Britain embraced austerity instead of following the advice of its own economic giants. What was David Cameron thinking?
- By Daniel AltmanDaniel Altman is the owner of North Yard Analytics LLC, a sports data consulting firm, and an adjunct associate professor of economics at New York University’s Stern School of Business.
How did Britain end up with such a terrible economic policy? The birthplace of John Maynard Keynes, John Hicks, and other economic giants was just starting to recover from the global financial crisis when its new leaders forced it back into recession with enormous cuts to the public sector. Two years into their government, the failure of the Tories and their coalition partners, the Liberal Democrats, looks like a case of overriding ideology mixed with naïve mistakes.
The British economy is the same size now, roughly speaking, as it was at the end of 2006, well before the onset of the global financial crisis. Since the most recent peak in early 2008, GDP has shrunk by about 3 percent, after adjusting for inflation.
Clearly, the United Kingdom’s problems are not all the fault of its current government, which took office in May 2010. After a promising start in economic policy — independence for the Bank of England and "golden rule" budgeting, which eliminates deficits over the economic cycle — the governments of Tony Blair and Gordon Brown lost their fiscal discipline and went along too easily as their American counterparts embraced financial deregulation instead of addressing systemic risk. Mervyn King, the governor of the Bank of England since 2003, and the Financial Services Authority, the industry’s independent regulator, must also share the blame for the UK’s travails.
Yet in the past two and a half years, the current government of Conservatives and Liberal Democrats, led by David Cameron as prime minister and George Osborne as chancellor, has chosen to inflict unnecessary economic pain on its people. The economy was on the cusp of its fifth straight quarter of growth when the government took office, but total employment had fallen for 7 of the past 10 quarters. The new government decided that the time was ripe for massive cuts to public services and employment. Over the next three years, 628,000 government jobs — about 10 percent of the entire public sector — would disappear.
As followers of the "fiscal cliff" debate in the United States surely know, a huge cut to government spending at a fragile moment in an economic recovery can risk sending a country back into recession. And indeed, this is what occurred in the UK: three straight quarters of economic shrinkage starting in 2011 and anemic growth thereafter.
How did this happen? Even in 2005, long before their alliance with the Liberal Democrats, Osborne and his cohorts in the Conservative Party were calling government spending unsustainable. As many right-leaning parties had done before them, they called for a combination of tax cuts and spending cuts that would, in theory, reduce the government’s deficits.
At the time, the Lib Dems called the Tories’ plans "flaky and unrealistic." In retrospect, the rhetoric on both sides was somewhat overblown. The UK’s overall debt in the public sector did climb over the next couple of years despite the growth of the UK economy – apparently the result of a political choice to abandon the "golden rule." But the change in debt was only slight, to 36.4 percent of GDP in the 2007-08 fiscal year from 35.1 percent two years earlier.
By the time Cameron took over in May 2010, the situation was very different. After two years of crisis, the country’s debt had shot up to 53.1 percent of GDP because of lower tax revenues, greater demand for public services, and some costly bank bailouts. The first two of these factors were to be expected in an economic downturn; the government used its ability to protect people, to the extent possible, from the full pain of recession. The third was unusual, but unlikely to recur anytime soon.
Nevertheless, the new government remained committed to the plans it had set down five years earlier, in a completely different economic situation. Rather than thinking twice about making deep cuts to the public sector while unemployment was still high, Cameron and Osborne doubled down. They had already decided that 35 percent of GDP was too high for the UK’s national debt, even though only Canada had a lower number among the G-7 economies in 2005. Naturally, debt over 50 percent of GDP made them even more determined to wield the axe.
Their main mistake, of course, was in timing. At some point, the UK would have to cut spending and reduce its debt. But 2010 was not the right time. The recovery was young and still precarious, and the increase in debt had not resulted in higher borrowing costs for the government. On the contrary, rates were lower than what they had been in 2005.
So why did this happen? Perhaps, for a start, because the leaders of the governing coalition had little training in economics. Cameron’s tutor in Oxford’s Philosophy, Politics, and Economics program was Vernon Bogdanor, an expert on British history, constitutional issues, and political systems. Osborne may have had even less exposure to the fundamentals of economic policy; his degree is in Modern History, which sounds quite recent but ends at Oxford somewhere around 1914.
In retrospect, it seems likely that the Conservative Party’s current leaders chose their economics via their politics. Their time at Oxford spanned the late 1980s and early 1990s, when Thatcherism and its laissez-faire doctrines were in full force. Embracing the party meant believing in small government and a diminished role for the state in the economy as a whole, with little consideration for the economic circumstances of the moment.
Starting in 2005, Osborne wrote repeatedly of the need to cut taxes and spending in order to compete with other advanced economies. Yet he and Cameron allowed these long-term goals to drive what should have been a short-term economic policy designed to mitigate the UK’s recession. Today, most economists accept the importance of fiscal policy as a short-term stabilizer in the economic cycle, and few would recommend the sort of fiscal austerity that Cameron and Osborne inflicted on the British people in the middle of a severe downturn. In essence, they were trying to treat a gunshot wound with diet and exercise. The patient is still waiting for intensive care.