Saturday, January 26, 2013

Austerity vs Stimulus - a false debate

When it comes to economic policy so many so-called economic experts seem to be completely missing the point. Contemporary economics is so often simplified down to the childlike "austerity vs stimulus" debate. I intend to show that this kind of myopic black and white thinking is hopelessly naive. Economics is not taught as a subject in the vast majority of British schools, so it is hardly surprising that so many ordinary people end up accepting such a shallow interpretation of the current economic crisis. However, if our leading economists and politicians allow themselves to get bogged down in this facile "austerity vs stimulus" debate, the wider economy, and millions of ordinary people, will be the ones to suffer the consequences.

The UK has experienced four quarters of negative economic growth in the last 15 months, the economy is still significantly smaller than it was before the neoliberal economic meltdown and George Osborne is still steadfastly refusing to abandon his failing ideological austerity experiment despite warnings that it is doomed from across the political spectrum, including from the hard-right neoliberal pushers at the IMF and from the Tory Mayor of London Boris Johnson.

It is important to remember that when Osborne came to power in 2010, his team of neoliberal economic wonks at the OBR were predicting that the economic growth rate in 2012 would be a fairly reasonable 2.6% of GDP. The reality is that the UK economy actually contracted throughout 2012, despite London hosting the world's biggest sporting event in the summer and all the ticket sales revenues from preceding years being misleadingly shoved into Q3 of 2012.

In previous articles I have identified the main problem with George Osborne's ideological austerity experiment; the assumption that all government spending is essentially "waste". This assumption is confirmed by the fact that the OBR openly admit that they have been using an assumed fiscal multiplier of 0.5 to calculate the value of government spending. This means that the economic calculations on which Osborne and the OBR predicted 2.6% growth for 2012 were reliant upon the assumption that for every pound the government spends (no matter which department, type of spending or geographical location) the economic return will only be 50p.

Given this arbitrary assumption, it is no surprise at all that they predicted that slashing government spending would cause the economy to grow, because they were working under the simplistic assumption that all of that slashed government spending was essentially 50% waste. Thus arbitrary across-the-board spending cuts made (and continue to make) sense to the OBR and the myopic Tory regime.

The problem of course is that the returns on investment vary dramatically depending on the type of spending, the government department and the geographical location. Many areas of government spending create much stronger returns than 50p in the pound. One specific example is the construction of flood defences, which saves £8 in economic damage for every £1 of investment; a fiscal multiplier of 8.0. The Conservative led coalition actually cut £860 million from the UK flood defence budget for the 2010-2015 period. This kind of blind ideological austerity was exposed as the lunacy that it obviously is, when several towns that had had their flood defence schemes cancelled were extensively flooded in 2012. If the fiscal multiplier of 8.0 for flood defence construction is to be believed, the Tory cuts to UK flood defence funding will eventually end up costing the UK £6.88 billion in economic damage. Incurring nearly £7 billion in economic damage in order to make short-term spending cuts of less than a £billion is a perfect example of Tory false economies in action.

Aside from flood defences, there are many other areas of government spending that create stronger returns than the investment cost, some of the best examples include construction of social housing, infrastructure development, investment in communication technology, certain health campaigns, certain types of welfare spending and investment in the education system. It should be quite obvious to anyone, that some areas of government spending are generally beneficial, whilst other areas are more wasteful. Hence the use of an arbitrary figure of 0.5 for all government spending is certain to lead to inaccurate economic predictions.

Anyone familiar with mathematics knows that if you simply bung an arbitrary assumed figure into your complex equation, you jigger the whole thing. This concern is confirmed by the fact that in October 2012 the IMF revised their fiscal multiplier values from an arbitrary and precise 0.5 to a much more reasonable and variable 0.9 - 1.7 range. In the very same month the OBR made an astonishing admission. They admitted that in order for austerity to be entirely responsible for the failure of their economic predictions of sustained growth, the UK fiscal multiplier would have to be around 1.3. This figure of 1.3 happens to be slap bang in the middle of the IMF's revised fiscal multiplier range. Essentially, the OBR had inadvertently admitted that ideological "Osbornomics" is entirely responsible for the flatlining of the UK economy.

The "Osbornomic" assumption that "all government spending is waste" is naive economic lunacy, but so too is the idea that all government spending is beneficial. The idea that you could stimulate the economy out of the doldrums by paying people to dig holes and then fill them in again (the kind of thinking that can be found on the LabourList website) is just as naive and idiotic. Splurging state funds on economically inefficient schemes can be found on the opposite side of the ideological nonsense coin to across-the-board austerity.

The solution to 30 months of couter-productive austerity is not to take the opposite tack and engage in across-the-board spending increases. This would be the same kind of simplistic all or nothing thinking. As is most often the case, something more nuanced than simplistic black vs white thinking is required. Ideological stimulus is no more the solution to the current economic crisis than ideological austerity.

A sensible growth strategy would be to implement a rational evidence based economic strategy, which would involve identifying areas of government spending that create substantially greater economic benefit than they cost (capital spending projects, improved transport infrastructure, certain types of welfare spending, social housing, affordable housing, flood defences, public education...) and increasing spending there. Conversely, areas of government spending that create particularly weak returns (PFI, transport subsidies, overpriced outsourcing deals, wasteful military procurement...) should be identified and targeted for reforms and spending cuts.

There are several problems with this kind of rational evidence based economic strategy for the current Tory regime. The main problem being that the Tories are ideologically opposed to most of the areas of government spending that actually create strong economic returns (especially social housing, welfare spending, public health spending and public education spending). Another is that their modus operandi is to always siphon ever more state funds to unaccountable and inefficient private sector providers (private health firms, private education academies and free schools, private security contractors taking over front line police duties, forensic science privatisation, the privatised court translation farce, local government privatisation, vast military contracts...).

Another problem the Tories face if they abandon ideological across-the-board austerity, is that it would be an admission that their austerity experiment was the principal cause of last 30 months of economic chaos. Thus they would prefer to stubbornly soldier on with their failing economic experiment, blaming whatever the hell they can think of (the previous Labour government, the Eurozone, the Royal wedding, the Jubilee, the Japanese tsunami, the cold winter, the wet weather...) and cherry picking whatever positive economic data they can grasp (no matter how tenuous) in order to weave a misleading justification narrative about how brilliantly they are managing the economy.

Another, more personal, reason that the Tory "cut now, think later" austerity experiment will not be abandoned is that George Osborne and David Cameron have been mates ever since their days of smashing up restaurants in the Bullingdon Club. Cameron is hardly likely to give his mate the boot, no matter how incompetently he seems to be running the economy. As long as Cameron remains leader of the Tory party, Osborne will continue to dictate his lunatic economic policies.

The final reason that the Tories will not abandon ideological austerity for rational evidence based economic policy is that they are currently comfortably achieving the principal goal of any Tory administration: Making sure the rich continue to get richer, no matter what the cost to wider society.




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