Budget 2011: as we predicted, austerity is hurting

By Douglas Coe & Ann Pettifor

The demonstration of 26 March, 2011 was a magnificent demonstration of people-power. Citizens are up in arms, even before the cuts bite into and unravel the social fabric of our society. They are ready to make sacrifices, to march and to assert, in a common sense way, that they can see what every sound economist can see: that the government’s policies are protecting and subsidising the City of London, while removing protection and subsidies from ordinary citizens.

It was disappointing therefore, to see how weakly the TUC and its affiliated unions framed and branded the march. There was no full-frontal attack on the Chancellor’s flawed economic strategy. Instead there is the implied concession that cuts to public spending are an economic necessity. Ed Miliband and Ed Balls of the Labour Party argue that the cuts are being imposed too quickly and too deeply. This approach neatly and strongly reinforces the government’s economic strategy. Bound by this assumption, the focus of the march was on the defence of the most vulnerable in the public sector. By conceding that cuts are necessary, and that the ideological battle is fought around public services, the unions on Saturday conformed precisely to the government’s framing of the debate.

Bankers out of the frame

Bankers must be chortling into their champagne flutes as the TUC and Labour Party help George Osborne guide the searchlight of public debate away from the City and on to poorly-paid public sector workers, pensioners and pre-school children – all innocent of causing the crisis.

Before the crisis, the overwhelming body of public sector activity continued to be undertaken in ways that met the needs of the British people, and largely satisfied them. Furthermore, public debt at a 58% share of GDP is low both in historic terms, and also relative to other OECD countries.

We cannot be as relaxed about the activities of the City of London, whose debt as a share of UK GDP soared from 46% of GDP in 1987 to 245% of GDP in 2009, according to the Treasury.

How should the unions frame the debate?

The correct framing should have been: “this has nothing to do with our backyard – where public services are provided. Let the searchlight focus instead on the unregulated City’s backyard – where the crisis began; where the failure to lend is hurting the real economy; and where future shocks lie. If we are to help private economic activity to thrive – then the banking system’s broken transmission systems must be fixed.”

But it is also important for the unions to emphasise the following: government spending now is only necessary because of private sector weakness. Without public investment, there is little hope of economic recovery.  Without economic recovery, there is no hope of fixing the public finances, of cutting the deficit or debt. Such an approach would have put George Osborne on the defensive. Instead the government and its allies were able to go on the offensive.

The March, 2011 Budget: affirming the strategy for austerity.

This was unfortunate, as the march took place immediately after George Osborne’s second – and very defensive - Budget statement. The most striking aspect of it was that there was no reference to the government’s central economic strategy. With unemployment at 2.5 million and rising, according to the most recent figures, Osborne demurred from his enthusiastic promotion of austerity – and tried instead to calm the private sector’s fears and improve the country’s mood with “a strategy for growth”.

In reality the Budget was just an affirmation of the strategy for austerity: cuts in government expenditure and rises in taxes. Its main feature is to reveal – already – the dangerous and wrongheaded nature of this approach.

In ‘The Economic Consequences of Mr Osborne’ (July 2010) we warned (and as a lone voice at the time, we know of no other economists that shared our concerns to the same extent) that fiscal “consolidation set by the coalition government will do further and severe damage to an economic and social situation that is already of grave concern.”  Less than a year later the forecast from the Office for Budget Responsibility affirms this analysis. GDP growth for 2011 has been revised down to 1.7% from 2.3%; and in 2012 to 2.5% from 2.6%. Unemployment in 2011 is revised up to 8.2% from 8.0%, and in 2012 to 8.1% from 7.6%. As a consequence public debt is forecast to rise by about £10 billion every year of the forecast time horizon.

As we predicted, cuts in public expenditure have already led to rises in public debt. And citizens should be very clear about this: the cuts in public expenditure have barely begun. On Friday 1st April government cuts will be implemented in full, and central government departments will begin to shed staff.

The condition of the economy in a year’s time is a chilling prospect.

It is perfectly understandable that private firms - hard-pressed for both customers and bank borrowing - called for a growth strategy. Osborne responded. But in responding he reinforced his initial analysis: the economic crisis was caused by inflexible workers, overgenerous benefits, low skills, high corporate taxes and planning restrictions. This is blatantly wrong: the economic crisis was caused by the relentless deregulation, and reckless activities of the finance sector.

And as a consequence of the conduct of the City of London, and of the most severe financial crisis on record, the UK and world economy is suffering an especially severe deficit of demand.

The growth strategy reflects the ongoing failure of the dominant economic orthodoxy to explain what is actually going on in the economy. It is based on an assumption that the problem is of supply.

Households have lost jobs and are fearful for the future. Firms – including banks -  and households are still indebted to an enormous extent. The condition of the financial sector remains highly precarious and reliant on taxpayer support.  These are not the conditions that will lead to anything like the level of demand needed to restore employment and the economy to health.

Instead the UK economy has become reliant on external demand bought by devaluation and expansionary policies in countries like China and Germany. These cannot be sustained at a level sufficient to compensate. At best the growth plan will offer some minimal advantage for UK companies.  But note that it is open for all countries to imitate exactly George Osborne’s approach.

With all countries relying on trade-driven recoveries, one country’s advantage is another’s disadvantage, and the growth strategy, just like devaluation, must be understood as beggar-your-neighbour.

The social welfare of the world will be steadily undermined to no overall gain.

The correct approach is for a fundamental change to the financial system and a large-scale expansion in public expenditure - to kick-start private business activity. At the same time we face a strategic imperative – driven by energy, food and climate insecurity - to invest in changes to our infrastructure and energy provision.

As we showed in ‘The Economic Consequences of Mr Osborne’, austerity policies over 1931-1933 intensified the Great Depression. Unemployment only began to recover when these policies were reversed, when government expenditure was expanded from 1934 (under Neville Chamberlain).

When Keynes championed expansionary policies, he did so on grounds of intuition and theory. We now have both empirical and historical evidence that he was right.

Mehdi Hasan of the New Statesman in his article (‘Ed Miliband must not be defined by his enemies’) advised his readers to "go online and download [our report;]". He has called on TUC and Labour Party leaders to take home copies, study the evidence carefully, and argue as follows: to reduce the deficit, the government must increase public spending. This is because “an expansionary fiscal policy will lead to growth in activity and employment, so that, with spare capacity, high government expenditure reduces the deficit.”

It’s common sense: the kind that most of the 300,000 on Saturday’s march comprehend, but that continues to evade our political leaders.