Thursday, May 14, 2015
The myth of abandoned austerity
Posted by David Smith at 03:00 PM
Category: Thoughts and responses

One of the most enduring claims about the British economy in recent years is that the then coalition government abandoned austerity in 2012. It is a claim that gives comfort to those who see everything that has happened to the economy through the lens of fiscal policy. Only when austerity was abandoned in 2012, some argue, did the economy begin to recover. Unfortunately it does not fit the facts. It is a myth.

There are two elements to this. The first is the question of whether, in response to slower growth in the economy, or other factors, George Osborne abandoned his programme of fiscal consolidation.

The two foremost authorities on fiscal policy in Britain are the Institute for Fiscal Studies and the Office for Budget Responsibility. The IFS set out the position clearly after each budget and autumn statement during the last parliament. Chart 1.6 on p26 in its latest green budget, here, sets out the broad position. As it shows, consolidation continues through the parliament.

The IFS's updated figures, published as part of its Election 2015 coverage, has the following sequence of numbers for the fiscal consolidation: 2010-11, 1.5% of GDP, 2011-12 2.3%, 2012-13 1.1%, 2013-14 1.5%, 2014-15 0.7%, 2015-16 0.6%, adding up to a cumulative fiscal tightening between 2009-10 and 2015-16 of 7.7% of GDP.

The OBR also addressed this, in its paper, Crisis and Consolidation in the Public Finances, here. Chapter 3 is the relevant chapter which, like the iFS, shows a programme of fiscal consolidation extending through the parliament. There was no abandonment of austerity.

The OBR also, however, highlights why there is a debate about this. As it puts it (p61):

"Our bottom-up approach relies on estimates of the impact of individual policies on the public finances, which are rarely revised after the event. The top-down approach relies on estimating the output gap and the sensitivity of the public finances to it.

"In normal times, both approaches would paint a similar picture. But the recent and sometimes large revisions to estimates of potential output from forecast to forecast have caused the top-down approach to deliver some potentially misleading conclusions. Specifically, the large downward revisions to potential output in 2012-13 changed the path of the cyclically adjusted fiscal aggregates significantly, which was interpreted by some as a discretionary fiscal loosening, whereas the path of incremental policy measures was little changed.

"While it is true that the Government chose not to offset the upward revisions that we and the IMF made to the estimated path of structural borrowing by tightening policy, that seems qualitatively different to announcing and implementing discretionary tax cuts or spending increases."

Surely, however, the proof of the pudding is in the eating? The budget deficit stopped falling in the middle of the parliament in both unadjusted and cyclically adjusted terms. The latest ONS release shows this clearly. Table PSA1, here, shows that while public sector net borrowing fell sharply in the coalition's first two years, dropping from 153.5 billion in 2009-10 to 113.4 billion in 2011-12, it then rose to 119.7 billion in 2012-13, before commencing its descent.

OBR estimates for cyclicallyadjusted net borrowing show a similar effect. It fell from 8.2% of GDP in 2009-10 to 5.1% of GDP in 2011-12. It then rose to 5.2% of GDP in 2012-13, before falling again to 4.1% of GDP in 2013-14.

It is important, however, to know that there are significant distortions in these figures. In 2012-13 the government took on responsibility for the Royal Mail Pension Fund, prior to the privatization of Royal Mail. At first, ONS estimates suggested this provided a 28 billion reduction in public borrowing, to be offset over time by the government taking on the liability for pension payments under the scheme, a liability estimated at just under 37 billion.

Last September, the ONS changed the treatment of the Royal Mail Pension Fund transfer, so the net long-term liability of nearly 9 billion counted as additional borrowing immediately, in the 2012-13 fiscal year. The underlying path of borrowing however remained downwards, as the ONS explains in its monthly press releases:

"PSNB ex peaked in in the financial year ending 2010 as the effects of the economic downturn impacted on the public finances (reducing tax receipts while expenditure continued to increase). PSNB ex has reduced since then, although remained higher than before the financial year ending 2008 and the 2007 global financial market shock. PSNB ex in the financial year ending 2013 was higher than PSNB ex in the financial year ending 2012. One of the reasons behind this was the recording in April 2012 of an 8.9 billion payable capital grant in recognition that the liabilities transferred from the Royal Mail Pension Plan exceeded the assets transferred."

The other distortion arises from Osborne's announcement of a cut in the additional rate of income tax from 50% to 45%, with effect from April 2013. This had the effect of shifting some income, and some tax revenues, from the 2012-13 fiscal year into 2013-14.

Adjusting for these distortions, in particular the Royal Mail Pension Fund distortion, has two effects. It means headline borrowing, on an undistorted basis, fell year on year throughout the last parliament. It also means cyclically adjusted borrowing - I would estimate the undistorted 2012-13 figure to be between 4.5% and 4.7% - also fell.

Did the pace of deficit reduction ease as the parliament went on and the election approached? Yes, it is fair to say that on both top-down and bottom-up calculations, though there was always an element of front-loading in the plans: the VAT hike and most of the cuts in public sector capital spending came through early on. Did the austerity stop? No, and the economy's stronger recovery in the second half of the parliament ran alongside continued austerity.