"I have long argued that the giving of offence, and even hate speech, should be a moral matter but not a matter for the criminal law. That is as true on the football pitch as on the streets. We should always challenge racism. We should also always challenge attacks on liberties in the guise of faux antiracism." Kenan Malik

Austerity Economics

Are The Cuts Necessary? And What Are The Alternatives?

by Chris Edwards in ‘The impact of national budget cuts, tax changes and local reductions in services on disabled people and their families in Norfolk’.

Are the cuts necessary?

The Demos report of 2010 is fairly thorough in its  analysis of benefit changes on disabled people but it includes  the following quote;

“we recognise that the government is facing an unprecedented deficit which needs to be paid off through a series of radical welfare and departmental cuts. We are not, therefore, suggesting that disabled people should be exempt from these cuts – we must as a society all bear the burden of the recovery from recession” (Demos Oct 2010, 16).

We do not agree with this conclusion. The government is facing an unprecedented deficit but it does not follow that we must all bear the burden. The burden was not created by the poorest half of the population – it should not be borne by the poorest  half of the population. As Seamus Milne has put it; “… 2100 promises to be a year of social and economic misery, as the coalition’s cuts and the heaviest costs of the bankers’ crisis are loaded on to the poorest under the slogan “we’re all in this together”” (Guardian, 30 Dec 2010).
In the calendar year 2009, the UK recorded a general government deficit of £159 bn, equivalent to 11% of GDP. This  is high by EU standards but by the same standards the UK has a reasonable debt-GDP ratio. The debt-GDP ratio is also low in UK historical terms being lower than at any time between 1950 and the late 1960s (Irvin et al 2010, 9, 14). Thus the flow is bad; the stock is OK. Nevertheless the running deficit is high and something has to be done, but what is being done is a grave mistake.

As Irvin et al point out, in 2010/11, the debt is 62% of GDP against 177% in 1932 with debt interest payments at 6.3% of public expenditure now, compared with 40% in 1932. Yet we are being told to take the same medicine.

As William Keegan observed in The Observer;

“They (Osborne/Clegg) have effortlessly altered the tenor of the debate from whether there should be drastic cuts at a time of relatively low economic activity to the question of how and where the cuts should be administered” (William Keegan, Observer, 12 Dec 2010).

This is in spite of the fact that at least two-thirds of the increase in the structural deficit is estimated to have been the result of the financial crisis of 2008 (Irvin et al 2010, 11). The cuts as proposed are not necessary and there are other ways of reducing the deficit without risking a double-dip recession and without  causing much greater inequality.

What are the alternatives?

There were and still are alternatives to the spending cuts. Irvin et al 2010 suggest the following;

•  a 50% tax rate on gross income above £100,000 a year (at present it is 50% on £150,000 or more) – this would raise £2.3 bn

•  uncap National Insurance Contributions (NICs) so that they are paid  at 11% all the way up the income scale  – this would raise £9.1 bn

•  introduce minimum tax rates for certain levels of gross income – this would raise £14.9 bn

•  increase the tax payable (higher multipliers) for houses in Council tax bands E to H – this would raise a further £4.2 bn

•  minimise personal and corporate tax avoidance by requiring tax havens to disclose information fully and by changing the definition of tax residence – this would raise a further £10 bn. In the Coalition Government’s agreement it was stated that “The parties agree that tackling tax avoidance is essential for then new government, and that all efforts will be made to do so, including detailed development of Liberal Democrat proposals” (Con-Lib May 2010, 3).

•  introduce a financial transactions tax at a rate of 0.1% applicable to all sterling transactions – this would raise a
minimum of £4.2 bn and a maximum of £34 bn (assume £10 bn).

Such reforms would mean that there would be no need for spending cuts since the above comes to a total of £50.7 billion extra revenue for the Treasury15 and compares with the Coalition’s proposed mixture of cuts and tax rises of £40 bn. in 2011/12.  Irvin et al’s proposals come to a similar reduction with  their suggested restoration of the 10% tax band (£11.3 mn) offset by a suggested cut in heavy military goods (such as Trident) bringing the net effect back to about £40 bn. (Irvin et al 2010, table 1).

This pattern of tax changes is far less likely to cause a double-dip recession than the present mix of spending cuts and tax rises. It is also fairer and would go some way to reversing the inequality trend in the British economy.                   One indication of increasing inequality is the increase in the ratio of the income of the richest quintile to that of the poorest. This has risen from 5.3 in 1994/95 to 6.0 in 2008/09 (HBAI 2010, 25). Over the last decade, the poorest tenth of the population have, on average, seen a fall in their real incomes after deducting housing costs.  In other words, after adjusting for inflation, their incomes are slightly lower than a decade ago (poverty.org website accessed on 15 Dec 2010)

Similarly, Stewart Lansley has highlighted the reduction in the share of wages in the UK’s GDP since the late 1970s and, over the same period, a growing inequality within earnings (Lansley August 2010, figures 1 and 3). As a result, to maintain living standards, households faced with a declining wage share have become increasingly indebted. The personal debt/income ratio has risen from 45% in 1980 to 157% in 2007 (Lansley Aug 2010, 4).

There is, Lansley also claims, a link between inequality, financial instability and economic cycles. He states that;

“The role of inequality in fuelling financial instability has long been recognised. Keynes made it clear that because of the lower marginal propensity to consume of the rich and their propensity for speculation, wealth inequality increases the risk of financial instability and economic collapse. In his book, The Great Crash 1929, J K Galbraith identified the ‘bad distribution of income’ and its impact on the pattern of demand as the first of five factors causing the crash and the great depression” (Lansley Aug 2010, 5).

As Galbraith put it; “The rich cannot buy great quantities of bread. If they are to dispose of what they receive, it must be on luxuries or by way of investment in new plants and new projects. Both investment and luxury spending are subject, inevitability, to more erratic influences and to wider fluctuations than the bread and rent outlays of the £25-week workman” (Galbraith 1992, 194, 195).

Therefore the argument is that reducing the deficit by measures which increase equality is likely to lead to greater economic stability. The measures set out by Irvin et al are  just such measures whereas the measures taken by the Con-Lib government are likely to have the opposite effect.

This bias of the Con-Lib government is, perhaps, not surprising given that 16 of the 23 members of the Cabinet are  multimillionaires. But perhaps that’s too much of an instrumentalist view.



When In Doubt, Escalate.

Ireland and Greece have had austerity forced upon them. Here in the UK, the coalition government has voluntarily chosen it. Why?


As is well known by now, the coalition government has declared its intention to cut £81bn from annual public spending over the four years to 2014-15, equating to an average of 19% being cut from the budget of every government department over that period, coupled with tax rises such as the recent increase in VAT.

Why are they doing this? Why are they taking what will cumulatively amount to £203bn out of the economy over four years (link, p78, table A.2), at a time when unemployment is 2.5m (according to official estimates) and rising, and economic recovery is by no means secure?

The Treasury has stated that “The economy has become unbalanced and too reliant on public spending and unsustainable debt. The Government is committed to promoting growth by tackling the deficit, rebalancing the economy and creating the right conditions to support a private sector-led recovery. In the medium term, sustainable growth must be based on expansion in the private sector, not the public sector” (link).

So essentially, the cuts are being justified on the grounds that 1) the deficit has to be reduced now because it is unsustainable, and 2) reducing the deficit will aid economic growth. Are these actually the case?

There is a coherent economic theory of sorts behind the cuts agenda, as has been outlined lately by the former Tory peer Robert Skidelsky. He summed up neatly the guiding principle behind the cuts in the Financial Times in June:

“The implicit premise of the coming retrenchment is that market economies are always at, or rapidly return to, full employment. It follows that a stimulus, whether fiscal or monetary, cannot improve on the existing situation. All that increased government spending does is to withdraw money from the private sector; all that printing money does is to cause inflation” (link).

In this ‘classical’, free market view of the world, there cannot be such a thing as insufficient demand or involuntary unemployment. Market conditions are governed by ‘Say’s law’: supply creates its own demand, there can never be an oversupply of commodities, all money earned will either be spent or invested, and all unemployment is due solely due to individuals choosing for their own reasons not to take work at the going rate (link).

With regards to spending cuts acting to stimulate the economy, or ‘expansionary fiscal contraction’ to give the technical term, Skidelsky writes:

“The proposition that cuts in government spending can grow the economy relies on ‘Ricardian equivalence’ – the oft-repeated claim, made by the likes of Osborne, that government borrowing is just deferred taxation. If households and investors factor in future levels of taxation when they are making spending decisions now, a stimulus would have no effect on economic growth: households will simply cut back on their consumption in anticipation of inevitable tax increases. So public spending ‘crowds out’ private spending.

“But now let’s ask: what would households and firms do in response to a cut in government spending? Ricardian equivalence says that reduced borrowing will create an expec­tation of lower taxes in the future (even if in the short term the deficit reduction includes tax rises). Freed of the burden of future taxes, private agents will happily spend more now, providing the required boost to demand when the government steps back. Increased demand means more jobs created in the private sector. The resulting increase in spending may well be enough to outweigh the money taken out of the economy by the government, and thus it will increase output overall.

“The other way cutting the deficit can reverse ‘crowding out’ is by leading to lower interest rates. According to this argument, government borrowing drives up interest rates, because at a fixed level of saving the government demand for borrowing increases the price that private borrowers will pay for access to finance. As a result, government spending “crowds out” private spending, substituting on a one-to-one basis. So, if government borrowing falls, interest rates will fall, allowing private firms to borrow more cheaply.’ (link)

That is a brief summation of the ‘theory’ behind the cuts: market economies don’t need stimulus, for if left alone they will automatically tend toward full employment and full utilisation of resources; any attempt at government stimulus will simply be seen by the populace as a form of future taxation, and they will withhold their spending accordingly.

Furthermore, the government borrowing required by stimulus measures only serves to drive up interest rates (which in turn drives up the deficit, leading to a vicious circle), further depressing the economy and discouraging investment.

Thus, the best thing the state can do is to eliminate deficits, stay out of the way and let the economy work its own, inevitable way back to full health. In this view, the only stimulatory role for the state lies not in fiscal policy (tax and spend), but in monetary policy: cutting interest rates, and creating more money if necessary via quantitative easing: as George Osborne has said, “Monetary policy is the principal tool for creating and regulating demand.”

“Austerity is not forced but chosen”

One might have thought that the epochal crisis in capitalist economics which we are currently living through might have dented the enthusiasm of our political masters for this idealised, free market view of the world. However, this doesn’t appear to be the case: indeed, the enthusiasm for the cuts agenda seems to show that its hold is as strong as ever. As Skidelsky writes, it comprises one of two fundamentally differing views on how capitalism should be run, this ‘classical’ view and the Keynesian view.

The ‘classical’ view has it that there can never be a lack of demand in a market economy; whereas one of the starting points of the Keynesian view is that it is entirely possible for there to be a lack of effective demand at any given point, that all money earned may not be spent or invested and may instead lay sterile, and when this happens it is legitimate for the state to run a deficit to stimulate demand in the economy and increase employment (a deficit which can be clawed back by running a surplus in times of rude economic health).

This isn’t a new argument, it was first had in the 1930s. Then, the Keynesian theory eventually won out: it was the only way to revive a capitalism which had taken itself and the world to the brink of annihilation.

This time, no serious debate has taken place, at least not up to this point. Among the political class in this country there has been almost unanimous agreement: the deficit needs to be cut now, as a matter of overriding priority; austerity has been unambiguously chosen over stimulus, the classical approach has won out over the Keynesian approach.

Clearly the Lib/Con coalition is wholly enthusiastic for this classical approach, and as Alistair Darling made clear before the election Labour were planning “deeper and tougher” cuts than those of Thatcher in the ‘80s had they retained power (link). For Labour to now try to paint themselves as opponents of the austerity agenda is no more than the simplest, most bare-faced hypocrisy.

But while the matter seems to have been instantly settled among politicians, among economists and in the financial press there exists a far greater degree of discussion and dissension. The American economist J. Bradford DeLong, a former US Assistant Secretary of the Treasury, has described Britain as a place ‘where confidence in the government has not cracked and where austerity is not forced but chosen’:

“[I]f you ask the government’s supporters why there is no alternative to mammoth cuts in government spending and increases in taxes, they sound confused and incoherent. Or perhaps they are merely parroting talking points backed by little thought. What is so bad about continuing to run large budget deficits until the economic recovery is well established? Yes, the debt will be higher and interest on that debt will have to be paid, but the British government can borrow now at extraordinarily favorable terms. When interest rates are low and you can borrow on favorable terms, the market is telling you to pull government spending forward into the present and push taxes back into the future.

“Advocates of austerity counter that confidence in the government’s credit might collapse, and the government might have to roll over its debt on unfavorable terms. Worse, the government might be unable to refinance its debt at all, and then would have to cut spending and raise taxes sharply. But that is what the British government is doing now. How is the possibility that a government might be forced into radical fiscal consolidation an argument for taking that step immediately, under no duress and before the recovery is well established?” (link)

DeLong raises a key point: ‘the British government can borrow now at extraordinarily favorable terms’. A crucial argument used by those who advocate immediate austerity is the threat of the ‘bond market boogieman’: that if the deficit is not urgently addressed, the cost of government borrowing on the international bond market will spike, just as happened to Greece and Ireland (and is soon to happen to Portugal and very possibly Spain) when their fiscal positions came to be regarded by the markets as untenable (see http://business.timesonline.co.uk/tol/business/columnists/article7034455.ece for one example of this kind of commentary).

While the ‘bond market boogieman’ is rhetorically useful, there isn’t any evidence for its actual existence with regard to the UK. For one thing, this country has options which the troubled Eurozone countries do not: we can reduce interest rates, we can allow the currency to depreciate to make our exports more competitive. There has been no evidence of any threat coming from the ‘bond vigilantes’ necessitating an immediate  tackling of the deficit in this country, or that the tough stance on the deficit has improved our standing on the markets (a fallacy recently repeated by Nick Clegg [link]). As Martin Wolf of the Financial Times commented in September:

“[I]nterest rates on index-linked gilts have been 1 per cent, or less, for more than a year; the yield on 10-year gilts has remained below pre-crisis levels and is now close to 3 per cent; and spreads over German bunds have been 1 percentage point, or less, throughout the crisis. The government argues that borrowing costs have been contained only because of its commitment to austerity. In fact, spreads over bunds have stabilised since February and fallen by just 0.2 percentage point since the election. This suggests that the coalition’s strong fiscal stance has brought modest credibility gains.” (link)

Scott Mather of PIMCO, the world’s largest bond house, said in the summer that “There are parts of Europe where austerity wasn’t called for immediately. We’ve been a bit surprised by how quickly even countries that don’t have austerity forced upon them by the market are willfully heading down that path”, mentioning the UK and Germany as examples (link).

Meanwhile, the Yale economist Robert Shiller has said:

“The supposed threat posed by government debt levels hasn’t hurt [bond] markets, at least in the relatively few countries that have inflation-indexed bonds. Long-term inflation-indexed bond yields have fallen to around 1% a year, or less, in the United States, Canada, the United Kingdom, and the eurozone. Elsewhere, yields have been a little higher – around 2% in Mexico, Australia, and New Zealand – but still very low by historical standards… low long-term real interest rates appear to reflect a general failure by governments over the years to use the borrowing opportunities that the inflation-indexed markets present to them…

“Surely, governments’ levels of long-term investment in infrastructure, education, and research should be much higher now than they were five or ten years ago, when long-term real interest rates were roughly twice as high. The payoffs of such investments are, if anything, higher than they were then, given that many countries still have relatively weak economies that need stimulating. It is strange that so many governments are now emphasizing fiscal consolidation, when they should be increasing their borrowing to take advantage of rock-bottom real interest rates.” (link)

Political choice dressed up as market necessity

Those are the counterarguments to the cuts agenda. Are they true, and compelling? Perhaps. But what is most illustrative and significant isn’t that cuts have won the battle of ideas over stimulus, it is that the battle never took place at all, even when many serious and credible people have publicly questioned the wisdom of the austerity agenda. As the FT’s Martin Wolf again states:

“None of this would matter if the risks went only one way – from a failure to tighten rapidly. This is not so. The danger on the other side is that the economy weakens sharply under a structural retrenchment averaging 1.6 per cent of GDP a year over five years. This would be bad for output and jobs.”

And should this happen, it is entirely possible that the cuts project will fail on its own terms and lead to an increased deficit, with increased unemployment leading to a lower tax take and higher numbers on welfare (link). Yet the coalition are quite prepared to blindly run this risk, and Labour would have done the same. Why?

The experiment in neo-liberal economics which Britain has been subject to over the past thirty years was intended, from the beginning, to destroy the post-war Keynesian settlement, a settlement which saw the working class in possession of full, secure, well paid employment and ready access to affordable housing.

Social mobility during this era (roughly the thirty years following World War II) was markedly better than now: a bright working class child had more chance of getting further in life then than they do now. This settlement impinged significantly on the prerogatives of the capitalist class: it rendered the position of capital relative to labour unacceptably weak, which is why it had to be destroyed. Keynesianism did its job of saving capitalism in the middle of the century, but by the last quarter of the century it hindered capital more than it helped, so it was time for Keynesianism to go.

All three main political parties are wholly committed to the neo-liberal project, the project to unleash capitalism on an unrestrained, global scale. Unfettered, deregulated capitalism always brings with it economic and financial crises, as we have seen, but for the neo-liberals there can be no going back now.

The current crisis of globalised capitalism represents not a defeat, but a golden and essential opportunity for them to push their project further: as the old imperial maxim goes, ‘when in doubt, escalate’. And for the neo-liberals it is not a question of choice: they have to do it, it is either push the boundaries or stagnate. After thirty years of neo-liberalism the social fabric has been stretched to (or beyond) its limit, and now it is being stretched further: there are whole swathes of the country where almost the only investment comes in the form of state spending, and now this is being slashed.

So while the cuts have been presented as economic necessity, in reality they are political choice, a choice deriving from the dominant economic and political doctrine of our time, a doctrine that from the beginning had the smashing of the organised working class at its centre.

The neo-liberals are grasping the opportunity to remodel the state and society along their preferred lines. This isn’t even hidden, the Tories have adopted the same approach in local government in recent years, in preparation for taking power nationally (link).

Will the same austerity be applied to the financial sector the next time it gets itself into trouble? Of course not, in that case the state will once again come riding to the rescue: indeed, the coalition government was able to raise £7bn to lend to Ireland to help protect British financial interests there during their most acute moments of crisis only weeks ago.

The situation is best summed up by the American Nobel-Prize winning economist Joseph Stiglitz. In December, Stiglitz proffered “a deficit-reduction package that boosts efficiency, bolsters growth, and reduces inequality”.

The first ingredient of Stiglitz’s alternative economic plan is “spending on high-return public investments… Even if this widens the deficit in the short run, it will reduce the national debt in the long run. What business wouldn’t jump at investment opportunities yielding returns in excess of 10% if it could borrow capital … for less than 3% interest?” (something alluded to by Shiller and DeLong above).

Stiglitz also calls for the elimination of “corporate welfare” and “a fairer and more efficient tax system, by eliminating the special treatment of capital gains and dividends…  Why should those who work for a living be subject to higher tax rates than those who reap their livelihood from speculation (often at the expense of others)?”

As Stiglitz notes, “a deficit-reduction package crafted along these lines would more than meet even the most ardent deficit hawk’s demands. It would increase efficiency, promote growth, improve the environment, and benefit workers and the middle class.”

However, Stiglitz concludes his proposal by noting why such a programme will not be chosen:

“There’s only one problem: it wouldn’t benefit those at the top, or the corporate and other special interests that have come to dominate America’s policymaking. Its compelling logic is precisely why there is little chance that such a reasonable proposal would ever be adopted” (link).

Indeed, and for America, also read the UK