Robert Skidelsky
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Britain’s Austerity Apostles Duck the Debate
Robert Skidelsky
Financial Times | Thursday, October 14, 2010

 
Next week the parliamentary battle over cuts will start up again. The chancellor, George Osborne, will say the government’s programme of fiscal retrenchment is necessary to “restore confidence”. Alan Johnson, his shadow, will say it threatens the “fragile recovery”. The government plans to cut public spending by 10 per cent over four years as part of its deficit reduction plan. This will extract 5 per cent out of a shrunken economy. It is the most audacious axe-cutting exercise in almost a century, double the size of the cuts in the 1930s, equalled only by the 1921 Geddes Axe, which cut government spending by 11 per cent in two years. Labour says it is too much, too fast.
 
The two positions are clear enough, the arguments underlying them less so. What macroeconomic theory do the budget hawks have to subscribe to, to believe that taking £100bn out of the economy in the next four years will produce recovery? And what do the budget doves need to believe to claim the cutters are wrong?
 
David Cameron, Mr Osborne, and Nick Clegg appear to believe in something called “crowding out”. This is the view that for every extra pound the government spends, the private sector spends one pound less. Jobs created by stimulus spending are jobs lost by the decline of private spending. Any stimulus to revive the economy is doubly damned: not only does it fail to stimulate, but, because government spending is less efficient than private, it reduces the economy’s longer term recovery potential.
 
Applied to the deficit, the “crowding out” thesis takes two forms. The first is “Ricardian equivalence’’. Government borrowing is simply deferred taxation, because it produces no revenue to pay for it. Households save more to pay the higher taxes they expect. This means that any extra income created by the deficit will be saved, not spent. Net stimulus: zero.
 
The other leg of the “crowding out” argument is that government borrowing causes interest rates to rise. There is a fixed lump of saving. The more the government borrows, the more private borrowers will have to pay for their loans.
 
A refinement of this argument is “psychological crowding out”. In this version it is not a shortage of saving, but a shortage of confidence in the government’s creditworthiness – due to a fear of default – which causes interest rates to rise. Either way the deficit “crowds out” private investment. Net stimulus: zero.
 
The supposed implication of this type of argument is that in the short-run the deficit can do no good; and that in the slightly longer term it harms the potential for recovery. What the cutters have to believe is that every pound of deficit reduction will be matched by an extra pound of private sector spending. That is, if the government weren’t spending this money, the private sector would be, and making much better use of it. Mr Osborne’s programme is a beautiful cure for recession, provided there’s no recession to cure!
 
Keynesians do not deny the possibility of “psychological crowding out”: markets are subject to all kinds of irrational hopes and fears. But what the cutters mean by “crowding out” can normally only happen at full employment. At full employment, extra public spending obviously subtracts from private spending. But this is not the position we are in today.
 
What Keynesians say is that when resources are unemployed, government borrowing is not deferred taxation: it brings resources into use that would otherwise be idle, and thus increases the government’s revenues without having to raise taxes. When the government borrows money for which there is no current business use, this increases people’s incomes and therefore the saving needed to finance the borrowing, without interest rates having to rise. And though confidence problems may occur even in an under-employed economy, the probability of the UK government defaulting on its debt is, if not zero, extremely low.
 
In short, the “crowding out” argument is false. The problem is not the expansion of the deficit but the shrinkage of the economy. The deficit is the stimulant the economy needs to start growing again: its withdrawal guarantees stagnation or worse.
 
Why aren’t we having this argument? The reason is that, against its instincts, the last Labour government accepted the pre-Keynesian economics of the cutters and sought only to ease the pain of the axe. To promise to cut a little less, and a little slower, than the coalition is an improvement, but not an alternative economic strategy. Only Ed Balls has the economic confidence and pugnacity to argue the Keynesian case. For political reasons he has been denied the shadow chancellor’s job.
 
I would sum up this way. When an economy is growing to trend with a low level of unemployment, “crowding out” applies, and the budget ought to be balanced at modest level of taxes and spending. But when it has large unemployed resources, the Keynesian theory is best, and the government should not be ashamed of running a deficit. A properly Keynesian opposition would say that the budget balance should be dictated by economic circumstances, not by some arbitrary timetable: who knows what the situation will be in two, three, four years’ time? But I doubt if this opposition will have the courage to do so.
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Comments:

By Dr Alister McFarquhar (cambridge) on Fri 15 Oct 2010 - 10:10

Much appreciate Skidelsky summary. Sadly its not really about theory but also about “some arbitrary timetable” Suspect Govt think that the quicker it dispenses medecine the longer the time for recovery before it faces electorate. If that comes before some recovery Govt can say the medecine had too little time to work.

Remember talk of cuts is likely to exceed reality.  Talk alone most likely constrains rate of borrowing for some time. And the Bank most likely follow the Fed in thinking they can print their way to inflation and growth confident that the tap can be turned off by raising interest rates

Might as well gamble on reducing the public sector while in power-which may not last long

Lord Skidelsky seemed to agree that little evidence suggests recovery would not be like Japan when presenting his recent book at a seminar in LM Hall in Cambridge. That prediction looks more plausible by the day

By Szabolcs Szikszai (Hungary) on Fri 15 Oct 2010 - 2:11

Good point, well made. It seems to me that some of the western countries with the neoliberal dogma up to their eyebrows - such as the UK, I guess - seem to be falling into their own traps and feeling the side-effects of their own one-sided pro-market ideologies these days.
I agree with Mr. Skidelsky that a bigger and not a smaller government is the solution in a recession. Necertheless, I should add that the Hungarian government are taking this point a little too far these days with the impending nationalisation of pensions, the taxation of every living thing in the economy, etc. I would say that our state is becoming slightly bigger than desired and I have not yet seen any feasible plans for job-creating public investments. We will see, though.

By Neill Harvey-Smith (GB) on Thu 14 Oct 2010 - 8:02

Firstly, thank you for your writing over the years. I know everyone commends you on the Keynes biographies but the World After Communism is also a terrific book.

On today’s article may I ask - are the allusions to previous recessions justified? Unemployment remains moderate (under 8%), the output gap is low when calculated taking the unemployment figure into account rather than just extrapolating from trend (deviation from the NAIRU = 2% / on CBI labour market data = 2%), average earnings are rising, inflation is above target. We don’t have 3-4 million people unemployed like the mid-eighties.

Who or what, in your view, are the “large unemployed resources”? Also, have you totally abandoned hope for a state where government accounts for around 30% of GDP?

Best wishes

Neill Harvey-Smith

 
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