Monday, December 29, 2014

Sticky Wicket

From Paul Krugman's New York Times austerity=baseball bat column today --

Let’s start with a tale from overseas: austerity policy in Britain. As you may know, back in 2010 Britain’s newly installed Conservative government declared that a sharp reduction in budget deficits was needed to keep Britain from turning into Greece. Over the next two years growth in the British economy, which had been recovering fairly well from the financial crisis, more or less stalled. In 2013, however, growth picked up again — and the British government claimed vindication for its policies. Was this claim justified?

The chart above is from an Institute for Fiscal Studies analysis of UK fiscal policy since 2008. IFS is widely respected. The story is very simple. There has been a significant slowdown in the UK trend rate of growth, which appears to date from the 2008 financial crisis and not the later move to austerity. UK public spending is set disproportionately in cash terms (health spending, welfare, pensions, salaries) while revenue is generally set as percentages, which ultimately means percentage of the economy.

So if you're setting spending in cash but revenue in percentage of something that's growing more slowly, you've got a big problem over time. That's what the IFS chart shows: the gaps between the lines was getting very large, very quickly.

The point is that the Tory/LibDem coalition was not being completely loony in thinking spending policy would have to change. The timing was not great, but the damage could be offset by the Bank of England, and over time interest on growing debt was itself going to squeeze spending even in the absence of discretionary cuts. As the IFS has been pointing out, the same fiscal logic is boxing in whoever wins the May election.

The point isn't that Krugman is wrong. It's that the push for austerity wasn't coming from long-dead economists or that there were lots of choices. And it's worth acknowledging the surprise of how well the UK economy has held up despite the austerity still in the pipeline.

UPDATE: This Matthew Yglesias Vox piece is very useful as a contrast in showing how the US was able to achieve very large cash adjustments to its budget in a short time, something that is much more difficult for the UK to do since it runs a tighter ship on health to begin with and other spending commitments are embedded in policy.