How much does austerity hurt growth?

Paul Krugman gives a rough-and-ready model based on yesterday's Eurostat figures.

Paul Krugman uses the Eurostat figures on European debts and deficits to do a rough-and-ready calculation of the effects of austerity on GDP growth in the EU:

The measure of austerity on the graph above includes budgets reduced in real, not just nominal, terms. If GDP in a country rockets up, and the budget stays flat, Krugman attributes this to austerity in just the same way as how, in the UK, GDP has stayed flat as budgets have plummeted.

From this model, he infers that cutting budgets by 1 per cent of GDP reduces GDP by around 1.25 per cent.

There is then a feedback mechanism that kicks in (if GDP is reduced, then the deficit is reduced by less), all of which means that his model predicts that £1 of austerity reduces the deficit by £0.40.

None of this will come as a surprise to the economists working at the Office for Budget Responsibility, who have been struggling with just this effect for the last two years. A large part of the perennial downwards revisions of their predictions for GDP growth, and the upward revisions of their predictions for deficit reduction, will have been due to the stagnation in the UK economy since 2010 – stagnation which, if Krugman is to be believed, is due to the austerity the UK has experienced.

By now, at least, the OBR seem to have begun to include the correct amount of pessimism in their forecasts. The office's March 2012 prediction for the deficit (or public sector net borrowing, PSNB) for 2012/13 was spot on, at £126bn. This is a long way off the rather more optimistic prediction made following the chancellor's first budget in 2010, when the deficit was expected to be £10bn less by now. Whether the new predictions will hold we shall see, but even if they do, they require for another five years of harsh austerity to pull off.

Paul Krugman. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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David Cameron’s speech: a hymn to liberalism from a liberated PM

The Prime Minister spoke with the confidence of a man who finally has a full mandate for his approach. 

At every one of his previous nine Conservative conference speeches, David Cameron has had to confront the doubters. Those Tories who rejected his modernisation of the party from the start. Those who judged it to have failed when he fell short of a majority in 2010. Those, including many in his own party, who doubted that he could improve on this performance in 2015. Today, rather than confronting the doubters, he was able to greet the grateful. As the first majority Conservative prime minister for 18 years, he rightly savoured his moment. "Why did all the pollsters and pundits get it so wrong?" he asked. "Because, fundamentally, they didn't understand the people who make up our country. The vast majority of people aren't obsessives, arguing at the extremes of the debate. Let me put it as simply as I can: Britain and Twitter are not the same thing." Labour should pin that line to its profile. 

With a full mandate for his approach, Cameron went on to deliver his most unashamedly liberal speech to date. Early on in his address, he spoke with pride of how "social justice, equality for gay people, tackling climate change, and helping the world's poorest" were now "at the centre of the Conservative Party's mission". A lengthy section on diversity, lamenting how "people with white-sounding names are nearly twice as likely to get call backs for jobs than people with ethnic-sounding names", was greeted with a standing ovation. Proof, if needed, of how Cameron has changed his party beyond recognition. The former special adviser to Michael Howard, who avowed that "prison works", told his audience that prison too often did not. "The system is still not working ... We have got to get away from the sterile lock-em-up or let-em-out debate, and get smart about this." From now on, he declared, the system, would "treat their [prisoners'] problems, educate them, put them to work." 

There were, of course, oversights and lacuna. Cameron reaffirmed his commitment to a budget surplus but glossed over the unprecedented, and many believe undeliverable, that will be required to achieve it (and which may fail to do so). He hailed the new "national living wage" with no mention of the tax credit cuts that will leave the same "strivers" worse off. His "affordable" starter homes will be unaffordable for average-earning families in 58 per cent of local areas. But it is a mark of Cameron's political abilities that it was easy to forget much of this as he spoke. Like George Osborne, he deftly appropriated the language of the left ("social justice", "opportunity", "diversity", "equality") to describe the policies of the right. Cameron is on a mission to claim ownership of almost every concept associated with Labour. The opposition should not sleep easily as he does so. 

There was little mention of Labour in the speech, and no mention of Jeremy Corbyn by name. But when the attack came, it was ruthlessly delivered. "Thousands of words have been delivered about the new Labour leader. But you only really need to know one thing: he thinks the death of Osama bin Laden was a 'tragedy'". The description of Corbyn as the "new Labour leader" shows the Tories' ambition to permanently contaminate the party, rather than merely the man.

There are plenty of potential landmines ahead for Cameron. The comically lukewarm applause for his defence of EU membership was a reminder of how divided his party is on this issue. But today, he spoke as a man liberated. Liberated by winning a majority. Liberated by not having to fight an election again. Like a second-term US president, he was able to speak of how he was entering "the second half of my time in this job". Tributes to Osborne (the "Iron Chancellor) and Boris Johnson (greeted with a remarkable standing ovation) alluded to the contest to come. But whoever succeeds him can be confident of assuming a party in good health - and more at ease with the modern world than many ever thought possible. 

George Eaton is political editor of the New Statesman.