Simon Wren-Lewis: Labour Has the Better Macro Policy from 2015

by Forgot About Keynes

While many, including George Monbiot, now believe that there is little substantive difference between the major parties, the Oxford economics professor Simon Wren-Lewis argues that this is a serious misconception because, as he says, “It is quite possible that we will see very little additional fiscal tightening under Labour, and a lot more public investment.”

Labour, he says, are going along with austerity not because they believe in its efficacy but because they are under immense pressure from the media to show that they are serious about deficit reduction. Wren-Lewis coined the term mediamacro last year to describe “macroeconomics as it is portrayed in the majority of the media,” which he explains is too concerned with financial markets and their participants and:

prefers simple stories to more complex analysis. As part of this, it is fond of analogies between governments and individuals, even when those analogies are generally seen to be false by macroeconomists. So after the 2010 election (and to some extent before it) mediamacro had bought with barely a murmur the view that reducing the government deficit was the top priority.

The media’s obsession with the deficit is bizarre from the standpoint of professional economists—most of those recently surveyed by the Financial Times do not believe that the continuation of the chancellor’s current austerity plans in the next parliament is feasible or wise—because, as Wren-Lewis points out, the government’s macroeconomic priority should be the country’s stalling labour productivity.

The Conservative Party has boasted about the country’s recent employment growth as a sign of its economic competence but this is not unequivocally a good thing. Essentially, if there are more people in work but the country is producing the same level of output as before, then output per worker (labour productivity) has gone down. This is what has happened in recent years in the UK and this is why real GDP per capita still hasn’t recovered to its pre-crisis peak. According to the Bank of England:

Despite some modest improvements in 2013, whole-economy output per hour remains around 16% below the level implied by its pre-crisis trend.

If this stagnation in labour productivity continues, the long term outcome will be lower standards of living … and economists are alarmed by this prospect.

THE NEXT PARLIAMENT
Over the past year, the Conservatives have been polling steadily higher to the point that it’s now difficult to predict the outcome of the general election. A couple of years ago, Labour seemed to have it in the bag. The difference between then and now seems to be that people, on the whole, feel better about GDP. But the major difference in policy over this period has been the fact that the pace of austerity has slowed.

In its December 2014 Economic and Fiscal Outlook, the Office for Budget Responsibility shows government borrowing trending downwards. This trend, however, is predicated upon forecasts of spending cuts and increased revenues.

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Austerity, however, comes at a significant cost. As Wren-Lewis points out:

The Office for Budget Responsibility estimates, somewhat conservatively, that austerity took 1 per cent off economic growth in both 2010-11 and 2011-12. It seriously blunted the recovery.

The most likely outcome if the Conservatives stick to their proposed deficit reduction targets is that the UK’s economic growth will once again slow down. We may see a return to recession in 2016 or 2017, by which point the pace of austerity may have to be eased once again. In other words, if the Conservatives stay in power, we’re more or less going to see a re-run of their first term in government. The Financial Times puts it like this:

Of the 87 economists who answered a question on deficit reduction in the Financial Times’s annual survey of predictions for the coming year, 52 thought the next government would deviate from the current plans at some point in the next parliament. Another 12 believed the outcome would depend on the election result, while 19 thought the next government would stick to current plans.

Plans for £50bn of extra spending cuts a year were widely seen as not credible and unlikely to be achieved.

What will be different come the mid-way point in the next parliament will be the country’s reaction. People will remember that they were promised a government that would make the tough choices necessary to eliminate the deficit and pay down the country’s debts.

The OBR’s predictions of a budget surplus by the end of the next parliament are predicated on the government’s economic plan working … but the government will not be able to deliver on its pledges just as it did not in this parliament, because spending cuts alone do not reduce the need to borrow. As it stated in December 2014:

“Despite strong economic growth, the budget deficit is expected to fall by only £6.3bn this year to £91.3bn, around half the decline we expected in March. “That would be the second smallest year-on-year reduction since its peak in 2009-10, despite this being the strongest year for GDP growth.”

The government was still set to miss its target of having net debt fall as a share of GDP in 2015-16, the independent forecaster said.

Wren-Lewis believes that the penny is finally beginning to drop. The coalition government could get away with delaying the recovery until 2013 on the basis that cuts had to be made and that they would reduce the deficit … but the deficit has not been eliminated and the stock of national debt continues to pile up.

Most glaringly, a government that insisted that “we are all in this together” has proceeded to make life for the most disadvantaged even harder while reducing the top rate of tax and essentially bribing wealthy OAPs in the run-up to the election. The Taxpayers Alliance put it this way:

“[The government’s pensioner bonds are] not only taxpayer-guaranteed investments for the already relatively well-off, but leave the government borrowing at above-market rates.

“Too often during this Parliament it has seemed as if austerity stops at 65 – it’s almost as if pensioners are more likely to vote.”

Chris Giles is not normally complimentary about the Labour Party, but even he admitted recently that: 

the Tories’ plans appear ideological and border on calamitous for many public services. The opposition should be pressing this point home.

Yet for all the flaws in its analysis and the missteps in its campaign, the intriguing thing about Mr Miliband’s Labour party is that its broad economic prospectus for the 2015 general election is perfectly sensible.

There is nothing definitively profligate in seeking to eliminate the current budget deficit by 2020, and reducing public debt as a proportion of output. This implies more borrowing than the Tories propose alongside an approach to cuts in public services that is more realistic.

MEDIAMACRO
Wren-Lewis has grown increasingly frustrated at a media which is focused on the wrong indicators of performance. Instead of giving Labour credit where it is due—he says that “it is hard to find a macroeconomist who does not think Labour has the better macro policy from 2015”—even broadcasters such as Channel 4 take Ed Miliband to task for failing to mention the deficit in a speech. Meanwhile, David Cameron’s silence on the productivity gap goes virtually unnoticed.

As the challenge to austerity is mounting on the continent, the British media’s appetite for cuts is as insatiable as ever – it continues to present “reduction of the government’s budget deficit as the overriding macroeconomic priority, when in reality that policy has done and may continue to do considerable harm.”

What most frustrates the likes of Wren-Lewis and Paul Krugman is the fact that the basic issues with austerity were obvious even in 2010. The UK did not have to inflict the spending cuts on itself that it did because it was never in danger of ending up like Greece, as George Osborne warned back then. This is why at the height of the sovereign debt crisis,

interest rates on government debt in almost every advanced country outside the Eurozone fell to record lows. Paul De Grauwe of the LSE suggested a very simple explanation for this: Eurozone government debt was uniquely risky.

The US economy recovered to its pre-crisis peak a full two years before the UK did. The Obama administration, for all its faults, cut its spending by proportionately less than the coalition government did, and this made a difference. Going forward, the real terms cut in education spending pledged by Cameron earlier this month will not dent the national debt and is in fact likely to compound the stagnation in the country’s labour productivity.

The UK’s economic fortunes are currently showing an improvement because the government has recently eased up on austerity. Resuming its programme of cuts will be as predictably harmful as the cuts were in the period 2010-2012 – and the government will face the same pressures to change course that it did back then, only this time they are likely to be greater.

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