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Robert Skidelsky: The welfare state did not cause the crash. So why is Osborne cutting it?

If a government has to cut its spending, it is much better to tax the rich than starve the poor.

The Institute for Fiscal Studies (IFS) has warned that there will need to be “colossal” cuts in public spending to balance the books by 2018-19 – at least £55bn extra. On 4 December, the day after the Chancellor’s Autumn Statement, the director of the IFS, Paul Johnson, said that it wasn’t for lack of effort that the deficit hasn’t fallen. Rather, it was “because the economy performed so poorly in the first half of the parliament, hitting revenues very hard”.

Very true – but what Johnson omitted to say was that the main reason the economy performed so poorly in the first half of the parliament was because George Osborne was busy cutting the deficit. He should have been expanding it!

This is something that expert commen­tators lack the guts to say because that would brand them as Keynesians. They may admit that fiscal consolidation has made eco­nomic recovery “more challenging”. But they don’t tell us why. This theoretical gap leaves them without a reputable story of why the economy behaved so poorly. They are in familiar “blown-off-course” territory.

Every possible event that might affect growth, however fleetingly, has been summoned in aid of explaining the failure of the economy to grow: the Greek crisis, the rising price of oil, the extra bank holiday on the Queen’s Diamond ­Jubilee and the closure of shops during the London Olympics, snow and floods – everything except the real reason, which is that a deficiency of ­private ­demand was not being offset by public-­sector investment.

The latest explanation of why the Chancellor has failed to meet his deficit targets concentrates on the nature of the labour market recovery. The government has congratulated itself on the fall in unemployment. We would expect falling unemployment to increase tax revenues and reduce public spending. However, this will not happen if government policy has created lots of new, mostly low-wage jobs whose holders pay no direct taxes and that must be propped up with benefits.

The catastrophic fall in productivity that we are now seeing was planted in the two and a half years of stagnation that followed the creation of the coalition in 2010. In October 2012, the Office for Budget Responsibility found that the economy had grown by only 0.9 per cent between Q1 of 2010 and Q2 of 2012, while its June 2010 forecast was 5.7 per cent growth over the same period. Subsequent upward revision has made these figures less dire but there is no doubt that Osborne and his advisers seriously underestimated the adverse effects of austerity on investment.

As is now increasingly recognised, this extended period of stagnation reduced the long-term growth rate of the economy through the destruction of both human skills and physical capital.

Despite his warning about the size of the cuts to come, Paul Johnson said that they could be achieved. He added, however, that they would require a “reimagining” (or, put another way, shrinking) of the state. Two questions arise. First, what effect will shrinking the state have on the economy? Second, what effect will it have on the polity?

On the first, Johnson seems to assume that the economy will go on growing at about 2.5 per cent a year, even as the deficit is being cut to zero. This is highly optimistic because the cutting is simultaneously reducing private incomes. It may be possible, by sufficiently heroic austerity, for a government to keep revenues for a time running ahead of cuts but at what level of GDP will the budget eventually be balanced? Certainly lower than it would have been without the cuts.

The cuts not only change the level of GDP but also its composition and, therefore, the relations between the state and its citizens. This point is recognised by Labour, which promises “fairer” cuts. If a government has to cut its spending, it is much better to tax the rich than starve the poor. However, this is alien to the spirit of cutting. The barely subliminal message of all austerity programmes is that the deficit has been caused by spiralling welfare payments to the poor, with the object of austerity ­being to “get them on their bikes” – like in the 1930s, when unemployment was consistently around or above 10 per cent.

We urgently need to have a proper debate about the role and size of the state. Prosperity does not demand that the state should spend 40 per cent-plus of national income as it does now, though justice may.

In the old days, people used to talk of a “trade-off” between efficiency and justice and some of those arguments may still be valid, though I am less and less persuaded that the private sector scores heavily over the public sector in efficiency. A financial system that allocates capital to itself and whose crash in 2008 left the population 15 per cent poorer than it would have been is hardly an advertisement for private-sector efficiency.

What is really indefensible is to cut the state for reasons of financial dogmatism, as though the size of the state – and especially the welfare state – were the cause of the slump. We need a cool discussion on the role of the state as owner and regulator in a market economy and in the light of the civic purposes that people set for themselves. It needs to be pointed out that these huge cuts imply serious losses to the quality of government services and the strength of the defence and police services.

I’m not sure which is worse: to bleed the economy with small cuts stretching many years ahead or to cut deeply now and hope for the best. What does seem clear is that politics will not allow the second and only a ­Labour government can avert the first.

This article first appeared in the 09 December 2014 issue of the New Statesman, How Isis hijacked the revolution

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How will Theresa May meet her commitment to low-earners?

The Prime Minister will soon need to translate generalities into specifics. 

The curtailed Conservative leadership contest (which would not have finished yet) meant that Theresa May had little chance to define her agenda. But of the statements she has made since becoming prime minister, the most notable remains her commitment to lead a government "driven not by the interests of the privileged few, but by yours." 

When parliament returns on 5 September, and the autumn political season begins, May will need to translate this generality into specifics. The defining opportunity to do so will be the Autumn Statement. Originally intended by George Osborne to be a banal update of economic forecasts, this set-piece more often resembled a second Budget. Following the momentous Brexit vote, it certainly will under Philip Hammond. 

The first priority will be to demonstrate how the government will counter the threat of recession. Osborne's target of a budget surplus by 2020 has wisely been abandoned, granting the new Chancellor the freedom to invest more in infrastructure (though insiders make it clear not to expect a Keynesian splurge).

As well as stimulating growth, Hammond will need to reflect May's commitment to those "just managing" rather than the "privileged few". In her speech upon becoming prime minister, she vowed that "when it comes to taxes, we’ll prioritise not the wealthy, but you". A natural means of doing so would be to reduce VAT, which was increased to a record high of 20 per cent in 2010 and hits low-earners hardest. Others will look for the freeze on benefit increases to be lifted (with inflation forecast to rise to 3 per cent next year). May's team are keenly aware of the regressive effect of loose monetary policy (low interest rates and quantitative easing), which benefits wealthy asset-owners, and vow that those who lose out will be "compensated" elsewhere. 

A notable intervention has come from Andrew Tyrie, the Conservative chair of the Treasury select committee. He has called for the government to revive the publication of distributional analyses following Budgets and Autumn Statements, which was ended by George Osborne last year (having been introduced by the coalition in 2010). 

In a letter to Hammond, Tyrie wrote: "I would be grateful for an assurance that you will reinstate the distributional analysis of the effects of the budget and autumn statement measures on household incomes, recently and mistakenly discontinued by your predecessor." He added: "The new prime minister is committing her government to making Britain a country that works 'not for a privileged few, but for every one of us'. A high level of transparency about the effects of tax and welfare policy on households across the income distribution would seem to be a logical, perhaps essential starting point." 

Whether the government meets this demand will be an early test of how explicit it intends to be in reducing disparities. 

George Eaton is political editor of the New Statesman.