Is austerity over?

Everyone is excited about the prospect of austerity ending. It’s understandable. The effects have been gruesome for lots of people and the politics of it are becoming quite difficult. In many respects it is a victim of its own success. It's only because we had austerity, cutting the deficit from 10% of GDP to 3% or so, that we can talk about ending it now. But it's quite likely premature:

  1. The deficit is 2.5-3%, depending on what measure you use. Most of that is current expenditure, rather than investment. During the early years of austerity, lots of people said that the time to cut spending was when the country was growing – fix the roof while the sun is shining. Well, the sun is (sort of) shining now and they're against cutting spending now too. If something happens in the next few years – Brexit goes wrong, China has a downturn, the Eurozone collapses – we'll be in an even worse position than we were before 2008 and we'll have even more difficult cuts to implement. The low-hanging fruit have been picked!
  2. Even though the deficit is fairly low now (compared to where we were in 2010, anyway), the debt-to-GDP ratio is 90%. Debt must be repaid, so borrowing is just deferred taxation, and is invisible to most voters. The danger is that people vote for spending rises that do not have commensurate tax rises now, and so vote for more spending/tax than they would if they felt the tax cost of the spending as well as the benefits. The higher taxes eventually needed to pay off the debt will be economically costly.
  3. Raising taxes now to eliminate the deficit is legitimate and better than borrowing, but if you raise taxes that affect growth (eg, on investment) you may end up making us poorer – maybe much poorer, if the taxes are on investment – in the medium- and long-run. 
  4. Government borrowing—outside of a period of mass unemployment—can only come out of activity elsewhere in the market. Empirical work bears this out too. You can’t employ people to build schools and also to build factories. Maybe Keynesians are right that this isn’t an issue when interest rates hit zero, but rates on gilts—not to mention every other market asset—have shown no sign of doing so.
  5. The Tories are exaggerating the extent of the changes for PR reasons. They want to look like they're "learning from the result". But spending plans already had deficit only being closed in 2025 – back in 2010 it was supposed to be 2015, a date which was then pushed back repeatedly. The public sector pay freeze (which only allowed 1% pay rises per annum, effectively a real terms cut) was brought in in 2013 – it is not synonymous with ‘austerity’ and as long as things like the welfare cap remain in place it’s not at all accurate to say that austerity has ended.
  6. Getting rid of the public sector pay cap might make sense for other reasons. When it was introduced, public sector pay was quite high compared to private sector equivalents. That’s changed, and (eg) recruiting nurses is becoming difficult. Just as any private firm should, when you can’t hire the workers you need, you need to offer higher wages.
  7. The welfare cuts were balanced out by lots of folks getting jobs. Unemployment at 4.7% takes a lot of the sting out of welfare cuts (though the worst are yet to hit). Food banks are mostly used by people who haven't received their welfare (or wages) on time – that is, it’s a function of a badly run welfare system, not necessarily one that is giving out too little money. (Maybe it’s badly run because the system is underfunded.) The welfare cap of £20,000 per household (£23,000 for London) affects about 88,000 families, mostly large families and families with high housing benefit bills. Politics aside, this is probably going to hurt people more severely with less fiscal benefit than the public sector pay freeze – but this was the cap that both the Tories and Labour (according to its manifesto) are apparently in favour of keeping.
  8. The cut in investment under austerity was bad, because projects with positive benefit-to-cost ratios that the private sector can’t carry out should go ahead as long as the government can borrow reasonably easily. If politics makes this impossible, the government should be trying to unlock some of the £2.5 trillion in pension funds for investment in infrastructure – it's more important to fix the rules than to borrow even more. But borrowing to fund current spending is the real problem, and it would probably be better if we only spoke in terms of that, and kept capital expenditure conceptually separate.
  9. Austerity probably didn't hurt the recovery – the UK had fastest growth in G7 between 2010 and 2015, while implementing harshest or second harshest spending cuts (US was arguably harsher and also had strong growth). Since we have an inflation targeting central bank, the reduction in spending and hence the macroeconomic impact of the cuts was mostly offset by easier monetary policy.
  10. If austerity really is politically impossible (ie, if they stick with it then Corbyn gets in), then the impetus for pro-growth policies is very high, because eliminating the deficit by means of growth now becomes the name of the game. For that, it’s all about housing, tax reform and infrastructure.