Austerity – Time to admit defeat?

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So this is my first blog and I thought it would be best to start with a current topic close to home, mainly the issue of austerity in the UK. This policy has mainly be guided by one leading principle of the conservative party – to maintain the UK’s AAA credit rating. Originally stemming from a letter sent to the government in February 2010 by 20 ‘leading’ economists, it was thought that reducing government spending would reassure investors into the UK. In turn this would keep government borrowing rates low and maintain currency stability. Austerity measures generally take two approaches. Firstly they aim to cut spending in areas such as social welfare which may hinder economic growth as it reduces the poor’s incentive to work. Secondly in a more top down approach policies such as cutting corporation tax (http://www.guardian.co.uk/uk/2012/dec/05/george-osborne-welfare-autumn-statement) and removing red tape aim to provide incentives to so called ‘wealth creators’ to invest and create jobs.

The reality of these such measures however have been far from intended. Most notably, the economy has contracted in three of the last four quarters, with the UK facing the prospect of a triple dip recession. Furthermore the UK’s level of national debt as a ratio of GDP has increased from 55.3% in the second quarter of 2010 to 70.7% in December 2012. These indicators alone would seem to suggest that the policy is clearly flawed. Such views are held by prominent economists such as Paul Krugman who points out that the lessons of the past 30 years have clearly not been learnt. Such a policy of austerity to a Keynesian is seen as self deflating, as cutting government spending causes output to fall which in turn reduces tax receipts, whilst spending on benefits increase. Consequently the policy makers are left with rising national debt and a sluggish economy, precisely the situation they were trying to avoid.

The empirical evidence on the effectiveness of austerity measures is also far from compelling. As pointed out by Ha-Joon Chang (http://www.guardian.co.uk/commentisfree/2012/jun/04/austerity-policy-eurozone-crisis) previous adoptions of the policy during the 1994 Mexican Crisis; 1997 Asian Crisis and the Argentine 2002 crisis all led to a further deepening of recession. The policy can further be contrasted to the differing response of the Obama administration who adopted a four year steadily declining fiscal stimulus plan. Over the last last two years the American economy has averaged a growth rate of around 2.1% in comparison to a sluggish 0.9% in the UK. Furthermore America has managed to bring down the size of its budget deficit almost as rapidly as the UK has.

Another point to consider is what would happen if the UK lost its AAA rating. The answer as pointed out in Robert Peston’s article (http://www.bbc.co.uk/news/business-20623626) is probably not much. Peston argues Investors are more concerned with the underlying economic performance of a country rather than a notch up or down on the credit rating. In this sense I have to agree with Peston’s summation of the present problem. It can be argued that the policy of austerity is now guided by political will rather than economic rationality. The evidence is clear and on the verge of a triple dip recession 9 of 20 economists who originally forwarded the policy have now admitted they were wrong in a recent New Statesman Article (http://www.newstatesman.com/blogs/politics/2012/08/exclusive-osbornes-supporters-turn-him).

What I believe we are witnessing is what psychologists like to call escalation of commitment. The prime minister and chancellor have invested so much in this policy that they now find themselves beyond the point of no return. A change of policy would not only risk their reputations but would fuel a torrent of attacks from the opposition which could tip the balance of the next election. This leads me to my final point, if the governments fiscal policy has become entrenched by political rather than economic concerns, and as the conservatives say ‘labour got us into the mess in the first place’ isn’t it time to look at the possibility of a independent fiscal policy? Such a policy however raises many more questions than it answers.

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2 thoughts on “Austerity – Time to admit defeat?

  1. Leon says:

    Interesting stuff. Agree completely. It’s only 2 years from election year so it would be political suicide to have to move to a Plan B. The idea of an Independent Fiscal policy is an intriguing prospect. Can’t see how it would work though.

    • The general idea would be to have something similar to that which is established at the Bank of England. This would involve a group of economists controlling fiscal policy, and would not manipulate such policy for political gain. However the main problem with this policy would be accountability as such of group of economists would be unelected and thus not responsible to the electorate.

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