What Osborne won't admit: growth has increased because of slower cuts

The Chancellor's claim that "the pace of fiscal consolidation has not changed" is not supported by any of the available data.

Many others – perhaps Fraser Nelson does it best – have poked fun at the most Panglossian elements of the Chancellor’s speech on Monday. But I’d like here to address the substantive arguments he makes about what the path of the UK economy over recent years says about the impact of fiscal policy on growth.

The Chancellor doesn’t deny that growth has been much weaker than forecast, although it’s worth repeating the scale of this underperformance. In June 2010, the Office of Budget Responsibility predicted that by now the economy would be about 7 per cent larger, driven by a sharp rise in business investment and exports, while the deficit would have fallen by two-thirds. What has actually happened? In fact, GDP has grown at less than a third of that rate, business investment has fallen, and the path of deficit reduction bears no resemblance at all to the original projections (which is, as I'll elaborate below, a good thing).    

But, the Chancellor argues, this underperformance has nothing to do with fiscal policy:

the composition and timing of the slowdown in GDP growth relative to forecast is better explained by external inflation shocks, the eurozone crisis and the ongoing impact of the financial crisis on financial conditions. 

The Chancellor claimed his analysis was supported by many "independent economists" - although, oddly, he failed to mention the IMF, which has been the most prominent independent organisation to argue the contrary. Of course, the IMF and those of us who thought the fiscal consolidation plan was too aggressive never denied that these other factors played a par (and that their reversal will indeed help boost recovery).  As I put it here:

it now seems clear that the negative impact of ‘Plan A’ on growth has been significantly greater than expected, although matters have also been exacerbated by even more damaging policy mistakes in the eurozone, as well as high commodity prices.

Coincidentally, on the same day the Chancellor made his speech, other "independent economists" (Oscar Jorda and Alan Taylor) published a widely reported paper suggesting precisely the opposite (an earlier, non-technical summary is here). They find, as shown in their chart:

Without austerity, UK real output would now be steadily climbing above its 2007 peak, rather than being stuck 2% below. 

And they conclude:

Fiscal contraction prolongs the pain when the state of the economy is weak, much less so when the economy is strong....Keynes is still right, after all: “The boom, not the slump, is the right time for austerity at the Treasury.

However, despite the weight of academic research, the Chancellor goes on to claim that current developments support his interpretation of recent past history:

Proponents of the ‘fiscalist’ story cannot explain why the UK recovery has strengthened rapidly over the last six months. The pace of fiscal consolidation has not changed, government spending cuts have continued as planned, and yet growth has accelerated and many of the leading economic indicators show activity rising faster than at any time since the 1990s.

But this is an obvious sleight of hand.  The claim that "the pace of fiscal consolidation has not changed" is not supported by any of the available data. Here is the OBR’s own chart. As Robert Chote, the OBR’s Chair puts it, "deficit reduction appears to have stalled".

Indeed, the OECD, the government’s favourite of the international forecasting bodies (since, as noted above, the IMF shares my interpretation of the impact of fiscal consolidation on growth) goes even further. According to its calculations, the UK is actually expanding its structural deficit in 2013. In other words, the government is engaging in fiscal stimulus.  Personally I find this implausible - the OBR's estimate is that the structural deficit was broadly flat in 2012-13 - but the data hardly seem consistent with the Chancellor's view.

How did this happen? As I explained earlier this year:

So what's going on? As I noted earlier, most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened - between 2009-10 and 2011-12.

But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what's happened since - with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat.

So the Chancellor’s argument is simply a non sequitur, supported neither by the research evidence nor the data. 

As I wrote here at the turn of the year, we should give the government credit for not digging us further into a hole by trying to stick to its original plans. Fiscal consolidation has slowed, at least for the time being, and as a consequence it is playing a considerably smaller role in driving economic developments than it did two years ago. Meanwhile, the eurozone and global environment is, at least at present, considerably more favourable. Poor policy and bad luck has delayed recovery, relative to NIESR's original forecasts and everyone else's, but has not removed the ability of the UK economy to generate growth. 

So it is perfectly reasonable to ask economic forecasters (including both the OBR and us at NIESR) why we appear so far to have underpredicted the strength of the current upturn. But claiming that this improvement vindicates the earlier damaging mistake the government made by going for front-loaded fiscal consolidation in 2010 just doesn’t make any economic sense. 

George Osborne makes a speech on the economy at a construction site in east London. Photograph: Getty Images.

Jonathan Portes is director of the National Institute of Economic and Social Research and former chief economist at the Cabinet Office.

Alison McGovern
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Forget universal basic income - this is how we can include voters in economic growth

The links between economic growth of the country and that of the people, families and towns have broken. The state can fix them again. 

Economic policy is always boring, until it’s too late.

Pensions. How they are funded, who they cover, what happens if they fail. Boring. Until it was too late.

Mortgages. Who has them, who needs one, who should have one. Boring. Until it was too late.

Finance. Capital markets, their products, their structure, their risk profile. Boring. Until it was too late.

You see the point I’m making. It’s easy to look away from numbers. The data doesn’t necessarily tell us an obvious story. And then one day, a catalyst sparks an unforeseen, if, with hindsight, predictable event, and we all wonder why we didn’t see it coming.

Something similar happened with the Brexit vote. Of course, it was a perfect political storm: an overconfident Prime Minister calls a referendum that he only needs to have to pay off his right flank, safe in the knowledge that the mainstream voters and the leadership of the Labour party will carry him through. Except he forgets that there is someone more despised than even his right flank - him. 

But beneath all of that, the Brexit vote revealed a divided country. Between those who felt that Britain as it was before the referendum offered them a decent enough – if imperfect - future, and those who felt it offered them nothing of the sort. 

Could we have seen it coming? Perhaps we could. Take two graphs.

Real wages are still, today, on average below what they were in 2008, nearly a decade ago. At the point of the referendum, average wages were yet to return to the level they hit eight years earlier. The difference between real and nominal wages is inflation. People have watched prices steadily drift up while their wages have remained stubbornly flat. Not an overnight shock, but a long drawn out crisis all the same.

Vast numbers of pensioners (over 60 per cent of them) voted to leave the European Union, and pensioners incomes have not seen the same fall as incomes for the working age population (in fact they rose by 19 per cent in real terms in the last 10 years). But it is important not to overinterpret the data with hindsight. After all, there are nearly 32m British people of working age. That surely should have been enough to carry the vote, had far too many people had so little reason to back the status quo.

In the years running up to the crucial Brexit vote, the economy was, by and large, moving ahead. But in the case of the most crucial, most noticeable, economic transfer - a person’s wages - the economy was not moving ahead at all. In fact between the crash and the 2015 general election, wages largely only fell, and since then, pay has struggled to make up ground, against a picture of an otherwise ‘growing’ economy.

Worst of all - nearly 4m households in measurable (and therefore known) poverty include someone at work. Of the 17m Brexit voters, some were wealthy retired voters who always hated Brussels. But how many more simply had too little to lose, and couldn’t stand David Cameron?

The problem with all this though, and the reason we didn’t see it coming, is that no one’s life is a graph. I mean, we are all data points. But no one feels like a data point. And people are notoriously bad at providing logical, graph-like, mathematical reasons for their political judgements. "My individual wages have failed to keep pace with growth in the economy at large," said no person on no doorstep, ever. Unhappiness with what is on offer manifests itself in lots of different ways but it isn’t likely to be an analysis of the macro-economy.

We all know of course that people are much more likely to connect with politics (and politicians) emotionally. That is how we make our choices. But our emotions are informed by the facts of our life and are responses to the facts we see. So, whilst the graphs above cannot tell us all we need to know about why Remain lost, they do tell us about some facts likely to impact on the choices we make.

The challenge is to work out how we can change the trends shown on the graph, and how this in turn will affect those who lost out over the past decade. What can be done to repair the link between economic growth and economic growth for all?

This challenge is to create "inclusive growth". Or as I think of it, making sure there is a hard chain which links growth in the economy overall to the growth of wages and incomes of the many. When the country rises, so must all within it.

The hard links in the chain are what should have kept our country together. They are the rules that should have meant that the British economy doing better meant individuals, families, towns, cities all doing better too. You can see from the graphs above that the rules worked between 1997 and about 2005. Our country grew, and we all grew in capacity with it. But then the model stopped working. And 11 years later people were asked to vote for the status quo, even though the status quo was clearly failing the many.

We will never be able to see the trends until it is too late. We need rules that shape our markets, including the labour market, to achieve an outcome that people can see and feel in their pockets. Analysis of the past is only any good if it can help shape the future. 

It’s not enough to say that somehow our economy is rigged against people, as if this was one great fiddle. Rather, we should remember that policy choices have consequences. 

Now some people suggest that the correct response to falling wages, and precarious work, is some sort of universal benefit, or citizens’ income. But recent Fabian Society research demonstrated that the vast majority of people – about 80 per cent - feel positive about their work even despite the story told here about wages. So even if it were practical for government to raise taxes in order to transfer something in the region of the state pension to every person in our country, it hardly seems like it would be popular. 

If people, in general terms, actually like their work, the problem is then making sure they get paid enough and get promotions. It means recognising what the past decade has taught us: that the growth of the economy must mean economic growth for all within the economy, or else there will be consequences.

So, the question remains: what are the hard links in the chain between the economic growth of the country as a whole, and economic growth of the people, families and towns within it?

Unfortunately, this is where the boring stuff still matters. You can get paid more if you have better prospects. That means a buoyant labour market, and the skills to participate in it.

Now the government say that they are addressing the challenges in our economy by investing in infrastructure, through an industrial strategy. And along with buzzy new ideas like universal basic income (where citizens are guaranteed a certain income), everyone in politics loves announcing campaigns for new railway lines (me included). Trains are big, fast, expensive and showy. But travelling to work by train tends to be the preserve of those who already have a high-skilled job and are commuting some distance. We should worry a little more about those who get the bus to work.

Then take those who work in low-pay sectors like care, retail, hospitality, or construction. Each sector has its own challenges, but one thing that unites of all these sectors is the likelihood of people working in them to be working below their potential skill level. Hopefully our new metro mayors will be able to provide better education opportunities for those at or near the minimum wage. But what about in those areas without mayors? Do they fall even further behind? Skills transfers matter much more for future growth than a massive financial transfer like universal basic income.

And in case anyone should think that I have forgotten, with less than 15 per cent of people in the private sector represented by a trade union, it is little wonder that workers have insufficient power to command better wages. Our labour market leaves too many people on their own, without the strength of collective bargaining to get them a good deal.

Universal basic income fails for another crucial reason. It would fail for the same reason that tax credits were economically effective but open to political challenge. For most people, the part of government, of the state, that they wish to defend are the things they can see, they can touch, emotionally engage with. The hospital their child was born in, that cared for a sick parent, the school they went to, the park they played in with their grandchild. They prefer to earn their wages, and do a job they enjoy. Transfer payments from the state are always harder to defend, as the history books attest. 

So for me, truly inclusive growth means making the most of the institutions we already have – colleges of further education for example – and building new ones like universal quality childcare. Many members of our workforce are prevented from returning to work after the birth of a child, simply because of the cost of childcare. Universal free childcare would allow many more women to go back to work or have the time to gain more skills, should they want to. Moreover, good quality childcare would benefit all of our children by narrowing the attainment gap. These hard links in the chain - the links that ensure that growth in Britain involves economic growth of all of those people and places within it - are, in fact, the institutions of the state. 

These are the platforms Labour governments have built for ordinary people to stand on. But these are the very institutions under attack from current government policy. If we’re going to rebuild the chain, then the government must change tack. We need to develop new ideas and solutions and the all-party parliamentary group on inclusive growth can be a place to bring people together across the party divide. Theresa May has spoken about an economy that works for all. Now’s the time to protect the institutions that can deliver that economy and inclusive growth, before it is too late.

The APPG on Inclusive Growth's 'State of the Debate' event with the OECD, World Economic Forum, RSA and IPPR is on Tuesday 21st February at 6.30pm at Parliament. See www.inclusivegrowth.co.uk for full details.

Alison McGovern is Labour MP for Wirral South.