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Mr Osborne's Economic Experiment: Austerity 1945-51 & 2010

By William Keegan

There have been two periods in the UK since the Second World War to which the label ‘austerity’ has been applied. The first was under the Attlee Labour governments of 1945–51, and the second under the premiership of David Cameron and chancellorship of George Osborne, from May 2010.

Both the Second World War and the 2007–09 financial crash were, in their different ways, economic cataclysms. But the appropriate policy reactions were very different.

A myth was propagated by Chancellor George Osborne and others that it was government deficits that caused the crisis. In fact, it was the banking crisis that caused the rise in public sector deficits, which were the counterpart of the collapse of demand. Policies of austerity were the last thing the British and other European economies needed, as I hope to show in the following pages.

Thus the long-held assumption of policymakers that having a job was a way out of poverty is no longer valid.

The austerity measures on the public services has caused hardship and misery for the ‘voiceless’.

Although much has been made of ‘Labour’s Mess’, government debt, as a share of GDP, was lower in the UK during 2007 than in every other G7 country except Canada.

Any illusions that he was not serious about austerity were surely shattered by George Osborne’s major speech to the Conservative Party conference in October 2013, in which he unveiled a seven-year plan to achieve an ‘absolute’ budget surplus before the end of the decade.

It is my belief that George Osborne’s initial pronouncements set the recovery back by several years, with the consequences covered in this book.

I told an economist friend that I was writing a book comparing and contrasting austerity in the immediate post-war period and austerity after 2010,if there is one startling difference between austerity then and austerity more recently, it is that the hard times of the immediate post-war years were shared by the vast majority of the population.

The hardship, in Britain has been confined to a minority of the population, and many people have never had it so good.

It was arguable whether Mrs Thatcher, with her policies of the early 1980s, was right to claim that there was ‘no alternative’. But in 1945–51 there was no alternative to austerity.

Some younger historians look back nostalgically on the two Attlee governments of 1945–50 and 1950–51 as a kind of golden era. But for those of us who were living in Britain at the time, the gold was on the distant horizon.

In fact, by comparison with the situation that faced Attlee in 1945, there was plenty of money left in 2010, and plenty more available.

Under the chancellorship of George Osborne, the most important stated aim of economic policy, right from the start in June 2010, was to bring down the budget deficit. It has been with this in mind that the Chancellor,has repeatedly aimed to justify its policy of ‘austerity’.

The contrast with the post-war years of austerity could hardly be more startling.

When Cripps arrived at the Treasury,he was less an architect than a prisoner” of Britain’s near-bankruptcy.

By contrast, when George Osborne arrived at the Treasury in the summer of 2010, he chose to be a prisoner of the Treasury and the Bank of England because it suited his political strategy and the experiment he was about to conduct.

Osborne’s political tactic was to blame the economic crisis with which he was faced entirely on his predecessors.

It mattered not that both Cameron and Osborne had backed Labour’s broad approach to public spending at the time.

Osborne’s commitment was made during the first signs of recovery from the 2008–09 depression. Unfortunately his first Budget stopped that recovery in its tracks.

Nowhere, to my knowledge, will one find an acknowledgement in a speech by George Osborne or in his reams of evidence to Treasury Committee hearings that the British economy was actually recovering in spring and summer of 2010. *

It was plain for all to see that the talk about the need for ‘austerity’ had a seriously dampening effect on Keynes’s famous ‘animal spirits’. Business investment not only failed to fill the gap created by the pruning of public expenditure – it fell.

It can hardly be emphasised enough that it was the banks that caused the crisis, not Labour’s public spending plans, which, as noted, had been supported by the Opposition in the run-up to the crisis.

Where governments were responsible, or should we say irresponsible, was in the way that, seduced by the vogue for ‘light touch’ regulation, and by the belief in the wisdom and ‘efficiency’ of financial markets, they allowed the financial markets to run amok.

But it was not New Labour that originally championed the deregulation of the 1980s. That was the product of a lethal mixture of the ascendancy of the free market philosophies championed by Mrs Thatcher and Ronald Reagan,and the financial pressure groups that stood to gain from what became a free-for-all, leading to a crisis in which the bankers were bailed out at the taxpayers’ expense.

Just as it was absurd, although politically advantageous, for the Coalition to blame ‘Labour’s Mess’ for the banking crisis and its consequences, so it was unfair to blame Carney’s predecessor Mervyn King for the fact that the Bank of England had failed to prevent that crisis.

At this point it may be useful to be reminded of the essential Keynesian message, as elegantly summarised by the Nobel Laureate Paul Krugman “First, economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment. Secondly, the economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully. Thirdly, Government policies to increase demand, by contrast, can reduce unemployment quickly. Fourthly, sometimes increasing the money supply won't be enough to persuade the private sector to spend more, and government spending must step into the breach.” Of course, under Mr Osborne’s strategy of deficit reduction during a depression everything was being done to prevent government spending from stepping into the breach.

It soon became obvious that Osborne’s plan to eradicate the so-called ‘structural’ deficit by 2015 was not only damaging but also unrealistic.

Why did the Treasury and the Bank of England back a deficit reduction plan that in this author’s view had been contrived for purely political reasons?

Also, the idea that the British government required an austerity programme to ‘make room’ for investment, most notably in the nation’s infrastructure, was a red herring: there was already plenty of room in the economy for investment after the collapse of demand that had followed the financial crash.

George Osborne stirred up a panic that the UK could be in the same position as Greece in what looked suspiciously like a politically motivated plan to introduce his strategy of austerity.

And the Bank of England was very much to the fore in highlighting its concerns about the size of the deficit, even though the Debt Office was having no trouble in financing it.

The Treasury knew full well that the incoming government was grossly exaggerating the degree to which the budgetary crisis was caused by Labour’s (public spending) mess rather than the banking crisis.

Moreover, the economy was already ‘on the mend’ when Mr Osborne shouted ‘fire’.

The collective decision of the policy machine was to accompany a fiscal squeeze with a monetary stimulus. But not only was a fiscal squeeze the last thing a fragile economy required: it was guaranteed to, and did, have a negative impact both on output and on the confidence of business and ‘consumers’.

By 2013–14 the ‘Great British Economic Recovery’ was finally sighted and much lauded by the Chancellor, as if it justified all that had gone before – or, perhaps one should say, not gone before.

Nevertheless, the IMF had been right to question this strategy. The fact is that it did hold up the recovery, and much damage was done.

Just think if Clement Attlee’s government at the end of the Second World War had decided that the first priority was to reduce the debts built up during the war – there would have been no money to fund the creation of the NHS, no money to rebuild the railways and housing destroyed in the Blitz, no moneys to fund the expansion of the welfare state.

As it became clear in spring 2014 that there was most certainly an economic recovery under way in Britain, Osborne aunched a frontal attack on his critics, arguing that the recovery had resulted from “an effectively deployed” monetary policy and “a credible fiscal policy”.

For British economic policymakers in mid-2010 there ought to have been a very obvious lesson of history: that lesson was that policymakers should not become obsessed with one economic indicator or objective, to the virtual exclusion of most others. Yet this is precisely what happened.

What was the one indicator that the new government focused on? It was the budget deficit, or the level of public sector borrowing.

The deficit that should have been causing most concern was not the budget deficitthat one would expect to occur in the face of recession, but the deficit in the balance of payments, and especially in overseas trade. *

All experience indicated that the best way to ‘solve’ a budget deficit problem was to grow out of it. But growth was evidently not the priority of the Coalition, or its members would have recognised that the surest way of restricting growth was to announce an austerity programme and quite deliberately raise taxes and cut public spending.

But it has become more and more obvious, in speeches and remarks made by every senior Conservative politician from David Cameron and George Osborne to Boris Johnson, that behind their crusade to cut the deficit lies another agenda: that is to reduce the size of the state itself, and in particular the social services and the welfare budget, in order to cut taxes. In other words, one is left with a growing suspicion that ‘welfare recipients’ are being blamed for a budgetary crisis that was caused largely by the temporary failure of the financial system, and the poor and the vulnerable are in practice being punished so that taxes can be reduced for the better off – not solely to reduce the deficit.

The speech given by George Osborne to the American Enterprise Institute in April 2014 was one that he took more seriously than some.Now he could boast of a revival of economic growth, with forecasts of more to come.

Osborne has an arrogant streak to his character, as well as an insensitive one.

The point that united his critics on both sides of the Atlantic was that the austerity programme was first delaying the recovery and then restricting its progress.

Osborne may well have been on firmer ground – and only time will tell – was in taking on ‘the pessimists’ who were arguing that the advanced world might have entered a period of ‘secular stagnation’.

But, as the American economist Paul Krugman has repeatedly pointed out, the latest recovery would almost certainly have been stronger if there had indeed been greater fiscal stimulus.

His policies during the first three years of his Chancellorship aggravated and prolonged a recession caused by the banking crisis. It was a relief when recovery was sighted.

But the IMF in spring 2014 echoed many critics on this side of the Atlantic in drawing attention to the unbalanced nature of the British recovery, with its dependence on yet more consumer debt and the ‘wealth effect’ from higher property prices.

By mid-2014 house prices were rising at 12 per cent in the UK as a whole and 20 per cent in London.

In London, the housing crisis was aggravated by the way the capital had become a millionaire’s, indeed billionaire’s, investment opportunity, often with buyers paying in cash.

The underlying problem was a severe shortage of supply. Successive governments had neglected to fill the gap left in the availability of social housing after the Thatcher government introduced its popular ‘right to buy’ scheme (council properties) in the early 1980s.

Attempts by the Coalition to control or reduce housing subsidies via what became known as the ‘bedroom tax’ turned out to be a very nasty exercise in social engineering.

This brings us to the nub of the phenomenon that distinguishes austerity now, in the UK, from austerity in the immediate post-war years.

Austerity in 1945–51 was experienced by most of the people, with even the young Princess Elizabeth and Prince Philip having to use clothing coupons for their wedding.

In the UK there has been precious little social disruption. The worst effects – reductions in state ‘benefits’ and maladministration in the distribution of ‘entitlements’ – have been causing hardship and misery to the ‘voiceless’. Many of these have turned up on the doorsteps of the nation’s churches.

When there is such a huge gap as there has been in recent years between the numbers of unemployed and the availability of jobs, it is blindingly obvious that there is a social problem which can only be resolved by an increase in economic activity and the accompanying demand.

Here we come to what might well turn out to have been a strategic mistake on the part of a Chancellor who appeared in the first half of 2014 to ‘have got away with it’.

Essential to the Chancellor’s case was that the fiscal squeeze had been a necessary condition for the recovery. But what seemed to be emerging in the course of 2014 was evidence that, by placing all his cards on the monetary table, Osborne had seriously unbalanced a policy that was intended to rebalance the economy.

George Osborne has been a very political Chancellor. I always suspected that, even though his deficit reduction strategy was debatable, and the forecasts had continually to be revised, this was of little consequence to him.

He had his eyes on the 2015 election, whose fixed date had been his idea during the Coalition negotiations in 2010. His basic strategy was ‘to get the pain out of the way’ and then appeal to the electorate on the grounds that it had all been worth it, indeed necessary for the eventual recovery.

Osborne had reportedly boasted to his Cabinet colleagues that the electorate would enjoy a good old-fashioned house price boom. *

The consequences of the housing shortage were therefore seen in the rapid rise in house prices.

A stark example of the problem was provided by the situation in London, where housing experts calculated that there was an underlying demand for some 52,000 houses a year, but a supply of only half that number.

Another interesting aspect of economic developments in 2014 was that, while proclaiming the arrival of the long-awaited recovery – which was supposed to be the reward for the earlier austerity – George Osborne was promising more austerity with regard to the public finances for the future.

In effect the Osborne strategy was not primarily about reducing the size of the budget deficit. It was about reducing the size of the state, and with a particular emphasis on cutting welfare spending. That is to say, the focus of ‘austerity’ was principally on the poor and the disadvantaged who were turning up at church doors, and having recourse to the proliferating food banks.

It has been put to me that the austerity strategy was a form of insurance policy, presumably against attack from the financial markets. But the idea, as still being propagated by George Osborne in 2014, that Britain was almost bankrupt in 2010 never rang true.

I believe that there has been a strong element of ideology behind Chancellor Osborne’s emphasis on austerity. This does not, to my mind, justify a strategy which delayed the recovery for so long, and has exacerbated social problems.

The ‘rebalancing’ problems of the British economy were still formidable after four years of Mr Osborne’s Chancellorship. In many ways, this had actually been aggravated rather than alleviated by his concentration on ‘austerity’.

Moreover, it had been the slowest recovery from recession on record – slower even than the recovery from the Great Depression of 1929–31, which took two years fewer than in 2008–14.

This stemmed from the decision to concentrate on fiscal austerity which George Osborne took right at the beginning of his tenure of office; this commitment to austerity was reinforced in October 2013 and the Budget of March 2014.

George Osborne’s economic experiment has been very political, and, to my mind, cynically calculated.

The new Chancellor arrived at the Treasury in June 2010 after the second cataclysm to hit the British economy in 70 years. The first was the Second World War.

In this author’s view, while there undoubtedly had to be a period of adjustment, the underlying economic situation did not require a period of austerity. On the contrary, it required budgetary policies to expand demand in the economy, not to cut it back even further. *

The burden of austerity in 1945–51 was shared among all social layers of the population, by contrast, since 2010 the burden of ‘cuts’were largely unnecessary, has fallen on the poorer members of society.

To make matters worse,it became clear that cuts hitting the more vulnerable members of society were designed to finance reductions in taxation for the rest of the electorate.

The recovery that had begun in the first half of 2010 was arrested in its tracks.The emphasis on austerity did not cause the crisis. The point is that it aggravated the crisis, delayed the recovery, and took the form of planned penury for the already vulnerable who became the scapegoat for a crisis that had little to do with them. *

The principal losers from the austerity programme were those at the lower end of the income scale.

It is also, sadly, a sign of just how pervasive the neo-liberal movement has been in recent decades that the Opposition Labour Party also found it necessary to bow to the fashionable cry for ‘cuts’.

The question society has to ask itself is does it want a reasonable standard of public services, in which case the level of taxation has to reflect that demand, or is it really happy with the neo-liberal desire for ever lower tax rates, at the expense of public services in general and the welfare of the poor in particular?