Bad economics is holding Britain back
Writing ahead of the Chancellor’s Spring Statement, PEF economist Michael Davies urges him to ditch austerity.
Later today the Chancellor will no doubt take great pleasure in announcing a surplus on the government’s budget for current spending. Indeed, the celebrations began last week, as David Cameron and George Osborne rejoiced in the “achievement” of a target that eluded them for so long in government.
Their jovial tone lies in stark contrast to the realities of life under austerity. Workers are set to go 15 years without a pay rise, the worst wage growth in over 200 years. The National Audit Office have issued a scathing report on the ‘unsustainable’ financial situation of local authorities, as funding cuts of almost 50% force councils to slash frontline services. Worse still, a study published by the British Medical Journal has linked cuts in health and social care spending to 120,000 excess deaths in England alone. As Hammond et al. pat themselves on the back, the disconnect between austerity’s architects and its victims becomes ever more jarring.
Dissecting the social costs of austerity is vital work, and there is much more to say on the subject. Today, however, I want to focus on the issue of investment. The government divides its expenditure into current spending – spending on day-to-day services to keep the country running – and capital spending, or investment.
Initially, Osborne aimed to eliminate the deficit on current spending alone; he only changed his target to a surplus on all spending in 2015, and this has remained Hammond’s ultimate goal. The relatively minor change in terminology disguises a major shift in approach. To achieve this new target, the government would no longer be able to borrow to invest. But why does this matter?
Borrowing to invest, or “why we have a financial system”
Borrowing to invest is an essential part of economic life. The idea is simple; if you expect your investment to bear returns in the future, you should be able to fund your investment through borrowing without cutting your current spending. Otherwise, students would be forced to pay their tuition fees out of their grocery money. Businesses wouldn’t be able to invest in new tech without docking workers’ wages, while prospective house buyers wouldn’t be allowed to take out a mortgage. In essence, borrowing enables us to invest in our future without bringing everything else to a grinding halt.
This holds for governments too. Investment in physical infrastructure, social infrastructure (e.g. education, childcare), and research and development ought to improve the productive potential of the economy. The state then recoups these gains either through direct charges, e.g. bus fares, or through higher future tax receipts. Issuing debt to fund capital spending means that the state can invest in our future without sacrificing frontline public services. So why do the Tories want to rule it out? From an economics perspective, they have two possible lines of argument.
Bad economics, part 1: the state is wasteful
The first, which has an established lineage in right-wing economic thought, is the assumption that the state cannot reliably be expected to add value to the economy. In the absence of a profit motive, the state cannot be expected to productively invest – instead it will spend frivolously to please the electorate in the short-term or simply displace private spending.
The work of economist Mariana Mazzucato shows us that, in fact, government investment adds enormous value to our economy. To take one example, all the technologies that make a smartphone ‘smart’ – touchscreens, microprocessors, GPS, the Internet etc. – are the result of public investment. In the private sector, by contrast, banking deregulation and ‘shareholder capitalism’ have encouraged short-term financial speculation at the expense of productive investment. If we want to secure a ‘strong and stable’ economic future, then bolstering state investment will be vital.
These considerations apply especially to the UK. Since 1980, Britain has chronically underinvested in its economy compared to its G7 counterparts (see graph below), leaving us with a yawning productivity gap. Meanwhile, Brexit-related uncertainty will subdue private sector investment even further.
Though this argument is implicit in much of the right’s economic rhetoric, the Tories have at least paid lip service to the importance of capital investment. Instead, they cling to their old favourite – that public spending cuts writ large are necessary to reduce the debt.
Bad economics, part 2: we need to reduce the debt
From the very beginning, the Tories have framed austerity as a difficult choice, but one necessary to reduce the public debt. Just this week, Hammond had the following to say on the Andrew Marr Show:
“We have a debt of 1.8 trillion pounds, 86.5% of our GDP. All the international organisations recognise that that is higher than a safe level and this isn’t some ideological issue, Andrew.”
This is nothing short of a bare-faced lie. The idea of a ‘safe level’ of debt is based on a 2009 paper which was riddled with errors and has been debunked time and time again – though not before Osborne used it as an excuse to slash the state. In 2016, the OECD called for countries like the UK to end austerity and boost investment. That same year, the IMF published a paper asking “is there really a defensible case for… the United Kingdom… to pay down the public debt?” – and concluded there wasn’t. The ‘international organisations’, and the economics discipline more generally, are categorically not on Hammond’s side. (See John Weeks here for more on the public debt.)
A decade on from the financial crisis, we can see just how much this line of argument has hamstrung our economy. Bogus comparisons with Greece scared the public into austerity. Economist Simon Wren-Lewis estimates that government cuts have cost the UK 15% of its GDP – around £10,000 per household – indicating that the UK could have grown out of its debt with a softer fiscal response. Indeed, there is still room for deficit stimulus. But yet the government marches on in the same mould.
Austerity is ideological
Neither of these arguments holds water. Hammond’s deficit-reduction framework is an edifice with no grounding in economics. By ruling out borrowing for capital spending, the government will be forced to either underinvest in the UK’s future or wreak further havoc on frontline public services.
We are reminded that austerity has never been a matter of ‘economic necessity’, but rather an explicit political choice – one that has hurt the worst off in our society. And so, as Hammond celebrates tomorrow, we must remember the devastation that his party has inflicted on the country.