The nature of UK austerity

by on October 25, 2012 at 1:15 am in Current Affairs, Economics, Uncategorized | Permalink

Veronique de Rugy sums up many points I continue to be thinking:

When I looked at the data back in June, we saw that of the roughly £40 billion that was shaved from the deficit during the 2010–2011 budget cycle, for every £3 of new tax revenue, U.K. taxpayers got £1 in cuts — exactly the reverse of what was promised.

What’s more, the evidence indicates that U.K. has, at best, slowed down the growth of spending, but it has not engaged in actual spending cuts. I documented the trend in British spending earlier this year:

A look at the data in Her Majesty’s Fiscal Year 2012 Budget shows (see table 2.3) that total managed expenditures will increase from £696.4 billion in 2011–2012 to £733.5 billion in 2014–2015, and further to £756.3 billion in 2016–2017. Adjusted for population growth, this is slow growth, but not a savage cut. That table also shows a “projected” drop in Public Sector Gross Investment between 2012–2013, but if it ever materializes, it will be contained to that year alone.

Spending cuts in the UK can’t be blamed for the weak growth path the country is on. On the other hand, tax increases can. Here is a list:

(For more, go here.) The bottom line is that the U.K. is another case of private-sector austerity (i.e., tax hikes) without public-sector austerity (i.e., spending cuts).

For more detail, here is a new and very good paper by Anthony Evans.  Here are some interesting remarks from Nicholas Crafts.

James B October 25, 2012 at 3:25 am

You are ignoring the politics: even if spending cuts aren’t actually as savage as promised, we’re all being told they are. Because most hear and believe this, we act (or rather pursue inactivity) as if austerity were happening. This, more than minor tax adjustments, is the root cause of the state of the economy.

John Thacker October 25, 2012 at 3:43 am

I don’t think I would blame Krugman and other fiscal stimulus advocates for the slowdown due to their exaggeration like you. Perhaps I am wrong.

a October 25, 2012 at 10:01 am

Sorry do you mean that the confidence fairy exists?

John Thacker October 25, 2012 at 3:49 am

This issue of the ratio being reverse of what is promised is the reason why no Republican raised their hand about a similar bargain. Republicans feel that every time, a deal is sold as X dollars of cuts to 1 dollar of tax increases, but the tax increases are immediate, the spending cuts in the future, and the cuts don’t happen as promised. At best, the rate of increase is slowed and the end result is even by that benchmark many more tax increases than spending cuts.

This is the GOP narrative. It is what they and Reagan said happened with a similar bargain then, and in other times. They don’t trust such grand bargains, and Woodward’s recent book suggest that they are right to expect Obama and others to alter the terms of any deal.

Rich Berger October 25, 2012 at 7:52 am

Sometimes the truth is too plain to be seen.

a October 25, 2012 at 10:00 am

Sorry, so do you mean to say that the confidence fairy exists?

a October 25, 2012 at 10:01 am

Sorry, that comment was put in the wrong thread.

Nyongesa October 26, 2012 at 3:42 am

There’s more than a whiff of bad breath in Republican complaints that bait and switch tactics are employed against them, particularly when it comes to rastling that great beast of public self-delusion, the desire for lower taxes AND more services.

The point of a “grand” bargain is that both sides need to gore a sacred ox or two, simply to signal they are serious about a legitimate intent to honest bargaining. As anyone who has been involved in arbitrating complex disputes will say, 90% of the work is in the “mix”, the final process. As much as transparency is the hallmark of modernity, arguably allot of good public policy emanated out of smoky backrooms.

Jeff Johnson October 27, 2012 at 2:13 pm

Who is it that made a big stink about wanting spending cuts, got our AAA rating downgraded in the process, and then started squirming and whining over the sequester and the fiscal cliff? Right. That blushing in your cheeks will abate. No harm done by a little look in the mirror.

Rob L October 25, 2012 at 4:18 am

They have taken three lessons from the Thatcher administration in the early 1980s:

1. It’s easier to cut capital than current spending (and that’s where the main spending cuts have come).

2. It’s easier to raise indirect rather than direct taxes.

3. You should exaggerate how ‘tough’ you are because Tory voters like that kind of thing.

Unfortunately, neither David Cameron nor George Osborne have Mrs Thatcher’s political nous.

UKGB October 25, 2012 at 6:01 am

Tyler, this is a bit misrepresentative. A teeny bit disappointing.

There have also been tax cuts – such as to corporation tax, and a really expensive raising of the Income Tax Threshold taking several millions at the bottom end out of paying tax altogether.

Tax as a proportion of GDP is staying at 36% across the period, even though GDP growth is weak.

The bonus tax IS one-off. The bank levy is counter-weighted by the corporation tax cut the banks get – and it is a rational response to the risk banks put on the national balance sheet (see the 2010 IMF work).

As for spending continuing ever higher, this is also misleading. Strip out debt interest and the natural demographic effects, and you have an underlying hit to real spending of 15-20% over five years. What the UK calls DEL spending (departmental rather than demand-driven benefits etc) is steady in cash terms from 2010 to 2017, which if you look at real deflators (read Brian Reading’s A Blunt Axe) is a huge real terms hit. Capital spending is 20% down in nominal terms, an even larger hit.

The deficit cutting for which the UK takes credit is a. a big hit to capital spending and b. a rise in consumption taxes. I am amazed that you are linking to such a misleading piece of work.

Tyler Cowen October 25, 2012 at 7:27 am
Andrew October 25, 2012 at 7:55 am

I don’t think the commenter is off-base UKGB at all.

You use PSNI. It is a national accounts measure (it’s a flow number, PSND is the stock) governed by international accounting conventions. It can be affected by a range of issues, especially classification of entities to the public sector. Reclassifying entities from public to private sector changes PSNI significantly (e.g. free schools? PFI? etc), and does not necessarily reflect the underlying economic reality.

Commenter UKGB refers to departmental DEL. This is a much better specific measure for actual public spending (and makes up part of PSNI). Capital DEL has been cut significantly in most departments, far more than current spending.

Brian Donohue October 25, 2012 at 8:49 am

‘Strip out debt interest and the natural demographic effects’.

Yeah, I don’t really think this way of thinking will be helpful to Europe’s long-term future.

It seems to me that ‘austerity’, at some point, is less a policy option and more a Mack truck barreling toward you.

In the context of constraints imposed by public sector finance, the UK, it seems to me, is not doing much in the way of ‘voluntary austerity’, except for the VAT increase, which Tyler (correctly IMO) identifies as the biggest culprit.

The tax cuts you cite run against the austerity thesis, but I agree with your point that Tyler overstates the private/public austerity sharing ratio.

Boonton October 25, 2012 at 10:22 am

Tax as a proportion of GDP is staying at 36% across the period, even though GDP growth is weak

So here’s a story. Imagine you have a country where GDP is 100B and unemployment insurance is 5B per year with 5% unemployment. A recession hits and the gov’t tries austerity. They cut unemployment benefits in half. But the unemployment rate doubles to 15%. Because the # of people collecting tripled, the country is now paying $7.5B in unemployment which causes austerity supporters to cry ‘what austerity?! we increased the unemployment payments by a whopping 50%!’

Now let’s just say the recession has caused GDP to fall to 90B. With unemployment payments running $7.5B unemployment is now 8.3% of GDP whereas before it was only 5% of GDP….again causing the austerity hypers to claim that no real austerity has happened despite the fact that anyone collecting unemployment can see clear as day that the monthly payment has been cut in half!

Now real numbers, in the US federal taxes were running about 18% of GDP and then dropped to maybe 16% with the coming recession. To hold taxes at the same level of GDP means essentially tax increases.

ZLD October 25, 2012 at 6:07 am

Lets imagine (stylized) Government spending is £100, and makes up 50% of GDP (easy numbers). If government spending rises to £101, then that adds 0.5% to GDP for the year.

If a countries trend growth is, say, 2%, and 1% of that growth comes from the government then thinking about the above you can immediately see that:
1) A freeze in REAL Government spending creates a 1% p/a drag on growth. Even if the private sector keeps on chugging, economic growth will drop from 2% pa/ to 1% p/a
2) Provided inflation is positive, you can have a rise in nominal government expenditure that still creates a drag on REAL economic growth.

For reference, in the UK the trend contribution from the government to REAL economic growth has been 0.4% per annum. The numbers you cite correspond to a NOMINAL growth of 1.7% per annum, which (given RPI of 2.8% over the period) would be negative growth of -1% per annum. So at the very minimum, the change in expenditure will take 0.5% off annual GDP for the next 5 years.

I don’t think your argument holds water, when put in the proper context.

UKGB October 25, 2012 at 6:37 am

… and while I am ranting, there has already been over 500,000 public sector jobs losses – from a payroll of around 6.0m – a case of unanticipated front loading in that area …

a October 25, 2012 at 9:57 am

But unemployment had a blip up and has now come back almost to the 2,5 M number. If the 500k has really been lost already, then it seems to have been absorbed by the private sector..

Hoover October 25, 2012 at 11:48 am

500,000?

Last time I looked, admittedly in about April, it was at 70,000.

UKGB October 29, 2012 at 3:25 am
JJ October 25, 2012 at 7:23 am

The data in the Tullett Prebon database show that the assertion that “U.K. has, at best, slowed down the growth of spending, but it has not engaged in actual spending cuts” is not correct. Public spending has been cut, even if you do not take population growth into account.

(http://www.tullettprebon.com/strategyinsights/UK_Economic_and_Fiscal_Database.aspx)

Orange14 October 25, 2012 at 7:35 am

A very one sided interpretation of the data that runs counter to what Martin Wolf and Simon Wren Lewis have written about over the past 18 months. Somebody has to be wrong here and I doubt that it is these two.

Jon Rodney October 25, 2012 at 9:36 am

When we’re trying to assess whether fiscal policy is hurting growth, isn’t the rate of spending growth alone rather uninformative? Don’t we need to compare spending growth with *expectations* of spending growth prior to the new policies? If expectations of government spending growth have gone down, we must expect that to impact growth in a depressed economy, even if the new rate of growth is still positive.

UKGB October 25, 2012 at 9:49 am

Andrew, thanks for that clarification.

Tyler, I love your blog so don’t intend to be rude.

But the fall in public investment here can’t really be denied. Capital programmes have been cut – the schools building programmes, for example. Contractors tell us all the time that outside of London, nothing is happening. And therefore look at the Construction data as a component of GDP, which is down 10% in a year. You can build this up from micro-interviews: the same contractors say “the public side has shrivelled up”. The multiplier feels fairly clear to them.

The DEL figures really can’t be denied. Because the UK has such a centralised state it is quite straightforward therefore to see the overall state picture. Just go to the OBR’s Fiscal outlook (I am looking at November 2011, Table 4.18).

There are some MPs here who deny that there is any austerity taking place, but they tend not to be from the most intellectual side. In the meantime none of them – including even here – really have a decent answer to why, if there is no austerity, construction has collapsed and 500k fewer public sector workers in employment. Sometimes the simple answer – the one you can find in the OBR’s published reports – is actually the right one …

UKGB October 25, 2012 at 9:54 am

In the meantime if you really are as balanced as those loving your blog hope you are, you may find http://blogs.lse.ac.uk/politicsandpolicy/2012/09/27/plan-a-blunt-axe-blind-axeman/ a more detailed piece of work – if you can persuade Lombard St to get you a copy. They are excellent.

Don’t worry, this is not another person saying “Krugman is Right” over 40 pages, I can see how that is driving some on the other side of the argument practically mad …

Donald Pretari October 25, 2012 at 10:37 am

I don’t think we’re all on the same page. Some of us believe it is a bad idea to raise taxes during an Economic Downturn. One consequence of this is that the Debt/Deficit will grow. The people who want to Increase Taxes are those who are more concerned about the Debt/Deficit. They think that showing resolve in dealing with the Debt/Deficit will speed up growth.

The next issue is the Composition of Govt Spending. Austerity, in my view, means Cutting Benefits to your citizens in order to pay more in Reducing the Debt. Some of us believe that, in the Shorter Run, it’s better to get money in the hands of citizens to spend, Invest in Infrastructure, and give Incentives for Hiring and Investment, etc. The question concerns whether the UK is more concerned with Cutting the Debt/Deficit or Increasing Demand through a Short Term Increase in the Debt/Deficit.

Or maybe I’m wrong about all this.

nemi October 25, 2012 at 11:05 am

“What’s more, the evidence indicates that U.K. has, at best, slowed down the growth of spending, but it has not engaged in actual spending cuts.”

Irrelevant. The relevant question is whether it is higher or lower than people expected.
Why do people get this with respect to monetary, but not fiscal, policy?

Go Kings, Go! October 25, 2012 at 1:29 pm

So “austerity” isn’t a thing, it’s a state of mind? I feel poorer, therefore I am austere?

j b October 25, 2012 at 11:23 am

Cutting the growth of spending *is* cutting spending, if you consider the proper counterfactual, and comparing the spending aggregates to tax rates is just bad empirics.

UKGB October 25, 2012 at 11:32 am

I think nemi and John Rodney make an excellent point about expectations, counterfactuals and so forth. I think to understand how demand has fallen you need to look at the combined effect of harsh forward statements about what WILL happen to government spending vs what had been expecting, and the BOE reinforcing this by saying “it’s all very difficult, nothing I can do, take your tough medicine” (read the incomparable Britmouse on uneconomical).

All in all, I find Tyler channelling “no spending cuts what are you talking about” stuff doesn’t help, analytically.

Andreas Moser October 25, 2012 at 1:45 pm

I have always wondered what the whining in the UK about the alleged “drastic budget cuts” is all about: http://andreasmoser.wordpress.com/2010/11/15/uk-budget-what-cuts/ The UK government still runs a huge deficit.

Benny Lava October 25, 2012 at 7:05 pm

Are these figures in nominal or real pounds?

Also, why did you delete my previous post?

Michael October 26, 2012 at 12:56 am

I was wondering that too. One would have to factor in inflation as well as population growth. And then there’s the issue of whether or not one should consider the size of the economy as a whole. Maybe talking about Gov’t spending as a percentage of GDP is a better metric. After all, a lot of the budget talks we’re having in the US are framed that way. Romney and Ryan often talk not in actual dollars but gov’t spending should be X% of GDP, defense should be Y% of GDP, etc.

In fact, the same document she references does just that. If you look at the numbers, it’s pretty clear why. It doesn’t fit her narrative. (nor do the numbers for 2012-2013, which you should notice she also omits).

Benny Lava October 26, 2012 at 8:43 am

Good point, though if British GDP is shrinking then the debt to GDP ratio will grow without spending increases. I seem to recall De Rugy omitting data that didn’t fit the narrative last time she wrote about “austerity”. This seems to be a trend.

FE October 25, 2012 at 7:40 pm

If a simple question like “Has the UK cut spending?” is subject to endless controversy, maybe we should consider shutting down the field of economics.

Michael October 26, 2012 at 12:45 am

Let’s review her numbers from table 2.3 just like she says to:

2011-2012: £696.4 billion
2013-2014: £733.5 billion

She seems to have skipped a year: 2012-2013. I wonder why she did that? Let’s add it back in and see if we can figure it out:

2011-2012: £696.4 billion
2012-2013: £683.4 billion

Hmmm….

Nylund October 26, 2012 at 1:31 am

I noticed that as well.

Referring to Table 2.3:

In 2011-2012, it lists £696.4 billion. For the current year, 2012-2013, it lists £683.4 billion. 683 < 696, isn't it? Why did she skip the current fiscal year that shows a lower spending number if we're debating whether or not current spending is lower?

The footnote mentions something about postal pensions for that year, resulting in a big negative number in one of the columns, so maybe you can't take that spending cut at face value. Maybe her point still stands. I just find it very odd.

Benny Lava October 26, 2012 at 8:40 am

Good catch!

Sector watcher October 26, 2012 at 3:37 am

How about weak finance and housing sectors and their associated income/spend whcih were bloated prior and are a reason why v difficult for GDP to approach prior “trend”. Its not even digging a little deep in the stats!!

MB194 November 4, 2012 at 3:58 am

Good article, I find it interesting that no one has mentioned UK total employment though which is already above its pre crisis peak.

“, construction has collapsed and 500k fewer public sector workers in employment. Sometimes the simple answer – the one you can find in the OBR’s published reports – is actually the right one …

It is also interesting that despite employment being above its pre crisis peak a huge movement (500k+) of labour from the public to private sector productivity is meant to have fallen. 2012 has apparently seen all time record employment growth whilst the economy shrank fromQ3 2011 to Q2 2012.

The ONS construction series (and post 2008 national accounts team) are not producing credible data. I would suggest having a look at this

http://www.theconstructionindex.co.uk/news/view/balfour-beatty-extends-its-lead-in-2012-top-100-rankings

Is it really plausible that the construction sector is shrinking 20% y/y? Perhaps the ONS should update who they send the survey to?

Oh and the pensions info can be found here:
http://www.telegraph.co.uk/finance/budget/9158721/Budget-2012-28bn-of-Royal-Mail-pension-assets-to-pay-down-national-debt.html

Nominal spending is rising every year, the £28bn Royal Mail pension transfer is distorting the 2013 spending figures I think.

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