It’s easy to get frustrated when using Twitter, particularly when you see politicians being somewhat hypocritical about big issues like the economy. That’s why last night I got so annoyed with the tweet below by Rachel Reeves MP, Shadow Chief Secretary to the Treasury, who said:
“V gd piece by @jdportes on how govt only reducing deficit at pace of Darling plan & thru cutting investment not waste”.
The article she was referring to was one written by Jonathan Portes (NIESR), who had criticised the Prime Minister’s claim in the Telegraph that the deficit had been reduced by a quarter since the Coalition had got into office. The bulk of this argument went like this: Cameron is now only cutting the deficit at the same rate as Labour’s plan under Darling (a rate of cutting the PM had previously criticised), and a large part of the cuts have come from investment spending, which is nothing to be proud of. Reeves leapt on this enthusiastically, no doubt feeling vindicated at her party’s policy stance.
I see two problems with this. The first is I don’t agree with Portes’ interpretation of events – though it is a perfectly honourable position to take. The second is that Reeves’ intellectual position on this is inconsistent at best, but to any neutral observer would be interpreted as hypocritical.
Portes criticises the fact that the Prime Minister is holding up the reduction of the deficit by a quarter as a success. He compares the path of the deficit outlined by the Coalition in March 2010 to the path now and the path under the Labour plan, and says:
“two years on, what has been the result? According to the OBR's March forecast is the line in green. So the deficit is falling at almost exactly the same pace - maybe a bit slower this year and next - as was projected before any of this [the Coalition’s implemented austerity].”
This to me feels a bit like saying that someone’s new diet isn’t working because they haven’t lost any weight, whilst completely ignoring the fact they’ve got a broken leg and haven’t been able to do any exercise. Our banking system is broken. The Eurozone crisis has accentuated and shows no signs of abating. Commodity prices spiked. But these only get mentioned in passing later in the blog, even though the OBR cited the latter two as the key reasons for our continued poor economic performance. In fact, the Ernst & Young ITEM club recently put the Labour fiscal plans (with higher spending) into the Treasury model to see what would have happened under the circumstances we’d seen: the result, marginally higher growth but with significantly higher debt. Both they and the IFS analysis have shown therefore that comparing Coalition outcomes with Labour forecasts is meaningless as so many things have changed since.
Now, Portes criticised the fact that investment spending had been cut so far as nothing to be proud of in achieving a reduced deficit. In the past, I’ve also criticised the fact that the government’s deficit closure so far has come through raising taxes and reduced investment spending (you don’t have to be a Keynesian to realise this will be more harmful for growth), and stated that they should have attacked current expenditure first.
But I can see why they’ve done it this way round. First, reducing current expenditure immediately is difficult, and especially with layoffs, often entails one time redundancy costs. Second, it is easy just to turn off the taps on new infrastructure projects and change a tax rate in the Budget. Third, almost all of the cuts to capital spending were planned by Labour anyway!
This is what makes Reeves’ position so hypocritical - to criticise the PM for meeting a target roughly equivalent to what her party wanted to achieve, ignoring all global developments since, and criticise it on the basis of inherited investment cuts that her party had set out. Perhaps we shouldn’t be surprised from a party who brought us the Golden Rule, obfuscated billions of pounds worth of spending off balance sheet, who’s approach to public sector remuneration and pensions left large pensions deficits and unfunded liabilities, one whose adoption of the Working Time Directive and other measures greatly increased the costs of delivery of important public services, and one which left a host of anti-enterprise taxes to pay for huge hikes in public expenditure during the so-called ‘boom’ years. But, still, it sticks in the throat a bit.
Jonathan Portes' blog should make clear - as the IFS have shown - that even if you think we should spend more now, this would come at the cost of a higher deficit and debt burden than without that additional spending in the short-term. As I pointed out in this piece for the Commentator, stimulus spending would require a multiplier of around 2.7 to be self-financing now, a number which even the most ardent Neo-Keynesians would find unbelievable, particularly since there is a) little evidence it’s above 1, b) where they tried stimulus in the US, it didn’t have anywhere near as beneficial effects on output and employment as predicted by the multiplier value of 1.6 used in the modelling. Two conclusions stem from this: first, if the Government wanted to stick to its original deficit targets, the answer is to now cut more, not less. Second, the claim made by some Labour MPs that the Coalition have ‘made the deficit worse’ is factually wrong, and intellectually bankrupt.
Now, this isn’t to say that we shouldn’t debate the fiscal plan. Some, like Portes, think we should use low interest rates to borrow more now to try to stimulate employment (I would question whether interest rates would stay the same with significant stimulus). My point is that this case would be much more honest if the Labour MPs who espouse it just said that they would be willing to borrow more, and admitted the deficit would come down more slowly under them in this Parliament.
Portes rightly pointed out to me that the effect of fiscal contraction on the path of debt in the longer term is more ambiguous. Delong and Summers (advocates of stimulus) recently produced a paper showing that under certain conditions where fiscal contraction leads to significant hysteresis effects on unemployment, in the long-term debt might follow a higher path than otherwise would be the case. This is based on highly debateable assumptions on multipliers and hysteresis.
Nevertheless, I think this still misses the point of the Government’s justification of the fiscal package. The Government’s view coming into office was clearly that they thought the deficit was unsustainable and debt too high, and so they wanted to implement a credible plan to eliminate the structural deficit and get debt on the downward path by the end of the Parliament. Anyone who reads Osborne’s speeches can see he has been heavily influenced by the work of Rogoff, Rogoff and Reinhart, who believe that there are large overhang effects when public debt exceeds >90% of GDP. Despite the early rhetoric, I’d suggest this influences the Government’s thinking much more than the thought that the Government was ever under immediate threat from the bond markets (which would have surely led to deeper, front loaded spending cuts). As such I’d imagine that even if Delong and Summers are right (a huge if), Osborne would still prefer to stem the increase in debt now and get it falling, even if this meant a slightly higher debt one day at a lower level in the future than the counterfactual. This also results in another payoff - I doubt that it’s beyond the realms of possibility that markets are more likely to view more sympathetically governments with immediate plans to get deficits down than those promising to do it over a much longer period. And the Government have at least, unlike their predecessors, made some significant efforts to undertake other structural reforms - reviewing big ticket items like public sector pensions and the retirement age, which will really help to reduce the future debt burden.
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