George Osborne’s big economic speech today has understandably drawn a lot of attention from economic and political commentators alike. That’s because the speech was an attempt to reframe both the economic and political debates. The reaction suggests he’s touched a nerve of those who most heavily argued against his deficit reduction plan, but equally he has come in from a fair bit of harsh criticism from my colleague Fraser Nelson over at Spectator blogs for abandoning his own fiscal framework (as I documented back during the Autumn Statement of 2011).
With these different views, the whole economic debate can be confusing to the layman. Is George Osborne really cutting deeply or not? How much do these cuts affect economic growth in the short and medium term? If you read across the wide variety of newspaper columns and took everything at face value, you’d be none the wiser.
That’s why George Osborne goes out of his way to always frame the economic debate. Today he did so in the following way: by focusing on “why GDP growth has been weaker than originally forecast” over the past three years. He was saying: ‘the OBR knew the government was going to raise taxes, cut capital spending and cut back in areas of current expenditure over the course of this Parliament. They factored this into their growth forecasts. So why has growth been so disappointing compared to what was expected?’
Rather than merely attempting to give his version of events, Osborne framed the question as having two possible answers (implicitly pinning one on the Shadow Chancellor Ed Balls and reserving one for himself).
1) “the ‘fiscalist’ story of the last three years – and it was advanced by advocates of a so-called Plan B. This argument claims that with interest rates at their lower bound, the fiscal multipliers – the impact of spending cuts and tax rises on output – have been much higher than anticipated, and the resulting impact of the consolidation on GDP growth far greater than forecast.” In other words, because of the conditions the economy faced, some believe the effects of “austerity” were much stronger on growth than expected.
2) “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.” Therefore, it has been other factors that have slowed growth.
It’s worth noting that neither of these arguments say that tax rises or spending cuts do not harm GDP growth in the short term. What this is about is an explanation for why the economy has disappointed compared to how the OBR thought it might perform.
Having painted these two distinct explanations, Osborne posits a simple and compelling question: if “austerity” was the key thing holding back the economy, then why is the economy recovering now when the government has stuck to its plans, not implemented Plan B, but instead is continuing to impose spending restraint?
Setting this up as two simple explanations was also a bit of a straw man. For example, composition matters as well. The Coalition front-loaded lots of tax rises and cuts to capital expenditure and are only from here going to focus more on current expenditure. Best practice at fiscal consolidation would suggest cutting current expenditure and welfare spending would have had less of a drag on growth over the past three years. But we are where we are. This could explain a part of why growth is picking up now compared to before, but my central view has always been much closer to the OBR explanation than the so-called “fiscalist” view. The problem for the fiscalists involved in politics is that their argument have always sounded like very crude neo-Keynesianism and they have often focused on the negative effects of cutting current expenditure. Others have been more nuanced. But it is going to be very difficult for the political actors to give a robust counter-explanation to the terms of Osborne’s question. Stephanie Flanders has set out how Ed Balls might respond , but given the extent to which many Labour representatives (more than Balls himself) have exaggerated the effects of austerity, most of those arguments would be difficult pivots.
What of Fraser Nelson’s critique that Osborne has abandoned his plans anyway? Well, it depends on what you mean by Osborne’s plan. He originally set out to eliminate the current structural deficit by the end of this Parliament and to get debt-to-GDP on a downward path by the same period. This, to my mind, was Plan A. Neither of these things will now happen. Our deficit is still extremely high and we’re borrowing much more than Osborne expected.
Yet Osborne has very much stuck to his discretionary spending plans, so it would be wrong for those who advocate more discretionary spending to claim that Osborne has done what they wanted. In fact what happened is that from Autumn Statement 2011, the OBR told him the structural problem was bigger than he first thought. He would need to cut more to stick to his Plan A. He chose not to, in the hope that the OBR would be wrong. As it stands, this means consolidation measures will need to continue until well into the next Parliament. Whether the OBR revise the potential of the economy again, we shall see in the Autumn Statement.
So why was George Osborne delivering this speech today, and with such gusto? It seems clear that he wanted to head off the new narrative Labour are trying to develop: that even though growth is returning to the economy, the government are not doing enough to raise “living standards”. Labour have been trying to disentangle the two, and have started advocating a range of actual or implied policies surrounding more government intervention to “help” families with the latter: minimum/living wages, rent controls, childcare subsidies etc etc. What Osborne was trying to do then was re-establish the link between the macroeconomic scenario and living standards: if Labour get back you would face higher taxes and interest rates. In fact, it was more subtle than that. The Chancellor was actually arguing, correctly in my view, that real living standards are ultimately determined by improvements in productivity and this requires a sound macroeconomic framework which a Labour government could risk. I’ve written before on here, for example, about how high government spending can undermine productivity. It was that sort of thing the government was alluding to.
The Chancellor was thus right to say: “you don’t solve the pressure on cost of living with simply a shopping list of interventions and government regulation” and that “Britain is poorer than it was not because government didn’t intervene enough, or rail regulation wasn’t tough enough, or rental policies weren’t fair enough.” But as Ruth Porter and I argued in a recent FT letter, there are things where government interventions that exist already drive up the cost of living, where government deregulation could help both the economy and families.
The question is: are the Conservatives, having been bold enough to call out Labour’s interventionist agenda, bold enough to be more radical on the supply-side? That’s the main negative of George Osborne’s speech. It implied: get the macro right and the economy will be fine. One of the CPS mottos used to be “monetarism is not enough”. Now you might say “macro is not enough”. There are whole areas of policy, from tax simplification, deregulation, planning reform right through to energy policy where the potential growth of the economy could be enhanced. Now the recovery seems to be getting locked in, the Conservatives need to use growth as an opportunity to lock in reform of these areas. Fix the roof as the sun is starting to shine again, some might say. And don’t agree to spending plans from your opponents out of political expedience ever again.