been abandoned in 2010 but neither can the critics of austerity say there would not have been. We do not know what would have happened to long-term interest rates, or what the Bank would have done. Would sterling have succumbed, pushing inflation even higher and exacerbating the squeeze on living standards? Possibly, but we do not know.

Fortunately, you do not have to take just my word for this. Wouter den Haan, co-director of the Centre for Macroeconomics, who took the neutral view, put it well. “I think the macroeconomics profession doesn’t have the evidence to answer this question,” he said.

Charlie Bean, the former Bank deputy governor, another neutral, also put it well. Coalition austerity was not undertaken in the belief “it would boost demand directly but rather that it would reduce the likelihood of a loss of market confidence in the UK government's economic policies, which - had it occurred - would have necessitated a much sharper consolidation.”

Just as economists cannot really know what would have happened in the absence of austerity, so we should take with a pinch of salt their recommendations on future austerity. Indeed, for some, there should be none at all, even though Britain is running a £90bn deficit.

On this I would give some credit to Ed Miliband and Ed Balls. Though their version of “balancing the books” means running a permanent deficit of around £30bn a year, at least they recognise the need for further deficit reduction.

Both Miliband and David Cameron have found themselves up against other leaders from the smaller parties, most of whom blithely wave away the need for austerity, knowing they will not have to carry the can if Britain goes into the next downturn with the deficit still large and government debt rising. The SNP’s Nicola Sturgeon is the worst but not the only offender in this.

In 2010, the coalition took a judgment that the deficit had to be reduced to bring Britain back from the fiscal edge. Whether or not the net effect of that was to reduce or ultimately boost growth, we cannot know but it gave Britain stability in what could have been a very rocky period..

As things stand now, with the economy growing well and interest rates still low – they have not increased for the whole of this parliament – it is hard to argue that this is not the right time for further deficit reduction, alongside supply-side policies to boost long-run growth. Sensible politicians know this. They have to live in the real world.