Spare us these cockroach arguments in favour of continued austerity

Paul Krugman has defined a category of economic arguments as ‘cockroaches’ on the grounds that, like the insects, ‘no matter how many times you flush them down the toilet, they keep coming back’. We are now hearing many over Government spending cuts

Philip Hammond wants to continue with his spending plans despite the public disaffection with austerity (PA)

“I thought we had won that argument,” said the Chancellor, Philip Hammond, at his Mansion House speech last month, as he rejected suggestions he should deviate from his spending plans in the face of clear public disaffection with seven years of austerity. He’s not the only one.

Paul Krugman has defined a category of economic arguments as “cockroaches” on the grounds that, like the insects, “no matter how many times you flush them down the toilet, they keep coming back”.

As the backlash against austerity has grown in recent weeks, we’ve seen a host of cockroach arguments bob up in the bowl: talking points that were comprehensively rebutted the first time around.

Evidently we need to rebut them all over again. So here goes.

“Britain never really experienced austerity”

This cockroach was offered by no less than the former chief civil servant at the Treasury, Sir Nicholas Macpherson, in a column for the Financial Times last month.

“Whereas Ireland managed to reduce its gross public debt from 86 per cent to 75 per cent of national income between 2010 and 2016, Britain’s public debt carried on rising: from 76 per cent to 89 per cent,” he pointed out. “In short, Britain never experienced austerity”.

As Simon Wren-Lewis of Oxford University points out, this confuses levels with rates of change. In other words, it’s possible for a fiscal consolidation to be taking place – even a very severe one with serious social impacts – while a country’s national stock of debt relative to its GDP continues to rise.

This is all the more likely to be the case if the austerity reduces the country’s growth rate, as it mostly does when interest rates are already at rock bottom.

Greece’s debt to GDP ratio is higher than it was in 2010. Under Macpherson’s bizarre definition, even Greece – where the state wage bill has been cut by a third and which the IMF calculates has undergone a structural fiscal adjustment of 16 per cent of GDP – never experienced austerity.

Another version of this “what austerity?” argument cites the fact that total UK public spending in both cash and even inflation-adjusted terms is higher than it was in 2010. What this ignores is the fact that as a share of GDP, public spending has fallen significantly from 45 per cent to 39 per cent.

Moreover, demand on certain sectors of state spending, such as health and pensions, have risen for structural demographic reasons, meaning almost every other area has had to bear far bigger reductions than these aggregate figures suggest.

“Without further austerity we will suffer a fiscal crisis”

In her response to Jeremy Corbyn in the House of Commons last week Theresa May resurrected the argument that the UK would turn into Greece, with spiralling interest rates and a fiscal crisis, if she acceded to Labour demands for higher public spending.

This was a common refrain from George Osborne, David Cameron and even Nick Clegg during the Coalition years as a reason not to follow a “Plan B” and relax the pace of cuts to support growth.

It remains almost total nonsense. The reason international investors dumped Greek debt in 2011, forcing a crisis, was that the country was locked into the eurozone. The Athens government couldn’t devalue its currency to a more appropriate exchange rate, which terrified investors in Greek debt who believed that this would ultimately compel the country to quit the single currency.

Further, the European Central Bank was failing to stand behind struggling member countries in the way that the Bank of England clearly stood behind the UK and still stands behind it today. And indeed, the massive spending cuts imposed by the rest of the eurozone and the IMF on Greece, as the price of its bailout, made the country’s budget crisis worse, not better.

Today there is no sign whatsoever, even with the self-inflicted economic wound of Brexit, that investors are wary about holding UK government bonds. Interest rates remain close to record lows, making state borrowing extremely cheap, rather than painfully expensive.

A more subtle variant of this argument is that what investors really want is a credible fiscal plan, and that deviation from that plan is liable to result in panic.

The answer to this is empirical. When George Osborne’s deficit reduction plan went well off course in the last Parliament and we ended up borrowing as much as was pencilled in under Labour’s plans in 2010 (plans that Osborne had claimed were dangerously lax) UK interest rates went down, rather than up.

Claims that a fiscal crisis is just around the corner, by their nature, can never be comprehensively proved wrong. Yet what we can say there is zero evidence from the behaviour of financial markets from recent years to support this alarmism in relation to the UK.

“It’s unfair to saddle the next generation with debt”

We heard this familiar canard from Philip Hammond in a speech to the CBI where he claimed “borrowing to fund consumption is merely passing the bill to the next generation”.

It’s spurious because the younger generation are already suffering the impact of a chronically weak economy, made feebler by excessive austerity. The average incomes of people in the twenties are still more than 5 per cent below where they were ten years earlier.

A great bill has been passed to them already. And to the extent that cuts suck demand out of the economy today, when there is scope for higher, non-inflationary, growth, they simply make the bill bigger.

The greatest unfairness towards the next generation is not bequeathing them a slightly higher debt to GDP ratio, but landing them with a weak economy with weaker potential productivity growth.

“We need austerity to restore our fiscal strength in case of a future shock”

This was the justification given by George Osborne when he ratcheted up austerity in 2015 with a plan to run perpetual budget surpluses.

The argument was that the UK’s level of debt to GDP needed to be brought down as soon as possible so that if we were hit by a new financial crisis or a recession borrowing would not spike even higher than the roughly 90 per cent of GDP it is today.

And now we hear it again in relation to Brexit, with the argument made that the Chancellor must not eat into the leeway provided by his own fiscal rules because he will need the room to cope with possible ructions around our exit from the EU in 2019.

Again, this gets things back to front. A surprisingly large number of commentators talk about Britain “paying off” its debt. But this is grossly misleading. The way Britain – like all modern economies – will improve its public finances is by growing the economy faster than the deficit so the stock of debt to GDP reduces over time.

It follows from this that the best way to put our finances in order is to ensure the economy expands healthily. If we achieve that, the Bank of England can safely raise interest rates from their current record lows. Then we can use monetary policy – cuts in interest rates by the Bank of England – as the first line of defence against the next shock.

The best possible insurance against a future downturn is a strong and growing economy today. Demand-sapping austerity, driven primarily by politics and ideology rather than genuine fiscal prudence, will not help deliver such a healthy economy.