The Five Big Reasons Why Austerity Has The Opposite Effect From The One George Osborne Expects

April 30, 2013

by Martin Odoni

Two major but basic economic terms are routinely confused by many in the wider public. They are debt and deficit. They are two very closely linked terms, but there is a very important difference between them; –

A debt is the total amount of money owed.

A deficit is the total amount of money that has to be borrowed to meet spending commitments.

In effect therefore, an annual structural deficit is the amount of money a debt is set to increase by. A deficit will only develop when the country’s tax yields are lower than the total price of its spending commitments, and so it has to borrow extra money to make up the shortfall. When there is an outstanding National Debt, it will keep increasing so long as there is any deficit; even a substantial reduction in the size of a deficit will not mean the debt goes down, it will simply continue to rise, only more slowly. The debt can only start being brought down when the tax yields are higher than the spending commitments, which is called a surplus.

In the case of the UK, it has a current National Debt of approximately one-point-four trillion pounds. It further has an annual structural deficit of roughly one hundred and twenty billion pounds. Were the deficit to remain at its present level, this time next year the National Debt would rise to over one-point-five trillion pounds (interest rates notwithstanding).

In tandem, these figures look very sobering. The obvious, logical reaction to them would seem on the face of it to be that to get rid of the deficit, the UK needs to reduce spending to the tune of approximately one hundred and twenty billion pounds. So let’s find bills the Government pays each year of that total and stop the spending programs, and the National Debt will stop rising. Right? Sure, the programs that get cut will be bad news for people who currently benefit from them, but if the country can’t afford them, it can’t keep paying for them. Right?

In fact, this is more or less what the coalition Government has been trying to do over the last three years, since coming to power. George Osborne, the Chancellor Of The Exchequer, has cut scores of billions of pounds from the public sector budget, in terms of large staff cutbacks and reductions in spending programs. This was the return to what is sometimes called ‘Austerity’; a severe, pared-to-the-bone reduction in Government spending, with all services that are not urgently necessary either starved of funding or cut off completely. Somewhat counter-intuitively, while the deficit has reduced by approximately a third – roughly sixty billion pounds – since the Government was elected, this deficit-reduction is substantially less than the Government was expecting. The Office for Budget Responsibility (OBR) had calculated back in 2010 that the structural deficit for 2013 would be down to eighty-nine billion pounds if its Austerity plan were strictly adhered to.

Furthermore, the cuts to public sector spending programs have allowed the Government to cut taxes for employers and companies. Money that was previously being diverted from the private sector to the Government was now being retained by companies again. This should have made money available for firms to hire more staff, increasing income tax yields, as well as more private funds available for people to make more purchases, which would logically increase VAT receipts. This would, in theory, allow the economy to grow, for the country’s total economic output i.e. its annual Gross Domestic Product (GDP) to rise, and so eat further into the deficit.

The problem in all this reassuring theory is that, no, the economy has not grown pretty much at all. Instead, the nation’s GDP has more or less flat-lined from the moment the coalition got in. Indeed, there was a rather weak spell of growth in the last months of the outgoing Labour Government, and it stopped when the coalition started its Austerity measures. Since that time, there have been spells of recession, including late in 2012 the dreaded ‘double-dip’ recession, where the economy shrank in two periods either side of a very, very slight period of growth.

If, as the theory goes, an ultra-low tax-and-spend Government program should lead to a healthy and vibrant private sector, free of the financial burden of propping up the public sector, something appears to be going quite bizarrely wrong. The economy is actually, and has remained steadly for the entire period of the coalition, far more sluggish and listless than it was at any stage under Labour (bar during the ‘Credit Crunch’ of 2008), when public spending was consistently a good deal higher than it is now. If lower public spending should lead to a healthier economy, why is it instead remaining slow and unresponsive?

Well, there are many and varied reasons, some of which are beyond my fairly basic understanding of economics, but I can give you the five main ones here.

1. National economies are cyclical and not linear in function.

The greatest problem with the low-tax-and-spend notion is that it fundamentally misunderstands the natures of both state funding and private enterprise, and the fact that money moves in cycles, and not in a one-way motion from being called into existence until ceasing to exist once it is spent.

One of the misleading illusions we suffer from is that when our money is spent, it is gone and will never return. But of course, this is not really true. All that has really happened is that the money has been transferred from one person’s possession to another. This is what happens pretty much indefinitely. Money goes round and round the population. National prosperity is not just a measure of how much capital it has, it is also a measure of how consistently the capital is able to keep cycling around. Every time money is spent, or paid out in wages to an employee, some of it is siphoned off in taxation to the Government, while the company or person receiving the money is able to spend money as well in turn, repeating the cycle. (This is why thrift with household income, or “good housekeeping” as the young Margaret Thatcher so erroneously called it in last year’s film, The Iron Lady, is a poor analogy for Government spending, as Government spending has money-generating feedbacks that the weekly household shopping will not, as we shall see below.)

With this in mind, it stands to reason that the more people in an economy have money to spend, the better the cycle is maintained, and the more broadly the money is spread around. Where a person becomes unemployed however, they cease receiving money, and so cannot spend. The businesses that they previously purchased from, be it a greengrocer, a supermarket, a corner shop, a tobacconist, a newsagent, a pub, or any of dozens of options, cease to do any trade with that person, resulting in a reduction in profits. (Fewer sales also mean less VAT for the Government.) If enough people become unemployed in an area – say a factory gets closed down and its entire workforce of a few hundred are left out-of-work – a number of the businesses they used to buy from will see a serious fall in profits. One or two of them may even have to lay off staff as well, meaning more unemployment, which will cause further loss of trade for other businesses in the area, and on and on.

However, if the Government intervenes and pays money to the people who have lost their jobs, then they can keep spending with the local businesses. Probably not as much as when they were in work, but enough to maintain sales that would otherwise be lost. With luck, it will probably be enough to make sure more job-losses don’t have to follow.

Therefore, benefits are not the damaging drain on resources that they are often assumed to be by one-dimensional thinkers who are usually looking for scapegoats for the nation’s problems.

Furthermore, public spending in other areas also has a positive consequence for the economy; investment in infrastructure such as roads and railways improves transportation and makes delivery of goods more efficient. Investment in an effective police force reduces crime, which otherwise does serious economic damage of various direct and indirect kinds too obvious to require explaining. Investment in education provides a literate and skilled workforce for the private sector to hire from. Investment in public healthcare provides a healthy workforce for the private sector to hire from. Investment in scientific research provides new technologies that can be used to run businesses more efficiently. All such investment by Government improves industrial efficiency and reduces the likelihood of extra overheads for private companies.

In other words, it does not necessarily follow that public sector spending is a burden on the private sector. It is true that it is an expense, but it should not be seen as the net-drain on resources it is often painted as. Instead, it has a more appropriate analogy within the private sector itself; it should be seen as an investment, in the same way that a commodities speculator invests in goods by paying money rather than by hoarding money – the speculator expects to get a larger sum of money later when he re-sells the stock to someone else who has a greater need for it.

These public sector investments are measured by a calculation known as a ‘Fiscal multiplier’. An investment that has a Fiscal multiplier rating of precisely 1.0 will result in a boost to the economy exactly equal to the amount of money paid into it in the first place. An investment that has a Fiscal multiplier rating of 0.5 will give a boost to the economy of half the value of the money put in. An investment that has a Fiscal multiplier rating of 2.5 will give a boost to the economy of exactly two-and-a-half times the value of the money put in, and so on.

The average Fiscal multiplier rating for public sector investments during the era of the Labour Government, not including the bail-out of the banks, was a little over 1.3, and none of the investments had a rating lower than 0.9. Therefore, the coalition cutting a lot of these services has actually stifled the economy, not boosted it, as although it has saved on the initial investment payments, it has also surrendered the greater profit that they had previously yielded. This has resulted in a net decline of about thirty per cent of the stimulus provided to the economy by public sector investment.

See 5. for more on the issue of Fiscal multipliers.

2. Benefits reforms are actively discouraging job creation.

This one isn’t so much the doing of George Osborne or the Treasury as it is the doing of Iain Duncan-Smith, alias ‘IDS’, at the Department of Work & Pensions (DWP). His handling of benefits during his time in office has so far been astonishingly bad, in a way that makes it all-the-more alarming that once upon a time he was briefly elected leader of the Conservative Party; if he was once considered the outstanding talent on the Tory frontbenches, how bad a shape must the rest of his party have been in after the 2001 General Election?

I am not just critical of his amoral stance on treatment of the out-of-work, or indeed on his equal heartlessness in his treatment of those on the lowest wages in the country. That sort of hatred-of-the-poor is merely to be expected, alas, of any Tory-led Government. I am equally critical of his amazing stupidity, as pretty well all of his changes to the benefits system have served only to make proper paid jobs less likely to become available – arguably have even encouraged increases in unemployment – have fundamentally worked against the Government’s own soundbite aim of, “Making Work Pay”, and actively reduced the stimulus created by general private spending.

The most critical blunder IDS has made is the scheme called ‘Workfare-in-the-UK’, which I am convinced he only introduced to make a big show of sounding ‘tough-on-scroungers’, to please the prejudicial snobs in the right-wing media. The Workfare system, in a nutshell, puts unemployed people into mandatory periods of work for private companies in return for receiving their Jobseeker’s Allowance, and any other benefits. (The DWP insists that the scheme is not mandatory, but as refusal to take part in it can result in the cancellation of an unemployed person’s benefits, this is a pretty empty objection.) This has been presented as a kind of ‘work experience’ scheme, as though everybody forced to do it has not yet left school.

Now, it is hardly necessary to go into too much detail about the moral void of forcing unemployed people to work for their Jobseeker’s Allowance, when the Allowance is so far below the Minimum Wage. It is not quite, as some people call it, slave labour, but it is still appallingly exploitative, and as the period on Workfare will not in any way improve a person’s chances of getting a job – the company recruiting staff through Workfare is under no obligation to offer them a paid appointment at the end of the period, and a Workfare term will not look very impressive on a CV, especially if all it says is, “Stacked shelves at J. Sainsbury for six weeks” – it is pretty well useless as work experience too.

But just as much as it is heartless, the scheme is also completely mindless, and has proven, as people were warning before it was even implemented, to be a free gift to employers whose only interest is to reduce their own overheads. When work needs doing, without a Workfare system in place, a company is forced actually to employ somebody and pay them at least the Minimum Wage. But if they sign up for the Workfare-in-the-UK system instead, they get allocated staff whom they do not have to pay anything, as the work done is effectively funded by the taxpayer. Therefore, many companies have simply signed up to Workfare and got extra staff at no cost at all, and so are now less inclined to hire anybody for real. So efforts to tackle unemployment have been hindered by a scheme that actively discourages companies from offering paid work. Furthermore, having to do unpaid work takes up a lot of the time the unemployed have, so they are given far less time in which to search for a job, presenting a further hindrance, while employees at some companies are resentful that exploitation of Workfare participants has made overtime a lot rarer – why should a company pay time-and-a-half when extra work needs doing when they can get in someone paid for by the taxpayer instead?

There are even claims from some out-of-work people – which I must stress I have no way of verifying – that they have been dismissed from their jobs to make way for Workfare participants. The most bizarre example of this I have heard so far is that one person was apparently laid off from her job at Poundstretcher, was put on Workfare as soon as she signed on as unemployed, and was allocated by her Jobcentre to do her Workfare at… Poundstretcher, where she resumed doing her old job, only now for no wages! (I repeat, I can’t verify whether this story is true or not, but it is entirely possible.) Given that Poundstretcher is part of Baron Philip Harris’ corporation of companies (the Baron, may I just point out, is a Tory member of the House of Lords), it is difficult to believe that it is so short of money that it needs the state to step in and pay its wage-bill.

Workfare kills employment

I don’t know whether this story is genuinely true, but there is certainly nothing in the Workfare system to prevent it.

The system is making unemployment worse. And as already explained in 1., unemployment is a key killer of economic growth.

So, the Workfare scheme is not only amoral, it is also economic suicide.

And it doesn’t stop with Workfare. In the last month, the so-called ‘2013 Benefits Uprating Bill’ (which is the paper-name equivalent of ‘Ministry Of Love’, seeing its only effective purpose is to downgrade benefits for the most disadvantaged in society) has done the passage through Parliament. With this legislative bullet-in-the-foot, IDS has set firm restrictions at precisely one per cent on how far benefits can increase during the remaining lifespan of the present Parliament. Given that one per cent is way below current inflation, this is in effect a serious reduction in benefits, and as I outlined in 1., this reduction can again stifle economic vigour. But more importantly, the overwhelming majority of people who will be affected by the caps in this Bill are not the unemployed, but people who are actually in work. Benefits such as Maternity Pay, Paternity Pay, Statutory Sickness Benefit, Council Tax Benefit, Working Families Tax Credits, and many more, are all being capped well below inflation. If unemployment is truly, as so many Tory-supporters in this country are so desperate to believe, a simple matter of lazy people who have no inclination to get off their backsides and earn their keep, a system that effectively reduces the amount of money working people receive will not do anything to incentivise them.

So much for ‘Making Work Pay’.

We can add to this IDS’ much-publicised direction of the multi-national private IT firm Atos to perform assessments on behalf of the DWP of people claiming incapacity benefits, to establish whether they are able to work. IDS incentivised the firm to find against claimants wherever possible by setting it targets to reduce the total number by. With these targets in mind, Atos has pulled every dirty trick it thinks it can get away with to find excuses to stop benefits for disabled people, either by unfairly loading questions at assessments, or even by making assessment appointments almost impossible for the claimants to be able to attend. (Claimants who are unable to walk being made to attend assessments on the top floors of buildings without wheelchair facilities, for instance.) The upshot is that large numbers of people who are not able to work are no longer receiving the benefits they need just to survive. And some of the people who have been ruled ‘fit-to-work’ are so transparently not fit-to-work at all that the amorality of the assessments has struck many members of the public dumb in shock. (See this video for one of the most brow-raising examples. EDIT: This article from the Daily Mirror provides a lot of numbing examples of Atos’ cynicism. And more here.)

Once again, this is not just deeply immoral, it is yet another economic backfire, for without any income, these jettisoned claimants are now unable to spend, and are effectively taken out of the economy’s spending power. So long as the private sector is dependent on selling its products to members of the public, an economy will require as many members of the public as it can find to have money to spend.

EDIT 8/9/2013: More IDS-shaped folly coming out of the DWP, read about it here.

3. The UK’s Debt issues are about private sector debt far more than public sector debt.

There is a bizarre myth that has taken root in this country over the five years of the economic crisis, a myth about where people seem to think most of the current National Debt problem came from. The idea that was allowed to take hold, especially in the aftermath of the General Election in 2010, was that excruciatingly high and reckless public sector spending through the years that Tony Blair and Gordon Brown were in office had piled up to trillions. Some people even seem to think that it was the cause of the financial crash – the notorious ‘Credit Crunch’ – of 2008. Now in fairness, public sector spending did add a lot to the National Debt in the last couple of years of the Labour Government, but nowhere near as much of it originated there as originated in the private sector. It’s not even close. The problem is that Gordon Brown’s administration managed to muddy the waters and make the public sector look like it was to blame, by effectively transferring the burden away from failed banks.

As recently as 2007, the whole public sector debt was around five hundred and one billion pounds. Still a lot, but at around forty-four per cent of GDP it was far lower than at present, while public spending was at a manageable forty-one per cent of GDP. These proportions were absolutely nothing out of the ordinary, and fairly consistent with previous Governments. (John Major’s Tory Government was never in surplus  in any of its seven years in power, and in 1993 it was running a deficit of fifty-one per cent.)

During this period, thanks to the absurdities of the US Derivatives Market, banks were lending crazy amounts of money to consumers who clearly had little chance of ever paying even half of it off. As many of their debtors were struggling to return funds on time, and in order to drum up extra business in the hope of eventually getting a better supply of capital in the longer term, the banks found even more customers to lend over-valued sums to, which inevitably increased the amount of bad debt, as still more of these customers proved unable to pay back their loans as well. By 2008, there were simply too many bad consumer debts that were going into default, and banks found they were suddenly running extremely low on liquid capital. A similar squeeze was occurring in the USA, some of whose banks had lent substantial sums to UK firms, and were now calling in the debts. The British banks hadn’t enough money to spare to make the repayments, and so finally the long-delayed-but-inevitable crash arrived. Some of the country’s largest banks, most notably Northern Rock, had choked, and they now went cap-in-hand to the Government, crying out for state investment to keep them from folding altogether.

(It is argued by some that blaming the banks exclusively for the crisis is unfair, as the customers who were unable to repay their loans still committed to something that they shouldn’t have. This may seem a fair objection from a personal responsibility standpoint, but it ignores two problems. Firstly, many of the loans were promoted by the banks in such ways that never really drew attention to how large the repayments would ultimately prove to be. Secondly, the general cost of living since Tony Blair had first come to power in 1997 had surged upwards, far in advance of the average wage-increase in the same period – house prices had worse than doubled, as had many basic living expenses (a loaf of bread, for instance, was nearly two-and-half times more expensive by 2009), whereas the average working wage by the late-2000’s had only risen by about fourteen per cent – in fact, consumer debt was deliberately used by the Labour Government to screen the fact that wages were rising far below inflation. So anyone down the social scale wanting to get on the property ladder, or even just wanting to ease the pressures of life on a low wage, needed to borrow quite a lot of money, and sometimes the deeply ill-suited loans the banks wanted to push were all that was available.)

In order to stave off a full meltdown, Gordon Brown’s Government agreed to bail out the banks. The initial bail-out was officially set at eight hundred and fifty billion pounds, which is startling enough, but in real terms it actually caused the National Debt to surge to over one trillion pounds, effectively quadrupling the public sector debt overnight. And of course, the bail-out was not conditional on any increased state regulation, nor, more importantly, on any consumer debts being written off.

None of this had anything to do with public sector spending on the unemployed, the disabled, or people in low-paid jobs, and yet it is the benefits system that the coalition Government is now putting the squeeze on in the name of cutting costs, reducing the deficit, and paying off the National Debt. The problem is, this approach actually makes the Debt problem worse; –

Many of the people who owe consumer debt in the UK are among the unemployed and low-paid – as highlighted in 1., the Austerity approach is killing stimulus and increasing unemployment. Even those who have lost their job but have received a new one are usually being paid less than previously, while other people have had to accept a pay-cut to avoid being laid off. This means the average working wage in the UK is slowly trickling downwards, while people on the bottom rung in general are getting less in benefits than before.

In short, even as the cost of living continues to rise, the poorest in society are receiving less money than they were a few years ago, and those of them who received unsuitable loans have now got less money with which to pay back what they owe. Many of them will be doing well just to pay off the monthly interest on their debts. Most cannot afford even that, and so the amounts they owe are rising faster than they can pay. And of course, as the debts get bigger, the amount of interest being charged each month increases as well. The Income Tax and VAT these people are paying back to the Government therefore isn’t rising.

This is why the National Debt is continuing to rise. Not because the public sector is paying too much in benefits, but because banks in the private sector have taken a huge bail-out of public money while still charging high interest rates on what the public, supposedly, still owes them. The attempt to make the public sector the scapegoat for the crisis is just a cynical blame-shift by the financial industry to evade the consequences of the chaos it created.

4. Tax-cuts have often resulted in money going out of the country instead of into creating more jobs.

Cuts in corporation tax and the top rate of income tax were supposedly designed, as I said above, to encourage firms to recruit more staff, and to help bring down unemployment. But unemployment has continued to rise. Why should that have happened?

Well, this is a quick, easy one to answer. There are the reasons listed in 1. about public spending cuts causing a loss of stimulus. But also, a lot of bigger companies have simply absorbed the extra cash that the tax-cuts have presented to them, and, taking the ‘let’s-bury-our-treasure-and-run-for-the-hills’ approach of the Dark Age Romano-British when boats of Anglo-Saxons arrived, they’ve transferred much of it off-shore into countries or provinces with far lower tax rates, such as the Cayman Islands, or even Jersey and Guernsey. (This technique of cowardice and greed is called ‘capital flight’.) Their hope appears to be to keep their money safely tucked away until the problems have all blown over, and to hell with trying to help with the business of making the problems blow over.

So all that the tax-cuts achieve is for banks in traditional tax-havens to get a juicy injection of liquid capital, while the UK has less money inside the national system. And of course, less well-off Britons – the people who are by far the most likely to spend money when they receive some (simply because they have to just to be able to eat) – have less to spend than they had before the crisis. And so the small businesses they used to purchase from are losing sales… oh, just go back and read 1. again – this is simply the other side of that.

5. The ‘Austerity’ program was based on data that the International Monetary Fund only arrived at by arbitrary – and very inaccurate – guesswork.

When the coalition Government was formed in 2010, one of the earliest policies they put into effect was to establish the OBR. (This was a jolly useful exercise that involved, a) setting up an office, and b) naming it the OBR. Other practicalities beyond that are still to manifest themselves.) To a large extent, this office has proven to be just a local mouthpiece for the International Monetary Fund (IMF), as all it seems to do is tell George Osborne the same things that the IMF have been mechanically reciting for thirty years. Rather than setting up a new Government department, it would surely have been less fuss or expense for Osborne just to pick up a telephone and call the IMF directly whenever he wanted advice. But then in truth it would have been even better if he had just ignored both of them altogether.

When the OBR set out its opening Austerity plan, it of course set the tone for its consistent behaviour since, as it simply took calculations from the IMF and set out a projected year-by-year budget entirely on that basis; how much should be cut from public spending each year, and what the structural deficit would look like at the end of each year accordingly.

There was a snag that neither the OBR nor George Osborne was aware of until late in 2012.

The IMF had spent most of the previous thirty years trying to push the whole planet into a uniform monetarist system. Almost everyone who has ever run the Fund has swallowed the ‘Friedmanite’ dictionary (see below) whole, and as a rule has spent far less time examining what effects its implementation has in the real world. This is why the IMF is often taken completely by surprise when economic crises occur, and will usually single out exactly the wrong things to blame for them – consequent remedial action therefore has a tendency to be ineffective, or to make matters worse. (See what is presently happening in Spain and Greece for examples.)

In this case, the snag of ‘heads-buried-in-the-books-so-intently-as-they-walk-that-they-don’t-notice-what-they-are-about-to-trip-over’ was an assumption the IMF had held for about three decades; a wild overestimation of the net expense of public sector spending. As explained in 1., the net expense of Government spending varies quite widely from service to service, and many services create an effective profit for an economy by generating knock-on stimuli. The measure of how profitable or profligate a public sector expense can be, as mentioned above, is called a ‘Fiscal multiplier’. The rather startling, and lazy, parameter that the IMF had been fouling up its own calculations with for decades was a completely arbitrary assumption that the Fiscal multiplier for all Government spending is 0.5. In other words, the IMF had been assuming for about thirty years that all Government spending generates a feedback of precisely half the value of the amount spent. No wonder that the IMF has always pictured all Government spending to be a burden and ipso facto a nuisance to be avoided as far as possible.

And this was a central parameter in the OBR’s calculations when helping Osborne to draw up an Austerity program in 2010. It was just assumed that all Government spending was running an automatic loss of fifty per cent for the country, in which case every time they cut a spending program, they would automatically get a net increase in money of one hundred per cent the value of the former feedback, which would help the private sector to generate growth.

It is hardly necessary to point out that the IMF’s assumption seemed highly unlikely even before it was finally checked late last year – it would seem an amazing coincidence that all services would generate exactly the same proportion of loss – but worse, no one at the IMF has ever been able adequately to explain where they got that figure of 0.5 from. It seems likely that they just made it up.

Needless to say, the figure was not just wrong, it was hopelessly wrong, as the IMF discovered to its deep embarrassment in the autumn of 2012. As mentioned in 1., no long-term British spending program prior to the bail-outs had a multiplier lower than 0.9, and although 0.9 still constitutes a loss, it is only a loss of about ten per cent, nowhere near the fifty per cent that the IMF had plucked out of thin air. Far more importantly though, the IMF discovered, and announced rather sheepishly in October (in a great blaze of suspiciously-little publicity across the British media), that most of the long-term public spending in Britain had actually been generating a profit through knock-on stimulus effects. The Fiscal multiplier range extended from no lower than 0.9 to as high as 1.7. In other words, at the high end of the range, for every pound that the Government invested, it was returning one pound and seventy pence to the economy. This was essential growth for tackling the deficit, growth that the Austerity cuts were sweeping away.

And Osborne shows absolutely no sign of grasping it, even though both the IMF and the OBR have finally admitted to him that they had got it completely wrong.

The interesting thing is that, historically, Austerity has never really worked when it has been tried. In the inter-war period, Britain, and many other countries, entered a period of Austerity, in the hopes it would help the country recover from the First World War. It failed to generate prosperity then, or to reduce the enormous debt burden the country owed the USA. And in the late 1920’s, the Wall Street Crash caused the Great Depression. Bizarre that such a Crash could occur during a period of prudent international Austerity, perhaps? Either way, it is noticeable that the Depression never really showed signs of ending until the US Government decided to take direct control of its economy with President Franklin Roosevelt’s ‘New Deal’ program from 1933. A Government intervening in the economy is the very antithesis of Austerity, or of Neoliberalism (which is really just the more typical modern name for Austerity). But the intervention worked, and it helped change the USA from an industrial power into a super-power.

It is also worth considering that there was substantial nationalisation of Britain’s industries after the Second World War. Now there were certainly many problems during the period, but between the early 1950s and the mid-1970s, Britain saw its longest ever sustained period of continuous growth. Growth averaged at over four per cent during that period, the proportional National Debt reduced from over two hundred per cent of GDP to a little over forty per cent, and even though there were frequently declines in growth, in only one year was there an outright recession. That was in 1974, and the Government had been powerless to prevent it due to the sudden surge in world oil prices caused by the ‘OPEC Oil Shock’ and the International Stock Market crash. Other than that hitch, growth was continuous for over a quarter of a century.

Recessions happen more in a free market than in a regulated one

You think regulation is what causes economic downturns? Think again.

And all of this was happening while the welfare state was being built from the ground up. It seems public spending and state intervention were not the burdens they are routinely painted as by right wing economists.

Yes, there were economic problems, especially in the 1970’s, but those who saw the Neoliberal/monetarist ideas of Milton Friedman as the answer were trying to solve the wrong problem. They saw regulation of the market and the nationalisation of industry as stifling the economy, when in truth many of the international circumstances of the period meant a decline was going to be difficult to avoid. But recessions became a more frequent event after Margaret Thatcher began the job of dismantling the post-war state institutions that Clement Atlee had started building, while spells of economic growth became far shorter and less pronounced than before. Regulation is not necessarily a safeguard against economic hardship of course, but it is clear that deregulation is even less reliable.

And the current crisis is absolutely a symptom of deregulation, regardless of Conservative claims to the contrary. The banks were reckless in lending to people they should not have lent to vast sums that should not have been lent. They did it in large part because policymakers refused to keep an eye on them, for apparent fear that to do so would ‘stifle’ economic growth – even though there was the obvious danger that, without oversight, some bankers would be tempted to fiddle the figures. This meant that the ‘growth’ could at any time have proven completely illusory, which is indeed what happened.

The odd reality is that Friedman’s monetarist ideas were always entirely hypothetical, and were never based on anything other than his own imagination. They were thought-provoking and ‘outside-the-box’ for sure, but they were completely untested in the real world when they started becoming popular in the 1970s, and part of the reason they appeared to be successful, at least in patches, for about thirty years is that the complete lack of market regulation meant it was very easy for failures in the system to be covered up. Fraud was a standard free market tactic from the early-1980’s right up to the very recent past.

But the current Government – and probably Labour as well should they get back into power in two years’ time – looks certain to persist with Austerity, like a World War I Army General persisting with constant trench attacks, even as hundreds of his own men get mowed down by machine gun-fire. In this stubbornness, there seems to be an ingredient of ‘doublethink’, almost.

Partly, the Tories have taken the Austerity route because it is good for their core supporters – or at least appears to be in the very short term – and by extension improves their own chances of re-election; lower taxes mean richer upper class people, as a rule.

But also, with at least parts of their minds, the Tories genuinely seem to believe that what they are doing will lead to fresh growth, when in fact it is killing it. They have their eyes so firmly fixed on the Friedmanite literature that keeps telling them that what they are doing is for the betterment of the whole economy – and it’s always a nice sop to your conscience to be reassured that what you are doing for your own good will also be for the greater good (it makes choices so much simpler) – that it genuinely catches them completely off-guard when it has the opposite effect.

I am fairly sure that Osborne’s stubborn persistence is as much because he has no wish to face an ugly fact – the fact that rich-people-friendly theories he has believed in religiously his whole life are inherently flawed – as it is because his current course is good for his chums. Hence his reaction is the same no matter what happens; –

When it’s bad economic news, he proclaims it a sign that the situation for the country is precarious and so we must stick with Austerity – we must not risk increases in spending when there is so little money available.

When it’s good economic news – is it ever – he proclaims it a sign that Austerity is clearly working, and so… we must stick with Austerity, because that is what has produced the good results. (Quarterly growth of 0.3%, as announced in the last few days, is a good result. Or at least that is what I am assured… by Conservatives.)

Osborne wants it both ways, as that allows him to continue denying to himself that his lifelong ideas are wrong. Osborne has never exactly been what you would call ‘a man of first-rate intelligence’, and his selection in 2010 to be Chancellor of the Exchequer was frankly mind-numbing, given the Prime Minister David Cameron had the options of both Kenneth Clarke and Vince Cable to appoint instead, both of whom are experienced economists. Osborne’s comparative inability is almost painful to behold at times, his attempts to take pro-active measures always taking him in the wrong direction, while his ideological blinkers stop him even from offering the right reactive responses.

Osborne’s denial – indeed the denial of most of his monetarist Cabinet colleagues – is a bit like Creationists when you try to explain to them why we know the Bible is a book of fantasy.

Although in this analogy, for the Bible you can substitute almost any book written by Milton Friedman.


More on monetarist fallacies can be read at How Thatcher Embodied The Conservative Lie

12 Responses to “The Five Big Reasons Why Austerity Has The Opposite Effect From The One George Osborne Expects”

  1. syzygysue Says:

    Huge amount of work .. very impressive. IMO George Osborne, the corporates, IMF and financial sector know full well that ‘austerity’ does not make sense. The deficit and debt are simply utilised to justify dismantling the welfare state and opening up health, education and public services to transnational corporations through harmonisation with the US. The scares about the debt/deficit make little sense in the current economic circumstances.

    Partic. liked your bit about benefits being recycled. Income = jobs = employment. In fact if GO wanted to reduce the deficit, he should be increasing benefits not cutting them!

    • hstorm Says:

      I know what you’re saying, but when people think the motives are exclusively insidious, I find that they’re probably giving the guy too much credit. I know I’m talking in stereotypes here somewhat, but Osborne really does show all the hallmarks of an upper-class-buffoon who is only in the job because he’s the PM’s chum. For Osborne, a balance sheet is just a page of squiggles, so he ignores them and re-checks what Friedman said would happen. He’s completely out of his depth.

      I might well be wrong, but I just can’t really associate the guy with ‘premeditated evil genius’, he’s just not bright enough.

      • syzygysue Says:

        No but his ‘minders’ are. All of this was plotted out over 30y ago.. the blueprint is in the 94 Uruaguay GATS treaty and often referred to as the Washington Consensus. Liberalisation and harmonisation opening up of all public services. Its shock doctrine, disaster politics in action.

  2. hstorm Says:

    Well, I’d agree with that. I just doubt that Wozborne-Yesterday is aware of it. He’s only a Tory because that’s the world he comes from, and he believes in monetarism because that’s what he was brought up to believe. I honestly doubt he’s ever been given to question it.

  3. A very concise, and easy to read analysis of the failure of austerity measures. One of the worst things about economics is that most people involved try to make something relatively simple – I did say relatively – far more complicated than necessary.

    Also, I think it is well worth pointing out the inconsistency continually promoted by governments of any shade that inflation in the property market is a good thing, whereas inflation in the real economy is a bad thing. Good for banks, maybe, as they lend more and therefore get a larger slice of buyers’ salaries each month, but a very bad thing for most of the rest of us, because it leads to less money floating around the economy to be spent on goods that stimulate manufacturing, business and employment.

    In some ways too much house ownership is very bad for the economy in a crisis, as it limits the mobility of a large percentage of the working population. Many of the newly-unemployed can’t move to find new jobs simply because nobody wants to buy a house in an area of high unemployment.

    • hstorm Says:

      Several excellent points there. Perhaps you’d like to write a blog-post about it? I’d be happy to re-blog it here.

      • Thanks. Though my grasp on financial affairs is not nearly as good as yours, I have been considering it.

        At the moment I’m busy trying to develop my blog, which is mainly fiction. That said, I have posted an article on how the war on drugs affects the global economy negatively,

        With lots of links to other articles, in part, The Myth Peddlars shows how too much money in the wrong hands severely distorts economies and can affect the balance of political power in some nations. There are parallels – and even links – between some of the biggest banks and drug barons. It’s the usual suspects.

        Link here:

      • Coincidentally, David Blanchflower has just written an article on the negative effects of house ownership on the econmomy in today’s Independent.

        His piece is based on a recent paper by Professor Andrew Oswald from the University of Warwick. The paper provides statistics that seem to support my view, and provide a good addtion to your piece.

  4. […] The Five Big Reasons Why Austerity Has The Opposite Effect From The One George Osborne Expects […]

  5. […] on welfare, accusations of public sector self-indulgence that I and many others have debunked elsewhere. In truth, the damage was done by ridiculous risk-taking in the financial services sector, […]

  6. […] on welfare, accusations of public sector self-indulgence that I and many others have debunked elsewhere. In truth, the damage was done by ridiculous risk-taking in the financial services sector, […]

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