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Wednesday 28 March 2012

Austerity doesn't work - in the short or long term

The Dangers of Austerity

The main economic argument behind George's Osborne's policy of austerity is that although it will involve some short-term and medium-term pain, it will restore our fiscal credibility with rating agencies and shrink the size of our public debt in the long-term. He believes that by sticking to his rigid economic plan, it will set our economy on the path to recovery.

In my previous post, I set about to disprove the Chancellor's argument that his policies are the only way for the British economy to recover and that there is in fact a better way to kick-start the economy. A recent presentation by J. Bradford DeLong and Lawrence. H Summers goes even further and suggests that the implementation of austerity in a depressed economy may worsen that country's long-run fiscal position. Furthermore, the crux of the argument made by both DeLong and Summers is that:

...while the conventional wisdom rejecting discretionary fiscal policy is appropriate in normal times, discretionary fiscal policy where there is room to pursue it has a major role to play in the context of severe downturns that take place in the aftermath of financial crises.    
This means that the course of action that the Chancellor has chosen to pursue will have huge ramifications on our economy, more so than if he were residing over a period of sterile economic growth. George Osborne has tried to portray Keynesian fiscal expansion as reckless and lacking in economic credibility.


Stimulus helps short and long term recovery and pays for itself


Yet DeLong and Summers demonstrate how such a policy is in fact self-financing:

A very simple calculation conveys the major message of this paper: A combination of low real U.S. Treasury borrowing rates, positive fiscal multiplier effects, and modest hysteresis effects is sufficient to render fiscal expansion self-financing.   
Although they are applying this to the U.S. economy, its logic could apply equally to the U.K. economy or any other European economy. Through the use of a detailed hypothetical example (which is well worth reading) DeLong and Summers demonstrate how 'a transitory increase in government spending' can eventually be self-financing thanks to, among other things, the outrageously low interest rates that the government would be borrowing money at during depressed economic conditions.

This means that George Osborne has it the wrong way round. A well thought out stimulus package for the British economy would be self-financing as well as providing the economy with both short-term and long-term growth. And although the government's borrowing would increase significantly in the short term (as it has done in the U.S.), it would pay for itself by the end of the economic cycle.

One can only hope that the Labour party has read this compelling study and will finally be brave enough to put together an ambitious stimulus package that shows that they can offer an entirely different (and fiscally credible) vision for the British economy.

Busting the 'private sector will stimulate growth' myth

Another one of George Osborne's often repeated mantras is brought into question by the presentation: the idea that as the public sector contracts because of the need to cut public spending, the private sector will make up for the shortfall in spending:

One channel through which an economic downturn casts a shadow on the future and reduces future potential output is through private investment. The financial crisis that began in 2008 brought a sharp fall in fixed investment in the American economy, especially in residential construction, from its trend average level of 16.5% of potential output to a post-2008 average of 12.5% of potential output, for a cumulative shortfall to date of 14% point-years of GDP less of cumulative investment than pre-2008 trends projected. This shortfall has two origins. The first comes from the financial stringency of the crisis. The second arises because it is hard to see why a firm would ever focus on building out its capacity rapidly if it already possessed substantial slack.

Even if the economy quickly recovers to its productive potential going forward, that productive potential will be lower because of the investment shortfall of the past 3.5 years.
Our Chancellor appears to think that by cutting the top rate of income tax and the basic rate of corporation tax, that these tax cuts will somehow lead to a 'quick fix' for the British economy as it will stimulate spending by the private sector. But given how badly burnt many companies were during the recession, there is an excellent chance that they will choose to save this extra sum of money rather than spending it.

Another problem with cutting corporation tax is that it only helps private companies who are making a profit, whereas there are tens of thousands of British companies who are not making a single penny of profit and would have benefited from a cut in V.A.T. instead - but that is a story for another article.

What is clear though, is that it is incorrect and even unfair to rely on the private sector to engineer an economic recovery, particularly given the appalling economic conditions many companies find themselves in. Those in retail, for example, are calling this February and March the worst trading periods they have seen in decades, as Osborne's cuts, which are starting to kick in, severely affect consumer confidence.

Austerity will bite for decades to come

The presentation goes onto make a connection between long-term unemployment and long cyclical depressions - as DeLong and Summers bring Europe into the discussion:


The case that high European unemployment in the 1980s and 1990s was a result of a long cyclical depression starting in the late 1970s is quite strong.
Which makes Osborne's decision to prioritise the cutting of government spending over tackling unemployment one of the most reckless decisions of this Coalition government. The latest budget did not provide a single measure to tackle unemployment on an ambitious enough scale.

It would be unfair to only level this accusation at this particular government, as the problem is rife across Europe. Europe's reckless austerity measures are in danger in creating a lost generation of youngsters.



Conclusion


As Paul Krugman pointed out a month ago, many anti-Keynesianists are back tracking on their once loud calls for austerity:


Niall Ferguson now says,
I think the issue here got a little confused, because Krugman wanted to portray me as a proponent of instant austerity, which I never was. My argument was that over ten years you have to have some credible plan to get back to fiscal balance because at some point you lose your credibility because on the present path, Congressional Budget Office figures make it clear, with every year the share of Federal tax revenues going to interest payments rises, there is a point after which it’s no longer credible. But I didn’t think that point was going to be this year or next year.
What he said then:
After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and I still don’t quite know who is going to buy them. It’s certainly not going to be the Chinese. That worked fine in the good times, but what I call “Chimerica,” the marriage between China and America, is coming to an end. Maybe it’s going to end in a messy divorce.
No, the problem is that only the Fed can buy these freshly minted treasuries, and there is going to be, I predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates, which will also have an effect on mortgage rates—the precise opposite of what Ben Bernanke is trying to achieve at the Fed.

If only our Chancellor would realise the error of his ways, as other anti-Keynesianists have too.

It is a shame that while the news has been flooded with Cash for Cameron and the latest News International revelations, that this important presentation has been widely ignored as it disproves many of the central principles at the heart of George Osborne's misguided policy of austerity.

Wednesday 21 March 2012

George Osborne’s Biggest Lie: There Is No Other Road To Recovery



While every minutiae of the Chancellor’s latest budget is picked apart by various commentators, I would like to focus on a point he made before getting into the substance of his latest budget. His third sentence to the Deputy Speaker was ‘there is no other road to recovery’.

If one is to look around Europe, with almost every major government pursuing austerity economic measures as well, you would think he had a point. But if we glance over the pond to our American friends, it is clear that the idea that austerity is the only way to engineer an economic recovery is not only misleading, it is a lie.

In 2009, a Democratic Congress and President Obama passed a stimulus package valued at anywhere between $850-$900 billion dollars in order to kick-start the U.S. Economy. 39% of this vast sum was apportioned for spending on infrastructure (note that this did not include selling off roads to sovereign wealth funds).

Rather than debating the merits of Obama’s stimulus package, here are the results on the country’s GDP:




Let us compare this graph to the U.K.'s growth over a similar period:


Note that since the Chancellor implemented his austerity driven policies, growth has never risen above 1.1.%, whereas in the U.S. growth has been (often significantly) higher than 1.1% in seven out of eight quarters during that period and has never gone into negative growth. 

Let us present another comparison between the affects of austerity vs. a stimulus package. This time, let us compare unemployment rates. First let's begin with the U.S.:


Here is the United Kingdom's unemployment rate over the same period:


While the U.S. unemployment rate has steadily decreased over the last two years, from nearing the 10% ceiling to verging on heading below 8%, unemployment has stagnated in the U.K and in fact sharply increased over the last three months. Furthermore, while the U.S. economy's base percent rate is similar to the U.K. rate, it has added 3.165 million jobs over the last 23 months. 

This evidence tells that not only is there another road to recovery, there is in fact a better road to recovery. 

Let us now compare George Osborne's 2012 budget to President Obama's proposed budget for 2012. Whereas the Chancellor has implemented a tax cut for the highest earners, President Obama intends to allow the Bush tax cuts to expire, which will see America's richest citizens paying a higher tax rate. 

The Atlantic points out that the President Obama wants to expand the stimulus program:

  • An upfront investment of $50 billion from the surface transportation reauthorization bill for roads, rails, and runways to create thousands of quality jobs in the short term.
     
  • Continuing to allow businesses to write-off the full amount of new investments.
     
  • $30 billion to modernize at least 35,000 schools and $30 billion to help states and localities retain and hire teachers and first responders. 
     
  • A new tax credit for this year focused on small businesses and that gives businesses that add jobs and wages a tax cut equal to 10 percent of wages added up to $500,000.


Where are similar ambitious attempts at engineering growth in the U.K. economy? Merely cutting corporation tax and the highest tax rate will not revive the British economy. In fact, it ties our Chancellor to that most foolish of economic ideas: trickle down economics.  

And most importantly, President Obama's stimulus would be followed by significant debt reduction. For every $1 in new revenue, there will be $2.50 of spending cuts. Therefore no-one can classify President Obama's plan as reckless spending, because all he is doing is giving the American economy a much needed jump start to ensure that it does not slip into another depression. 

It is worth remembering that when President Obama came to power, there was a great fear that America was on the verge of economic depression. Through his initial stimulus package and bailing out the auto industry, the President not only prevented a depression, he decreased unemployment and gave the country a decent level of growth, given the appalling economic climate. There is still a long way to go before America can say they have truly recovered, but the President's economic policies have set them on the right path.

So the next time George Osborne or any Conservative tries to claim that austerity is the only way to recovery, show them the raw economic data that proves them wrong.  

Monday 19 March 2012

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FAQs


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The Right Way Is Left is a British political blog that specialises in providing in depth analysis of current affairs as well as proposing innovative ideas to kick start our flagging economy.

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No. The blog has deliberately avoided associating with any of the major parties so that it does not have to defend decisions it would never agree with. For example, the blog's most natural ally would be the Labour Party, but it found the decision to go to war with Iraq indefensible and would never want to have to defend a decision because it was in bed with a particular political party.

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Please feel free to email me at therightwayisleft7@gmail.com