Austerity has become the default mode of European – more especially British economic policy; in his speech to the Conservative Party conference last week David Cameron reiterated that there is no “Plan B” and mocked the Labour Party for its alleged tax and spend profligacy – even though the statements of shadow Chancellor Ed Balls appear to lock Labour into an endorsement of austerity that is in many respects more rigorous than that of the Coalition, raising the prospect of deep cuts after 2015 on top of those that the Tories have already made.
Against this background, it has been fascinating to read the assessment of Jonathan Portes, director of the National Institute of Economic and Social Research (NIESR), on his blog Not the Treasury View. In my view his analysis is desperately important.
Portes’ assessment matters because it goes right to the heart of the theoretical justification for austerity economics. Portes examines the multiplier – the key theoretical construct that underpins Keynsian economic analysis and explains the effect that changes in Government expenditure have on the economy as a whole. The fundamental principle is that government and individuals behave in different ways. Individuals consume and save (and, increasingly in the boom years before the 2008 crash) borrow. Governments spending goes on procurement, projects, transfer payments (benefits and subsidies), and of course paying public workers. They also borrow, and repay debt; but at different levels to individuals. Put crudely, a key assumption of Keynsian economics has been that Governments – especially in bad times – spend a higher proportion of their income directly than individuals, especially in an environment where they are borrowing, than individuals, who have a propensity to save or offshore – the wealthier they are, the more likely they are to take demand out of the economy in this way. Thus increasing Government expenditure is, other things being equal, more likely to stimulate economic activity than cutting taxes – it’s the basic reason why many of us on the left see the Coalition’s economic policy as so utterly disastrous.
The multiplier, then, is the mathematical expression of this relationship. It’s obviously something that is pretty approximate, based on a mixture of theory and observed effects in a massively complex economic world. But as a rough rule of thumb it has plenty going for it.
Portes shows that there are three views of the way in which the multiplier operates under austerity.
- First there is the view articulated by the supporters of austerity – that empirical evidence suggests that, far from stimulating activity as Keynsian policy-makers have assumed, increasing government expenditure decreases it. As Portes argues, this counter-intuitive view was based on a single influential paper by Alesina and Ardagna which emphasised confidence and exchange rate effects; it has the effect of telling politicians whose inclination was to reduce public expenditure what they wanted to hear. Portes concludes that this view was not very credible economically, but hugely influential politically.
- The second view – pretty mainstream among economists, including the IMF – was that austerity would be damaging but not disastrous. Based on historical evidence it postulated a multiplier of around 0.5 – i.e. a reduction of 1% in public expenditure would lead to a fall in output of around 0.5%
- The third view was exemplified by the writings of Nobel Laureate Paul Krugman and numerous others, and argued that institutional factors meant that the multiplier was likely to be much higher; these economists crucially argued that rather than relying on historical data to understand an economic situation that had few precedents, it was necessary to revisit the macroeconomic theory. Krugman famously and scathingly caricatured the advocates of the first view as “waiting for the confidence fairy”. They argued that this approach led to the conclusion that the multiplier would be far higher, certainly greater than 1 and possibly as high as 1.7.
Portes quotes from the latest IMF Bulletin which shows that the Fund is moving much closer to the third view – and points out the policy implications: first that the assumptions used by the OBR to feed into UK economic policy were way too optimistic (and its puzzlement over why things have not gone as it predicted misplaced); and that the impact of fiscal expansionism, the obverse of austerity, will be all the greater. In other words – the bang for each buck of extra Government spending appears to be greater than many have assumed.
There are a number of conclusions that I draw from this.
- First – as Portes notes – there is the utter contradiction of using fiscal contraction as a means of restoring stability to economies after the 2008 blowout. The feedback problem – that austerity is trashing tax revenues to the point where more austerity becomes necessary to achieve deficit reduction – is already savagely at work in the Greece, Spain and Portugal and is happening in the UK too. The effect of the IMF’s shift in position is essentially to knock the legs out from underneath radical austerity. Portes points to the contradiction between the aim of long-term stability and austerity’s effect of short-term upheaval and instability is crucial.
- Second, in shifting its position, the IMF is actually – if probably not explicity – responding to one of the fundamental Marxist critiques of capitalism, that the growth of capital requires, among other things, buoyant consumer demand to allow capital to expand. Crises of demand could in the past be assuaged by things like colonial expansion and the monetization and privatisation of common assets, but the scope for doing that no longer really exists. The IMF understands what politicians – with their ideological hostility to the state and their apparent desire to pursue regressive policies that transfer wealth from poor to rich – apparently do not; that economic stability in a capitalist society is dependent on people buying things (indeed, one can argue that the transfer of wealth from people who predominantly spend to those who accumulate has its own multiplier effect). The IMF’s tone sounds rather like that of Keynes, whose mission was not to abolish capitalism but to save it from itself. There are long term arguments about whether capitalism based on mass consumption is sustainable (my own view is that it isn’t) but the point is that on capitalism’s own terms the evidence against Plan A is becoming overwhelming.
- Third, as I have argued before, there is a huge failure on the social democratic left to challenge the austerity narrative with one that is altogether more grounded and evidenced. The failure of the British Labour Party is salutary in this respect. Ed Balls is far from being a stupid man, and is certainly one whose technical understanding of economics far outstrips that of George Osborne. But he has become part of a political consensus that is simply unwilling to challenge the fundamentals of austerity, and to argue that even measured against the aim of achieving stable capitalism it simply isn’t working.
For me, one of the most frightening aspect of the politics of the right in general and of the UK Coalition in particular is the way in which ideology repeatedly triumphs over evidence – a major theme of the three weeks of party conferences that have just finished. Is there anyone left in the political mainstream who is prepared to champion an evidence-based critique of austerity?