Leader: The deficit fetish is over

All of the original justifications offered for austerity have collapsed.

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In 2010, in the aftermath of the financial crisis, George Osborne heralded an “age of austerity”. The then chancellor asserted that sharp spending cuts were essential to reduce government borrowing.

From this moment onwards, the deficit defined political debate. Being willing to embrace austerity became the central test of political credibility. In the 2015 general election, Labour was denounced as profligate for refusing to match Mr Osborne’s target of a budget surplus. Though borrowing costs were at historic lows, few were prepared to make an explicit case for investment.

In the United States, too, the issue of austerity predominated. For years, congressional Republicans held President Obama hostage over the raising of the debt ceiling. The need for infrastructure investment was continually neglected by the libertarian right.

However, in just five months, the twin shocks of the EU referendum and the US presidential election have combined to end the obsession with deficits. In Britain, the new Chancellor, Philip Hammond, who delivered his first Autumn Statement as we went to press, has abandoned Mr Osborne’s surplus target. Had he not done so, the government would have been forced to impose further spending cuts and tax rises at a time of economic volatility.

Rather than pursue this path, Mr Hammond has sensibly vowed to invest billions more in infrastructure, including housing, roads, rail and flood defences. Under his predecessor, spending in this area fell from 2.8 per cent in 2009-2010 to 1.9 per cent in 2015-16: the lowest level in the G7. The UK’s abysmal productivity rate is an inevitable consequence.

In the US, Donald Trump has upended Republican orthodoxy by vowing to invest $1trn in infrastructure (double the amount promised during his campaign). The president-elect’s plan is, unsurprisingly, short on detail and partly dependent on private backers.

All of the original justifications offered for austerity have collapsed. It was claimed that spending cuts would promote growth by stimulating private investment. But “expansionary fiscal contraction” proved to be as oxymoronic as the phrase
appears. Indeed, the modest growth achieved by the UK occurred partly through the relaxation of Mr Osborne’s targets.

Others contended that government borrowing unreasonably “burdened” future generations. Yet the consequences of underinvestment – inadequate housing, transport and utilities – are graver than those of higher debt. As in the past,
the latter is best managed through sustained growth, rather than precipitous cuts.

A more active fiscal approach would reduce the strain on monetary policy, as Tony Blair notes in his interview with the New Statesman this week. Ultra-low interest rates and quantitative easing primarily benefit high earners, and risk creating unsustainable asset bubbles.

For decades, the UK has traded on its economic stability, its financial pre-eminence and its membership of the EU’s single market. But in a post-Brexit era these advantages may no longer apply. The UK has no choice but to improve its levels of productivity, research and innovation. Over time, the government should aim to meet the OECD’s target of devoting at least 3.5 per cent of GDP to infrastructure. Unlike day-to-day spending, such investment generates permanent assets that support balanced growth.

In both the US and the UK, fiscal policy continues to be skewed through a misguided focus on tax cuts. Mr Trump’s plan would gift the top 0.1 per cent of earners a tax reduction of $1.1m per capita (14 per cent of their income), compared to one of $110 for the poorest fifth (0.8 per cent of their income). Mr Hammond remains committed to increasing the higher-rate threshold to £50,000 and raising the inheritance-tax threshold to £1m (benefiting just 6 per cent of estates). Rather than being concentrated on the top, tax cuts should be aimed at the least well off. Not only would this narrow inequality, it would promote growth: the poorest are forced to spend, rather than save.

The election of Mr Trump and the UK’s vote to leave the EU were in part symptoms of economic discontent. After the longest-ever fall in living standards, it is unsurprising that political tumult has resulted. Across the developed world, populists are insurgent. If mainstream politicians are to resist them, they must prove that governments can deliver. l

This article appears in the 24 November 2016 issue of the New Statesman, Blair: out of exile