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.

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Arsène Wenger: how can an intelligent manager preside over such a hollowed-out team?

The Arsenal manager faces a frustrating legacy.

Sport is obviously not all about winning, but it is about justified hope. That ­distinction has provided, until recently, a serious defence of Arsène Wenger’s Act II – the losing part. Arsenal haven’t won anything big for 13 years. But they have been close enough (and this is a personal view) to sustain the experience of investing emotionally in the story. Hope turning to disappointment is fine. It’s when the hope goes, that’s the problem.

Defeat takes many forms. In both 2010 and 2011, Arsenal lost over two legs to Barcelona in the Champions League. Yet these were rich and rewarding sporting experiences. In the two London fixtures of those ties, Arsenal drew 2-2 and won 2-1 against the most dazzling team in the world. Those nights reinvigorated my pride in sport. The Emirates Stadium had the best show in town. Defeat, when it arrived in Barcelona, was softened by gratitude. We’d been entertained, more than entertained.

Arsenal’s 5-1 surrender to Bayern Munich on 15 February was very different. In this capitulation by instalments, the fascination was macabre rather than dramatic. Having long given up on discerning signs of life, we began the post-mortem mid-match. As we pored over the entrails, the curiosity lay in the extent of the malady that had brought down the body. The same question, over and over: how could such an intelligent, deep-thinking manager preside over a hollowed-out team? How could failings so obvious to outsiders, the absence of steel and resilience, evade the judgement of the boss?

There is a saying in rugby union that forwards (the hard men) determine who wins, and the backs (the glamour boys) decide by how much. Here is a footballing equivalent: midfielders define matches, attacking players adorn them and defenders get the blame. Yet Arsenal’s players as good as vacated the midfield. It is hard to judge how well Bayern’s playmakers performed because they were operating in a vacuum; it looked like a morale-boosting training-ground drill, free from the annoying presence of opponents.

I have always been suspicious of the ­default English critique which posits that mentally fragile teams can be turned around by licensed on-field violence – a good kicking, basically. Sporting “character” takes many forms; physical assertiveness is only one dimension.

Still, it remains baffling, Wenger’s blind spot. He indulges artistry, especially the mercurial Mesut Özil, beyond the point where it serves the player. Yet he won’t protect the magicians by surrounding them with effective but down-to-earth talents. It has become a diet of collapsing soufflés.

What held back Wenger from buying the linchpin midfielder he has lacked for many years? Money is only part of the explanation. All added up, Arsenal do spend: their collective wage bill is the fourth-highest in the League. But Wenger has always been reluctant to lavish cash on a single star player, let alone a steely one. Rather two nice players than one great one.

The power of habit has become debilitating. Like a wealthy but conservative shopper who keeps going back to the same clothes shop, Wenger habituates the same strata of the transfer market. When he can’t get what he needs, he’s happy to come back home with something he’s already got, ­usually an elegant midfielder, tidy passer, gets bounced in big games, prone to going missing. Another button-down blue shirt for a drawer that is well stuffed.

It is almost universally accepted that, as a business, Arsenal are England’s leading club. Where their rivals rely on bailouts from oligarchs or highly leveraged debt, Arsenal took tough choices early and now appear financially secure – helped by their manager’s ability to engineer qualification for the Champions League every season while avoiding excessive transfer costs. Does that count for anything?

After the financial crisis, I had a revealing conversation with the owner of a private bank that had sailed through the turmoil. Being cautious and Swiss, he explained, he had always kept more capital reserves than the norm. As a result, the bank had made less money in boom years. “If I’d been a normal chief executive, I’d have been fired by the board,” he said. Instead, when the economic winds turned, he was much better placed than more bullish rivals. As a competitive strategy, his winning hand was only laid bare by the arrival of harder times.

In football, however, the crash never came. We all wrote that football’s insane spending couldn’t go on but the pace has only quickened. Even the Premier League’s bosses confessed to being surprised by the last extravagant round of television deals – the cash that eventually flows into the hands of managers and then the pockets of players and their agents.

By refusing to splash out on the players he needed, whatever the cost, Wenger was hedged for a downturn that never arrived.

What an irony it would be if football’s bust comes after he has departed. Imagine the scenario. The oligarchs move on, finding fresh ways of achieving fame, respectability and the protection achieved by entering the English establishment. The clubs loaded with debt are forced to cut their spending. Arsenal, benefiting from their solid business model, sail into an outright lead, mopping up star talent and trophies all round.

It’s often said that Wenger – early to invest in data analytics and worldwide scouts; a pioneer of player fitness and lifestyle – was overtaken by imitators. There is a second dimension to the question of time and circumstance. He helped to create and build Arsenal’s off-field robustness, even though football’s crazy economics haven’t yet proved its underlying value.

If the wind turns, Arsène Wenger may face a frustrating legacy: yesterday’s man and yet twice ahead of his time. 

Ed Smith is a journalist and author, most recently of Luck. He is a former professional cricketer and played for both Middlesex and England.

This article first appeared in the 24 February 2017 issue of the New Statesman, The world after Brexit