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Our Austerity Basics all in one place!

James Meadway

Welcome to Transition Network's Austerity Basics series.  Ever wondered what austerity actually means?  Where the idea comes from?  Whether it actually works?  Over 9 days in late November 2013, we posted a series of answers to the most commonly-wondered-about aspects of austerity, with the help of James Meadway, Senior Economist at new economics foundation.  Now we've gathered them all together in one place.  We hope you enjoy them.

List of episodes

  1. What is austerity?
  2. Where did the idea come from?
  3. Is the UK's debt really historically unprecedented?
  4. What are the dangers of trying to pay our national debt off too fast?
  5. Can austerity ever be said to have worked anywhere?
  6. Why is the flight of jobs to the private sector a problem?
  7. What will 'permanent austerity' look like in practice?
  8. Who benefits from austerity?
  9. Is there an alternative, and if so, what is it?

Austerity Basic 1: What is austerity?

"What austerity means at the minute is a plan by goverment, by any government really, but by this one in particular, to reduce the amount of weight it has in the economy, to reduce its presumed burden on the rest of the economy.  Generally this means cutting government spending, so the government just spends less, it reduces expenditure on libraries, on hospitals.  Ideally on all sorts of inefficiencies and waste, but more likely it starts to chew into real expenditures of some sort.  

Potentially it also means whacking up taxes, increasing taxes, whatever that might be: Income Taxes, VAT, Excise Duty, could be anything.  That, in very broad outline, is what the plan amounts to.  The aim of this usually is to try and reduce the government deficit.  The government deficit is the gap between what the government gets in taxation and what it spends on public services and everything else.  Your aim overall, usually, is to try and shrink that deficit by cutting spending and maybe pushing up taxes as well.  At the moment for this country the balance is very largely in favour of cutting spending, with not very many tax increases, either now or scheduled".

Austerity Basic 2: Where did the idea come from? 

"This particular usage of austerity as a description for a programme like this I think only really enters in this form in the 1970s.  Obviously, it is a word with longer standing than that, but it changes its meaning slightly.  It enters as an idea to do with a perceived notion that governments were spending too much money at the time, so if they cut their spending, if they were quite strict about their spending, if they were “austere”, then you could reduce government deficits, reduce government expenditure, and the economy would, in theory, run much better.  That was the theoretical outline of it.

You’ve got that sort of approach being taken now.  The Coalition here, and similar for governments across Europe, are saying that government has been spending too much money, that’s why things are a mess, therefore we have to cut government spending.  That’s the kind of claim they make about it.

It’s quite similar, in this country certainly, to something that used to be known as ‘The Treasury View’ in the 1920s and 1930s.  This was the orthodox view at the time of governments’ role in the economy as being one of balancing the books.  The government gets money in, and it spends a certain amount of money over there, so it levies taxes, it has spending over here, and the ideal aim for government, as the Treasury believed at the time, as was the economic orthodoxy, the ideal aim for government was to have a complete balance between taxes and spending.  That was the Treasury view. 

The implication is that potentially you end up imposing very very sharp austerity, that maybe you don’t have much coming in in taxes, so you have to cut spending a long way.  That’s what happens in the Great Depression here". 

Austerity Basics 3: Is the UK's debt really historically unprecedented?

 

There’s two parts to that. Firstly, we’re nowhere near record levels of government debt. Just to be clear about this, we’ve been talking about the national debt or the UK’s debt. Really they’re talking about the debt of the government, they’re not talking about the debt of everybody else. This government, when it talks about the national debt, is not talking about everybody else’s debt, it’s just talking about its own public sector debt. But we’re not even close to record levels of public sector debt. 

On the Bank of England figures, it’s predictable really, in the Second World War, the First World War, and the Napoleonic Wars. If you fight a war, it involves an awful lot of expenditure. It costs a lot of money to employ soldiers, supply them with bullets and food and all the rest of it. It’s incredibly expensive. The Second World War and the First World War were financed by a very large amount of government borrowing.  The Napoleonic Wars, the wars with France over the course of the 18th century were also incredibly expensive. At that time, you were looking at a national debt, the debt of the government is the debt of the public sector, pushing up to 200, 300%, massively higher than it is now.

The idea that we have a particularly high level of debt to the size of the economy is nonsense, historically speaking. It’s certainly not very high internationally. It’s a little bit higher than Germany which is about 82-83% debt to GDP ratio. It’s about the same, maybe a bit higher than the US as a debt to GDP ratio. It is very, very substantially lower than Japan which is about 200% of debt to GDP.

Austerity Basics 4: What are the dangers of trying to pay our national debt off too fast?

The danger here is one of pursuing the analogy too far. If you or I have a large amount of debt, and what happened with the crash of 2008 is that government debt leapt up from about 60% of GDP to about 80& of GDP. It’s carried on rising since 2010, it’s risen quite a bit since then. That’s the jump that you get with a very deep financial crisis, a very deep recession. That pushes up debt: the bailouts, the recession itself. All these sorts of things add to the amount of debt the government has. The problem with rushing to try and repay that debt is something that, although it makes sense for you or I, if we have an increase in our debts, to repay it. If, for whatever reason, my debt suddenly explodes tomorrow, this is a real burden for me and it makes sense for me to try and repay it to get it out the way.

The problem that you’ve got is when, if everybody does this in the whole economy, if everybody says let’s repay our debt; if you take the whole economy, every time I spend money, or you spend money or any of us spends money, somebody else is earning that money. This has to be the case: if somebody else isn’t spending the money, you’re not earning the money. If I go to the shops and buy a packet of crisps, if I spend 50p, the shopkeeper earns 50p. So every time I spend money, someone else earns. So if I cut my spending, somebody else must be earning less. So if everybody cuts their spending, which is kind of what happened in the crash of 2008-2009, the economy goes into recession. If everybody cuts spending, the economy starts to shrink. That’s what’s happened, and that’s what’s been happening for the last few years.

If the government also turns up and says we have to cut our spending; the government spends a huge amount of money, so if it cuts spending a huge number of people earn less, so you make the recession worse and worse. In other words, by saying we’re going to rush to pay back our debt, we want to impose austerity because we want to shrink the government deficit, repay our debts, that’s the only way out of this mess, you’re actually potentially making the situation worse and worse because you’re not shrinking the debt, you’re shrinking the economy. Potentially, you’re shrinking the economy faster than you’re shrinking the debt.

The most extreme example of this is Greece, where at the end of 2009, the start of the debt crisis, they had a debt to GDP ratio of 130%. They then impose exceptionally severe austerity, much, much worse than here. Two years later the debt to GDP ratio is 160%. So debt to GDP has ballooned because the economy is shrinking. The economy is shrinking because you impose austerity, and you impose austerity to try and repay your debt. It’s completely a vicious circle. You’re not even running on the spot, potentially you’re running and going backwards with this one, and that’s happened to some extent in this country over the last few years.

Austerity Basics 5: Can austerity ever be said to have worked anywhere?

You can sort of make cases – it’s very hard because the economic logic of this, this is really John Maynard Keynes’s insight back in the 1930s when he’s sitting in the middle of the great depression wondering what’s happened, and he basically comes up with an explanation which is exactly that story I’ve just told, which is that if I cut my spending someone else earns less. If the government cuts its spending, loads of people earn less so you get a recession, or you make a recession worse. That’s John Maynard Keynes’s story and it is very widely accepted, any economics textbook will tell you something along these lines.

You will sometimes find claims that austerity has had a beneficial effect overall, you might try and construct an argument that by imposing austerity now the immediate cost is severe but it makes your economy more efficient, it clears out lots of inefficient firms who should go out of business; it forces people out of work so they have to get new work of some sort and they will become more productive as a result; you can kind of try and make an explanation like that. It’s usually not very convincing. The ones that get talked about at the moment are the Baltic States, Latvia, Estonia and Lithuania which had very dramatic, very sharp recessions in 2008-2009, you’re talking 20% or more of their economy wiped out in the space of a year or so. Very, very sharp recessions to which the governments responded by imposing austerity, really quite harsh austerity as well.

The argument from a lot of people, people like Paul Krugman for example, was that that was making the recession much worse. In Latvia, the economy has actually started to recover a bit over the past year. A lot of people say this is a good success story for austerity. The problem with saying what’s good for Latvia is good for everywhere else is that there are very exceptional conditions in the Baltic States. The first one is that about up to 20% of the Latvian population have emigrated over the last 5 years or so – just a huge number of people have upped and left because they can’t find work there, so they go somewhere else. That’s not really a particularly successful functioning economy. But it does mean that you’re unemployment rate is kept down somewhat, it only goes up to 15% rather than 18, 19, 30%. So mass emigration is one part of it.

The EU supplies a very large amount of Latvia’s government budget, and the other Baltic States, just in the form of direct assistance. That’s not quite a free gift, but it’s nice if someone’s just going to give you the cash, that always helps.

The final bit is that these are very small, open economies. They’re very dependent on their export trade, which means they’re very dependent on what the economies next to them are doing, which means in this case Sweden and Finland have both recovered from the recession. They didn’t have a very sharp recession. The Baltic States have been able to sell more to the rest of Scandinavia and they’ve recovered on the back of that. So it’s got very little to do with austerity. Austerity has quite dramatic effects, that’s why you lose – 1 in 5 Latvians decide to leave the country. That’s a dramatic impact. But what gets you out of the mess is a recovery that’s starting elsewhere, and I don’t think you can really say that Sweden wanting to buy more of your products is a direct result of you imposing austerity.

Austerity Basics 6: Why is the flight of jobs to the private sector a problem?

"The problem we’ve got is that the evidence for the private sector actually being more efficient than the public sector, particularly in the delivery of things that the public sector always historically provides, fairly complex services like healthcare or education, things where the outcomes are not actually very well defined, there isn’t a monetary value immediately attached to this.  It’s very hard to say, for instance, what the value of a good education is, you just have to go out there and make use of it and maybe you’ll find out.

It’s quite hard, unless you directly privatise a thing and charge every parent. Of course, there are schools that do this. It’s quite hard to stick a value on it. It’s similar with healthcare. It’s very hard for me to know how valuable it is to have a healthcare system. I reckon on not wanting to be sick, I reckon on wanting to be able to go to the hospital if something goes wrong, so does everyone else. But it’s very hard for me to make a judgement on how much that is worth to me at any point in time. Usually, or course, if any of us are healthy we tend to have an optimism bias. We tend to understate the value of healthcare in the future, and then we panic about in and overspend on insurance.  

This is what happens in America. This is why America spends an absolute fortune, a huge great chunk, 10%, 12% of its economy, on healthcare.  Yet you still end up with huge numbers of uninsured, the enormous political wrangling that takes place over Obamacare, this attempt to expand healthcare provision there, deep inequalities in the provision of health but huge huge amounts of money being spent by people who can afford it to get in there.

Relative to that, the NHS is very efficient. Britain spends a proportionally small amount of its GDP, of its total economy on healthcare, and actually gets a very good universal service out the other side.  The public sector is really quite efficient at doing this. But the difficulty when you start to creep in private sector providers is instead of what might be, if you’re lucky, a relatively clear public service requirement of any given service: "run this hospital", "keep this school open", it suddenly starts to be: "run this hospital and make a profit". "Keep this school open and make a profit".

That’s why, as a private provider, you get involved. Some parts of the whole provision, perhaps private providers might or might not be better at offering a particular element of a service in the public sector.  You can maybe construct a case-by-case argument here.  But if you take the public sector as a whole, once you start to impose these additional requirements on what public services are doing, "provide this service AND make a profit", you can see that immediately that's an additional pressure on everything.  

It's a pressure on costs, it's a pressure on the service provision, and it's not one that immediately translates into a public benefit.  In theory, competition should improve efficiency and all the rest of it.  In practice, as we've seen with major privatisations like the energy companies, or the railways, this doesn't necessarily follow.  The economic theory sometimes says that it ought to follow, but it doesn't necessarily appear in practice".

Austerity Basics 7: What will 'permanent austerity' look like in practice?

It means a very dramatic reshaping of the kind of country we live in. This is over and above an immediate claim about economics or the management of the economy. It’s not about making the economy work better in some senses, it’s about making it work rather differently. It will change if they go through with it, it will change how we perceive ourselves as citizens and the kind of relationships we have with each other and with the state, and the sort of expectations we have about our society to limit the economy like that.

But bearing in mind we’re not actually very far into the original austerity programme that the Coalition government wanted to get us all to stick to. We’re only about 15, 16% of the way through it. So if you then say we’re going to have permanent austerity, we’re going to lock all this in place, and we’ve already seen the dramatic impact of things like the bedroom tax, the incredible increase in the use of food banks, the series of slow-burn disasters in welfare cuts and the rest of it, this is really reshaping how all of us think about what it means to be a citizen in an economy that looks like this. So this is over and above just an economic management claim about the world. I don’t think there was ever really any credible basis, just in pure management terms, for imposing austerity in the way that the Coalition has done. That was never just about how to make things work better for people. It’s really been about how to make things work differently. It’s a reshaping of the economy.

Underlying this is probably somewhere along the line, an attempt to try and reduce costs, that would be the easiest way to look at it. If you have to provide for a large welfare state, a substantial NHS, lots of publicly funded education, it’s going to appear as a cost on doing business; somebody has to pay taxes for this. You as a business might have to pay taxes for this. If you are concerned to reduce costs, and try and make bits of your economy more competitive internationally, and you thought cost pressures from around the rest of the world were going to grow and grow. If you thought China and India were going to be chewing away at Britain’s market share, then that might be a reason to try and think like this. 

Austerity Basics 8: Who benefits from austerity?

On the whole, most people don’t. I think what we’ve seen over the last few years, at least partly as a result of austerity is a substantial decline in real living standards for most people. Average real earnings have fallen by 9% to 9.5% since 2008, so it’s a very long decline in real earnings. You have to go back several generations, you have to go back to the 1870s or thereabouts before you find comparable period of decline in real earnings, it’s just several generations, my great-grandparents or great-great grandparents wouldn’t have had experience of anything like this. To the extent austerity just undermines economic activity, that long, drawn-out period of decline in living standards is definitely part of it.

But on the other hand, if you take the political economy into consideration, so not so much how the machinery of the economy fits together but who benefits from it, who benefits from the machinery working this way, I think the clearest thing you can say about austerity is it definitely privileges those who hold financial assets above those who hold real assets. It privileges people who hold debt and govern debt in particular above those who, for instance, have to sell their labour to make a living. There’s a hierarchy in the economy, it’s what it creates.

What you do in austerity is say, we know this is going to damage real economic activity, be a drag on growth, on employment, on people’s real standards of living, but nonetheless we’re going to do it, and we’re going to do it to make sure that those who hold debt are definitely going to get repaid, and those who hold government debt are definitely going to get their money back. We’re going to use the tax system, use spending cuts to make sure they get repaid. So that’s really the drive behind austerity.

If you hold financial assets, or you’re somebody who’s interested in making use of Britain’s financial system or you want to invest in maybe property here – property in London is very popular for large overseas investors – then having a government that thinks about the world like this can look very attractive, and I think that’s one of the political economy considerations that’s working away in the drive to austerity.

Austerity Basics 9: Is there an alternative, and if so, what is it??

"There’s actually any number of different proposals that have been made over the last few years. There’s almost too many in a way. The most obvious one is that if this is damaging the economy, in particular hurting some of the weakest, most vulnerable people in society, the thing to do is not to do it. Just stop. If you wanted to promote a recovery with jobs and wages and all the rest of it, the quickest and easiest way to do that would be to just not do austerity. But you can only really treat that as a short-term solution.

A long-term solution to any of the tangle of issues that austerity is the most immediate part of, but really there’s some very deep long-term issues in the British economy. We don’t invest, it doesn’t create secure jobs, the private sector doesn’t create secure well-paid jobs. We are increasingly dependent on our energy supplies from the rest of the world, and that means in particular a dependency on non-renewable energy.

The education system, public services, you can carry on down the list of different things. If you wanted to start to address that, probably the biggest one to get into is how do we get investment. British companies just aren’t investing, they aren’t spending any money at all. In fact, the amount of investment taking place is declining at present in Britain. Without investment you don’t create jobs, you don’t create work into the future, you end up with just a stagnant economy forevermore.

So how do we promote investment, and how do we get investment in things that are going to be future-proofed? How do we invest in the green economy, how do we invest in renewables? How do we invest in improving how the economy works rather than just going back to what we’ve always done? I think that means that we have to talk about the economy rather differently. It’s not just about saying whatever the private sector does, it will do better than everybody else.

It’s about having a much more involved conversation about what we can collectively do. How do we organise the economy so it produces the outcomes we want. That will mean intruding on the private sector in lots of different ways. It might mean, for instance, government directly investing in public transport. It would be sensible for a government to borrow and spend the money on new buses, bus routes, new train services, because the government can borrow very cheaply at the moment. That would create jobs and all the rest of it.

It would make sense for the government to borrow again, because it can do so very cheaply at the moment, to go out and build new houses. Not just jamming them into the South-East but thinking about where we can put new jobs across the rest of the country. These are all things that could be done fairly rapidly, but involve turning on its head a lot of what austerity means and a lot of what the Coalition government is talking about. 

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