Chris Dillow – The austerity choice

Austerity: Coming soon to the EU nation nearest you.

Chris Dillow is an economics writer at Investors Chronicle. He blogs at Stumbling and Mumbling, and is the author of New Labour and the End of Politics.

Cross-posted from Chris’s website Stumbling and Mumbling

The Tories, aided by much of the media, are trying to pull a con trick. They want to present spending cuts as a technocratic necessity when they are in fact a political choice.

A big part of this trick is the idea that there is a fiscal “black hole” that needs to be plugged. Fiscal black holes, however, are not like stellar ones. They are not objective physical facts, but are subjective economist-made artefacts. This is partly because they are products of economic forecasts and any forecast, as Carsten Jung says, “depends hugely on the assumptions for economic growth, inflation and interest rates.” But it’s also because, as Ed Conway says, “they exist only relative to particular fiscal rules.” If the fiscal rule mandates a large surplus, a given forecast deficit will imply a big “black hole” but if it permits a large deficit – voila – the black hole disappears.

For example, the IFS’s Carl Emmerson says:

We need a credible plan to ensure that government debt can be expected to fall over the medium-term.

But this poses questions. Why must government debt be expected to fall? Why isn’t mere stability sufficient, given that there is no credible evidence that a particular debt-GDP ratio leads to trouble? What does “medium-term” mean – two or three years, or five or ten? And should the requirement to cut debt be absolute, or instead contingent upon factors such as economic growth, inflation or bond yields?

The size – or even existence – of the “black hole” is therefore a choice. It depends upon the choices you make when you produce economic forecasts. And it depends upon your choice of fiscal rule. And fiscal rules, remember, are very much a political choice: since 2010 the government has changed (pdf) them in April 2011, March 2014, December 2014, October 2015, January 2017 and January 2022.

The only black hole that exists for sure in this debate is in the media, where political journalists are so dense that little can escape from them. 

None of this, however, is to rule out some type of austerity. There might be a case for it. But if so, it is for a reason the Tories don’t want to advertise.

Quite simply, it is because we are a poorer country than we would like to be, and if we are poorer we just can’t afford stuff (yes, economics can be simple.)

One reason for this, of course, is that higher energy prices are cutting our real incomes. To the extent that these are temporary, there is a strong case for government borrowing to smooth out higher costs over several years. But it’s not clear that this is wholly the case: although gas prices have fallen since the summer, they are still well above their pre-2022 levels.

But there are other causes of our low incomes. Some are policy choices, such as Brexit, antipathy to migrants and the failure to invest in infrastructure. Others, though, are the failures of the private sector that have given us 15 years of flatlining productivity. One symptom of this, as Duncan Weldon has pointed out, is that labour-intensive hand car washes have replaced automated ones.

And herein lies the fiscal policy problem. Our economy is so labour-intensive that we are near full employment – maybe not actually at it, but near it. There is therefore a real resource constraint upon fiscal policy: a loosening of fiscal policy will lead not so much to increased employment and output but to inflation – which is one reason why bond markets took fright at the Truss/Kwarteng Budget.

Herein lie not one but two different arguments for austerity.

Argument one is that tigher fiscal policy will cut aggregate demand and thus inflation, and so prevent interest rates rising as far as they otherwise would. Austerity, then, is the price to pay for lower mortgage rates.

This is a choice. Such a policy would benefit home-owners, and especially that minority that benefits from rising house prices, to the detriment of public service workers and users. Which poses the question. Why should wealthy people gain more at the expense of some of the most vulnerable such as those with serious health or educational needs? Talk of needing to fill a fiscal black hole effaces this question, and denies a key fact – that policy-making is about power, and choosing whom to throw under the bus.

Argument two is that when we are near full employment, fiscal austerity is necessary to release the real resources needed to work on our priorities. If we want more nurses, social care workers, home insulators or solar panel manufacturers we need to stop some people doing the jobs they are currently doing so they can transfer to these others. The question “where will the money come from?” has always been a bullshit question asked only by dickheads. But the question “where will the nurses come from?” most certainly is not.

Of course, in a rationally governed nation, part of this answer would be: from migrants. In the real world, however, the answer lies in tighter fiscal policy. This was the (largely unspoken) logic behind Sunak’s health and social care levy: higher national insurance contributions would cut consumer spending, thereby forcing some retail, hospitality and nail bar workers out of their jobs, from where thry could find work in social care.

Which brings us to the problem. Neither left not right are making this argument. The right isn’t justifying austerity on the basis that it’s needed for a greener, caring economy. Nor, of course, can they, because such an economy requires higher public spending. And Labour are dodging the question. To a greater extent than other taxes, windfall and wealth taxes seize money that would otherwise be saved rather than spent. They therefore do little to depress demand and thus little to free up labour. Such taxes are vindictive (for me, a feature not a bug), but they are cargo cult fiscal policy – a worshipping of the fetish of “sound money” whilst failing to identify the fundamental question.

Which is: what kind of economy do we want? In a resource-constrained economy, we cannot have more private consumption, more people working to decarbonize and more social services. Nor even can we have adequate public services at current levels of taxation and economic growth.

We must choose. Carys Roberts is right: macroeconomic policy “isn’t simply a technocratic exercise to fill a ‘black hole’. It’s deeply political.”

Which is why talk of fiscal black holes is so nasty. Not only is it terrible economics, but it is also terrible politics in two ways. First, because it tries to pretend that politics is a merely technocratic recognition of necessity, thus effacing the fact that it is about choice. And second, because it denies the fact that years of economic dysfunction have left us with real and nasty choices.

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