Interview: Robert Skidelsky

As George Osborne prepares to unveil his austerity cuts, the leading economist warns that the coalit

"We're all Keynesians now" or "again" at least, came the cry last year. The phrase -- reluctantly coined in the 1960s by the free-market economist Milton Friedman, and often attributed to President Richard Nixon -- resurfaced last year as G20 leaders agreed on "fiscal stimulus" public spending measures to boost jobs and prop up the economy in response to the global banking crisis.

The Return of the Master, the title of John Maynard Keynes's prize-winning biographer Robert Skidelsky's latest work, last year triumphantly summed up the times. That was then, and this is now. Skidelsky, a cross-bench peer, is now emerging as a leading British voice in opposition to the Damascene conversion, at the eleventh hour, by the UK and many other G20 nations to starting austerity cuts this year.

Emeritus professor of political economy at Warwick University, Skidelsky spoke in the Lords Queens Speech debate, warning that £6bn of coalition government cuts this year risked counterproductively tipping the economy back into recession, and further harming the prospects for deficit reduction.

What makes him different is his independent voice. Skidelsky is championed by the shadow chancellor, Alistair Darling, who wrote to him last week to offer words of encouragement. He is friendly with the former Labour leader Neil Kinnock, his next-door neighbour in the Lords' offices of Fielden House in the shadow of the Palace of Westminster.

Yet this 71-year-old with Russian Jewish ancestry is a freethinker who took the Conservative Party whip for eight years in the 1990s. He became disillusioned by Labour in the 1970s and ripped up his party membership card in favour of the emerging Social Democratic Party in the 1980s, until its dissolution in 1992. That came a year after he was made a life peer.

He was removed as an opposition Lords front-bench Conservative spokesman ten years later by the then party leader, William Hague, for publicly opposing Nato's bombing of Yugoslavia. "I was attracted to Major's Conservatives, there was this thing of having lost one's political home all of a sudden," he says.

". . . I thought, well if I'm in the House of Lords I can't really do anything unless I attach myself to a political party. I probably attached myself to the wrong party in retrospect."

He is not alone in being a non-leftist voice against austerity cuts this year. Recent vociferous opponents of governments "folly" include the eminent economic columnists Martin Wolf of the Financial Times and Nobel Prize-winning Paul Krugman of the New York Times.

Dissenting voices couched in more diplomatic tones have been heard from the US treasury secretary Timothy Geithner, and Desmond Lachman, of the conservative think tank the American Enterprise Institute.

All believe that European governments cutting now at the same time, rather than waiting for better private-sector growth next year, will depress demand and create more unemployment, risking recession for years to come.

"Cruise missile"

In his first interview since publicly joining the cuts debate, Robert Skidelsky predicts the coalition government could U-turn within six months on its march to fiscal consolidation. He accuses it of "irresponsibly" talking down the economy, and of falsely presenting the former New Labour government as centralist and statist.

David Cameron, Nick Clegg and George Osborne should look to history, he says, including to the failed fiscal conservatism of the 1930s Conservative/Liberal coalition. Says Skidelsky: "I think partly there's some kind of intellectual theorem behind Osborne's and the Conservatives' view of the economy: which is the pre-Keynesian view that the economy would be at full employment or would get back to full employment very quickly if these [government] interferences weren't taking place.

"In fact, in 2008, he [Osborne] said that a Keynesian stimulus would be 'like a cruise missile aimed at the heart of the economy'. Well, that was just a month after the collapse of Lehman Brothers. If you believe the economy is basically right, there's no scope for stimulating it."

An intellectual thereom maybe, but does it work in practice? After all, Margaret Thatcher failed to get the public spending share of national income (GDP) below 40 per cent. Bust followed boom. To what extent does the ideology -- that if you shrink the state you can expand entrepreneurship and growth in the private sector -- match the reality?

"Well, reality always interferes with ideology," says Robert Skidelsky. "Thatcher didn't shrink the state, but she stopped its growth in its tracks. And I think reality will interfere with Osborne's plans.

"The main reality, which I think will start to kick in, is that the economy actually doesn't revive, and therefore he will have to abandon some of his cutting programme just to stop unemployment going up.

"There's a wave of austerity sweeping over, and somehow the people who hold out against it are a minority. But what we have to see is how the economy develops over the next six months.

"If, as I expect, the austerity drive will dampen the recovery and even abort it, I think then people will start to hear another song.

"It's very fickle, and if you have no view of the economy at all you're likely to be swung by every passing breeze. One day you're a cutter, the next you're not.

"At least, whatever happens, I will be able to say I was consistent. Either consistently wrong, or consistently right. But I think it's much too early to take the view you should suddenly drop your model just because there's suddenly this herd stampede towards cutting."

"Life-support system"

Yet could the coalition easily make a U-turn in six months, with the Conservatives, although not the Liberal Democrats, having a mandate for five years of hard cutting to reverse the "structural deficit" (the part of the £155bn Budget deficit, estimated at £77bn, or 5.2 per cent of GDP, by the new Office for Budget Responsibility, which is thought to be impervious to rising or falling tax receipts and growth).

"Oh yes, just like all governments do," says Skidelsky. "They'll say, 'Events, dear boy,' as Harold Macmillan used to say . . . 'Blown off course by events beyond our control.'

"The speeches are already there. They've been made hundreds of times already. Everything can be blamed on unexpected world developments.

"No one thought the Greek crisis or the eurozone crisis would bubble up a year ago. When I was writing The Return of the Master I don't think Greece was even mentioned in there. Now I've got a new paperback version, I mention Greece half a dozen times, because it just happened."

Lord Skidelsky has little doubt about the dangerous effects of withdrawing public spending with £6bn cuts this year, which he says are "just the tip of the iceberg".

"Dangerous, yes, it's costly to withdraw. It's very unfair just to inflict unemployment. It has knock-on effects because people go on the dole or their incomes are reduced, and unemployment and other benefits don't make up for full-time work. Therefore you get a downward spiral of spending, and that of course means that other jobs are lost.

"That is the effect of public spending cuts. If you're on a life-support system and you withdraw it, the whole thing grinds to a halt. And that is the huge risk. If the Keynesian model of the economy is right, that is what will happen.

"But my hunch is that the government will find some way, if unemployment does start rising very seriously. It will find some way of fudging its cuts -- either postponing them, or there are also clever and stupid ways of cutting. You can cut some programmes but expand others that might help you in the slightly longer run.

"What the government is doing is also very serious for much of the country outside the financial services sector."

Skidelsky believes the next few years could be a crucial moment in history.

He says: "I think this will be the huge test of Keynes. If, in fact, all these fiscal consolidations produce a wonderful spurt of growth, then he's wrong. Then you just have to lock him up, and his picture of the economy is wrong.

"That's if that happens. But I don't think it can. I don't see how you produce a recovery by cutting down demand everywhere. What they have to suppose is that the psychological boost to entrepreneurs of the government cutting and getting its budget more into balance will be so huge that they'll all start re-employing in people and investing."

But wouldn't credit and cash flow, with improved back-lending, need to underpin such a psychology?

"Yes, but also it depends on real things like their anticipation of orders coming through," he argues. "As someone said in the last great depression in Coventry, 'If no one's ordering cars, there's no point making them, is there?' And ordering depends on your income."

Fear of contagion

How about the role of exports in this, I ask. "Because we're not in the euro, so our currency's depreciated, that will help exports. But on the other hand, if the countries we export to are also in the doldrums, the effect of the depreciation of our currency would be less than it would have been.

"And there's another point that's one of those interminable riddles, that if in fact Osborne's cutting policy reassures the markets, then they'll want to hold sterling more, and that will drive up the exchange rate, just when you want it to go down in order to encourage exports.

"It is very similar to 1931, and again, you had an economy bill introduced that cut a lot of spending. A Labour government broke on it because it wouldn't agree to cuts on employment pay. A Liberal/Conservative coalition took over and introduced its economy bill.

"Then the deficit was about 5 per cent of GDP, not 10 per cent, because in those pre-Keynesian days they tried to keep it as small as they could. And the Budget was supposed to be balanced to save the pound. Anyway, the pound wasn't saved, then the currency fell, interest rates fell, and you had a little bit of recovery but not a very big one.

"I think 1931's a very good parallel. We didn't recover as a result of these wonderful Budget balancing policies. We didn't actually properly recover until the Second World War, when of course they abandoned all that."

Skidelsky is also critical of coalition government rhetoric about the causes and the scale of deficit reduction, not least in its comparisons to the Greek economy, now bailed out by fellow eurozone countries, which has triggered their austerity packages in a drive to save the euro. David Cameron has also blamed the Labour government for leaving a bigger mess than feared, which would "hurt every single person in the country".

The eminent economist says: "I don't think the markets really think there's a solvency problem for Britain. But you see, everyone goes on saying it, and you get a certain feeling that they think there may be some contagion from the Greek fallout and it'll spread.

"There's a lot of the banks that hold Greek government debt, and if those debts become useless you'll have these knock-on effects. That's what happened in 1931 when you had the financial crisis."

So had it almost become an ideological contagion, a contagion of fear, with no hard evidence that markets were set to take action against Britain, leading to soaring interest payments?

"There's no hard evidence, none at all," he says. "It's all in the mind. It's all, 'If you don't do this, well, there's a risk these terrible consequences will flow.'

"I think Osborne and the Conservatives were not being responsible in the last year, because they constantly put the fear of God into the markets that the Labour government was constantly extravagant, that it had lost control over the fiscal position; that unless there was an immediate reduction, people wouldn't want to borrow money, lend the British government money, that the rate of interest would go up. One fear after another, they planted.

"If your leading politicians are saying this about your own government's policy -- what I mean is, the British government's policy -- well, then they do start thinking there's something in it. I think they were not responsible, and it does raise an issue about how we conduct our politics. On these matters if you really do think you're in a hole, you should tone down your criticism."

Nor does Skidelsky subscribe to the view New Labour was statist, pointing to five years before the recession when its budgets had sustainable structural deficit levels of roughly 2 to 2.5 per cent of GDP. "It's only as a result of the recession that the deficit has grown to where it was. If we didn't have that recession, the deficit would be very small," he says.

He accepts Labour's opponents "had a case" in contesting deficit forecasts, and that these should have been up to double the size because of an unsustainable, above-trend growth path.

"The forecasts, the division of the deficit between structural and cyclical (subject to changes in tax revenue, such as from recession), are all subject to very large uncertainties, and I take the view that most of the deficit is just caused by the deterioration of the economy.

"Other people say, 'Yes but the economy had basically started to deteriorate long before the recession struck, therefore the government's actual net borrowing requirements which had averaged about 2 per cent to 2.5 per cent, should have been much larger, because the economy was on an unsustainable growth path.

"Then it suddenly shifted to 6 per cent and then it went to 7 per cent. I don't think it takes rocket science to understand that was due to the fact we were in a bloody great recession."

Sustained borrowing

The unpredictability, the argument goes, came from unsustainable revenues such as highly inflated oil prices and rising housing values, he says.

"Some of the revenues were sort of Teflon, they weren't going to stick, and therefore the deficit should have been higher in the pre-recession years, if you can just abstract from those windfalling kind of features."

Of the Conservative view on this, he says: "They have a case, but it's not a conclusive case. I mean, you never know that things are unsustainable until they stop being sustained. The American current account deficit for years everybody thought was unsustainable. It went on being sustained, and it's still being sustained. In fact, it's increased as a result of the recession, because the dollar has become the only safe haven."

Had New Labour been too centralist and statist, too much a tax-and-spend government, as its opponents successfully claimed at the election? The independent Insititute for Fiscal Studies placed the UK in 2007-2008 as a middling public spender among OECD and G20 countries. And its spending for three years pre-recession had been backed by Cameron's Conservatives.

Skidelsky replies: "No, not particularly. I mean, I think it was within self-imposed constraints. It was trying to shift spending towards the poorer sections of the community by focusing a lot of the NHS, pensions and education. But it wasn't by any means a tax-and-spend-freely government.

"On the whole, maybe Gordon Brown as chancellor lost a bit of control in the last year. There are other criticisms you can make of his chancellorship, but I don't think this was the important one: that he was spending way over limits.

"The real criticism of Brown's chancellorship was that he bought much too readily the hype of financial markets. That somehow he had confidence to plan quite large expenditures several years ahead on the assumption that nothing would go seriously wrong -- and that was what all the financial orthodoxy was telling him.

"There, I think, he should have been more sceptical. Some sort of anti-market instinct should have been working somewhere around there."

Les Reid is political correspondent of the Coventry Telegraph and a freelance contributor to the Guardian.

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?