Tax and Fiscal Policy

Austerity and silly surveys


Robert Peston is currently running a piece entitled: ‘Who to trust – business leaders or economists?’ regarding the election and broad economic strategy on the BBC website. This morning 100 businessmen wrote to the Telegraph urging the country to stick with the Conservative plan. As a packaged story, the BBC is balancing this by highlighting a survey of macroeconomists from the Centre for Macroeconomics, in which the majority of respondents respond ‘Disagree or strongly disagree’ to the question Do you agree that the austerity policies of the coalition government have had a positive effect on aggregate economic activity (employment and GDP) in the UK?  and ‘Agree or strongly agree’ on the question Do you agree that the outcome of the general election will have non-trivial consequences for aggregate economic activity (employment and GDP)?

Inevitably the combination of these two answers is being interpreted by the media as ‘The Coalition deficit reduction policy was wrong’ and a re-election of a Conservative government would have a non-trivial impact on economic activity (given the first answer, presumably negative). Ergo, business support the Tories, and economists support Labour.

This survey is just, well, stupid. For a start, the second question is so broad that a whole number of different issues other than fiscal policy could lead to ‘Agree or strongly agree’ answers (EU policy, supply-side policies etc). It tells us precisely nothing about the relative merits or demerits of the different parties’ fiscal policies. But perhaps more importantly from a media perspective, the first question is just not interesting.

The question simply asks whether austerity policies had a positive impact on the economy. Now, there are broad range of people in favour of fiscal consolidation for different reasons. But the overwhelming majority of even supporters of austerity would disagree with the question, because in the short-term they would also believe that cutting spending and raising taxes would dampen growth. Indeed, the OBR and others factored this into their models. It is well known.

Yet one can still believe that consolidation was the right thing to do. This could be for a number of reasons, including: a) a belief that a failure to set out a medium-term deficit reduction plan and show your credibility by taking steps to implement it would lead to an increased cost of borrowing, b) a belief that we need to get debt on a downward path sooner rather than later to put the public finances in a better position ahead of the next potential recession and due to the headwinds of an ageing population, c) a belief that a smaller state sector will improve the potential productive growth rate of the economy.

In other words, these proponents of austerity were willing to make a trade-off: slightly slower growth today, in order to achieve other objectives. Now, we can debate all of these points – and do regularly. But the survey doesn’t give room for this nuance.

A much better question would be to ask the extent to which the economists believed the slow growth 2010-2013 was down to fiscal policy as opposed to other external factors. To believe that fiscal policy was key, then many Keynesians would have to argue that the multipliers many of them believed were right in 2010 were in fact wrong and that multipliers are much bigger. Or monetary policy was less effective than they thought.

The OBR clearly believes that the oil price spike, the Eurozone crisis and the hangover from the financial crisis are the key explanatory variables that explain why growth was slower than expected. I’ve yet to see a robust Keynesian analysis of how fiscal policy was the key or even a major factor in that story of growth being much slower than expected. Given the economy is still growing well as current spending continues to be cut, one potential argument could be that the front-loaded tax rises and investment cuts are much more damaging than cutting day-to-day government spending (and there’s a substantial literature that agrees here) but as yet I haven’t heard that line from any austerity opponents.

Instead there seems to be a host of post hoc rationalisations about what has happened to fiscal policy. Some even claim that the reason the economy is recovering more quickly now is because austerity slowed down after 2012.

This is nonsense. The spending and taxes we’ve seen of late (bar a bit of reallocation from the current to capital budget) are pretty much unchanged from the plans set out in 2010. There has been no relaxation, though the degree of fiscal consolidation was slightly front-loaded. Yet none of the Keynesians predicted the robust recovery we’ve seen in the past 2 years even though they were aware of this.

The truth is the government has not borrowed more because it has ‘relaxed austerity’ or because it’s thrown its spending plans out of the window. Rather, when the productivity performance of the economy was much slower than expected and the OBR revised up the size of the structural deficit, the government opted not to cut more to hit its deficit targets. They’ve therefore borrowed more, and it will take longer to close the deficit, because the productive performance of the economy has been slow.

Which brings me to a final criticism of some of the analysis we’ve seen. Certain commentators are keen to claim that employment growth has only been strong because the productivity performance of the economy has been weak. This is an utterly bizarre claim. As the blogger ‘Britmouse’ has outlined, it seems to assume output is always determined by fiscal policy – indeed, fixed by it – and that a fall in productivity thus inevitably leads to more employment. Yet if all computers suddenly stopped working, do we honestly believe employment would just rise so that we met a fixed output? Of course not. The supply-side and hence productivity have real effects on GDP.

Indeed, that is the key lesson of the past five years, and helps explain both the fiscal story and the economic challenges facing Britain going forwards. This survey and its media coverage will do little to enhance understanding of either.

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.


1 thought on “Austerity and silly surveys”

  1. Posted 02/04/2015 at 11:42 | Permalink

    I’m confused on your last point
    in a simple production function with labour and capital y=akl , if we assume that the productivity of labour is fixed then either productivity of capital must rise, the amount of capital used must rise or the amount of labour must rise or a combination barring an improvement in technology, so why couldn’t it in part be explained by a rise in the labour input? I’m not saying it’s entirely explained by a rise in labour just that it could in part?

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